II
ThefollowingfromhisPrinciplesofPoliticalEconomyp。511
putsthesubstanceofRicardo'stheoryoftherateofinterest:
'TheinterestofmoneyisnotregulatedbytherateatwhichtheBankwilllend，whetheritbe5，3or2percent。，butbytherateofprofitwhichcanbemadebytheemploymentofcapital，andwhichistotallyindependentofthequantityorofthevalueofmoney。WhethertheBanklentonemillion，tenmillions，orahundredmillions，theywouldnotpermanentlyalterthemarketrateofinterest；theywouldalteronlythevalueofthemoneywhichtheythusissued。Inonecase，tenortwentytimesmoremoneymightberequiredtocarryonthesamebusinessthanwhatmightberequiredintheother。TheapplicationstotheBankformoney，then，dependonthecomparisonbetweentherateofprofitsthatmaybemadebytheemploymentofit，andtherateatwhichtheyarewillingtolendit。Iftheychargelessthanthemarketrateofinterest，thereisnoamountofmoneywhichtheymightnotlend；¾；iftheychargemorethanthatrate，nonebutspendthriftsandprodigalswouldbefoundtoborrowofthem。'
Thisissoclear-cutthatitaffordsabetterstarting-pointforadiscussionthanthephrasesoflaterwriterswho，withoutreallydepartingfromtheessenceoftheRicardiandoctrine，areneverthelesssufficientlyuncomfortableaboutittoseekrefugeinhaziness。Theaboveis，ofcourse，asalwayswithRicardo，tobeinterpretedasalong-perioddoctrine，withtheemphasisontheword'permanently'half-waythroughthepassage；anditisinterestingtoconsidertheassumptionsrequiredtovalidateit。
[Page191]APPENDIX
TOCHAPTER14
Onceagaintheassumptionrequiredistheusualclassicalassumption，thatthereisalwaysfullemployment；sothat，assumingnochangeinthesupplycurveoflabourintermsofproduct，thereisonlyonepossiblelevelofemploymentinlong-periodequilibrium。Onthisassumptionwiththeusualceterisparibus，i。e。nochangeinpsychologicalpropensitiesandexpectationsotherthanthosearisingoutofachangeinthequantityofmoney，theRicardiantheoryisvalid，inthesensethatonthesesuppositionsthereisonlyonerateofinterestwhichwillbecompatiblewithfullemploymentinthelongperiod。Ricardoandhissuccessorsoverlookthefactthateveninthelongperiodthevolumeofemploymentisnotnecessarilyfullbutiscapableofvarying，andthattoeverybankingpolicytherecorrespondsadifferentlong-periodlevelofemployment；sothatthereareanumberofpositionsoflong-periodequilibriumcorrespondingtodifferentconceivableinterestpoliciesonthepartofthemonetaryauthority。
IfRicardohadbeencontenttopresenthisargumentsolelyasapplyingtoanygivenquantityofmoneycreatedbythemonetaryauthority，itwouldstillhavebeencorrectontheassumptionofflexiblemoney-wages。If，thatistosay，Ricardohadarguedthatitwouldmakenopermanentalterationtotherateofinterestwhetherthequantityofmoneywasfixedbythemonetaryauthorityattenmillionsoratahundredmillions，hisconclusionwouldhold。Butifbythepolicyofthemonetaryauthoritywemeanthetermsonwhichitwillincreaseordecreasethequantityofmoney，i。e。
therateofinterestatwhichitwill，eitherbyachangeinthevolumeofdiscountsorbyopen-marketoperations，increaseordecreaseitsassets¾；whichiswhatRicardoexpresslydoesmeanintheabovequotation¾；thenitisnotthecaseeitherthatthepolicyofthemonetaryauthorityisnugatoryorthatonlyonepolicyiscompatiblewithlong-periodequilibrium；
thoughintheextremecasewheremoney-wagesareassumedtofallwithoutlimitinfaceofinvoluntaryunemploymentthroughafutilecompetitionforemploymentbetweentheunemployedlabourers，therewill，itistrue，beonlytwopossiblelong-periodpositions¾；fullemploymentandthelevelofemploymentcorrespondingtotherateofinterestatwhichliquidity-preferencebecomesabsoluteintheeventofthisbeinglessthanfullemployment。Assumingflexiblemoney-wages，thequantityofmoneyassuchis，indeed，nugatoryinthelongperiod；butthetermsonwhichthemonetaryauthoritywillchangethequantityofmoneyentersasarealdeterminantintotheeconomicscheme。
[Page192]THE
