ABSTRACT
Easily the greatest source of the demise of the classical theory of interest (explained in Chapter 4) is Keynes’s attack on it in the General Theory. Instead of the supply and demand for “capital” or savings explanation, Keynes offered the cash-or liquidity-preference theory, which he regarded to be his principal or novel contribution to economics (1937b:249, 250). Keynes came to this conclusion on two main grounds. First, he misinterpreted “capital” in the classical theory to mean capital goods. Second, he adopted a definition of saving that practically means only the hoarding of cash. The latter definition prevented Keynes from accepting his critics’ claim that his liquidity-preference theory was simply an elaboration of the neoclassical loanable-funds supply and demand theory of interest, mostly argued by Dennis Robertson. The loanable-funds theory recognizes savings as the principal source of funds besides a central bank, while Keynes’s definition of saving to mean or include the hoarding of cash places saving on the side of the demand for liquidity (cash). Rather, according to Keynes, a central bank supplies the liquidity, with the commercial banks somewhat playing a supporting role with their lending activities. These two bases of Keynes’s reading of the classical theory of interest in the works of contemporary writers rendered the theory invalid for him. By their failure to focus especially on Keynes’s misinterpretation of “capital” in the classical theory, his contemporary critics, including R.G.Hawtrey, Roy Harrod, A.C.Pigou, Bertil Ohlin, Dennis Robertson, Frank Knight, and Jacob Viner were unable to convince him of his errors of interpretation. This chapter elaborates.