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ItisworthaddingthattheconcludingsentencesofthequotationsuggestthatRicardowasoverlookingthepossiblechangesinthemarginalefficiencyofcapitalaccordingtotheamountinvested。Butthisagaincanbeinterpretedasanotherexampleofhisgreaterinternalconsistencycomparedwithhissuccessors。Forifthequantityofemploymentandthepsychologicalpropensitiesofthecommunityaretakenasgiven，thereisinfactonlyonepossiblerateofaccumulationofcapitaland，consequently，onlyonepossiblevalueforthemarginalefficiencyofcapital。Ricardooffersusthesupremeintellectualachievement，unattainablebyweakerspirits，ofadoptingahypotheticalworldremotefromexperienceasthoughitweretheworldofexperienceandthenlivinginitconsistently。Withmostofhissuccessorscommonsensecannothelpbreakingin¾；withinjurytotheirlogicalconsistency。
III
ApeculiartheoryoftherateofinteresthasbeenpropoundedbyProfessorvonMisesandadoptedfromhimbyProfessorHayekandalso，Ithink，byProfessorRobbins；namely，thatchangesintherateofinterestcanbeidentifiedwithchangesintherelativepricelevelsofconsumption-goodsandcapital-goods。[112]Itisnotclearhowthisconclusionisreached。
Buttheargumentseemstorunasfollows。Byasomewhatdrasticsimplificationthemarginalefficiencyofcapitalistakenasmeasuredbytheratioofthesupplypriceofnewconsumers'goodstothesupplypriceofnewproducers'
goods。[113]Thisisthenidentifiedwiththerateofinterest。Thefactiscalledtonoticethatafallintherateofinterestisfavourabletoinvestment。Ergo，afallintheratioofthepriceofconsumers'
goodstothepriceofproducer'sgoodsisfavourabletoinvestment。
Bythismeansalinkisestablishedbetweentncreasedsavingbyanindividualandincreasedaggregateinvestment。Foritiscommongoundthatincreasedindividualsavingwillcauseafallinthepriceofconsumers'goods，and，quitepossibly，a[Page193]APPENDIX
TOCHAPTER14
greaterfallthaninthepriceofproducers'goods；hence，accordingtotheabovereasoning，itmeansareductionintherateofinterestwhichwillstimulateinvestment。But，ofcourse，aloweringofthemarginalefficiencyofparticularcapitalassets，andhencealoweringofthescheduleofthemarginalefficiencyofcapitalingeneral，hasexactlytheoppositeeffecttowhattheaboveargumentassumes。Forinvestmentisstimulatedeitherbyaraisingofthescheduleofthemarginalefficiencyorbyaloweringoftherateofinterest。Asaresultofconfusingthemarginalefficiencyofcapitalwiththerateofinterest，ProfessorvonMisesandhisdiscipleshavegottheirconclusionsexactlythewrongwayround。A
goodexampleofaconfusionalongtheselinesisgivenbythefollowingpassagebyProfessorAlvinHansen:[114]'Ithasbeensuggestedbysomeeconomiststhattheneteffectofreducedspendingwillbealowerpricelevelofconsumers'goodsthanwouldotherwisehavebeenthecase，andthat，inconsequence，thestimulustoinvestmentinfixedcapitalwouldtherebytendtobeminimised。Thisviewis，however，incorrectandisbasedonaconfusionoftheeffectoncapitalformationofihigherorlowerpricesofconsumers'goods，and2achangeintherateofinterest。Itistruethatinconsequenceofthedecreasedspendingandincreasedsaving，consumers'priceswouldbelowrelativetothepricesofproducers'goods。
Butthis，ineffect，meansalowerrateofinterest，andalowerrateofintereststimulatesanexpansionofcapitalinvestmentinfieldswhichathigherrateswouldbeunprofitable。'IncentivestoLiquidity[Page194]
Chapter15
THEPSYCHOLOGICALANDBUSINESS
INCENTIVESTOLIQUIDITY
I
Wemustnowdevelopinmoredetailtheanalysisofthemotivestoliquidity-preferencewhichwereintroducedinapreliminarywayinchapter13。Thesubjectissubstantiallythesameasthatwhichhasbeensometimesdiscussedundertheheadingofthedemandformoney。Itisalsocloselyconnectedwithwhatiscalledtheincome-velocityofmoney；¾；fortheincome-velocityofmoneymerelymeasureswhatproportionoftheirincomesthepublicchoosestoholdincash，sothatanincreasedincome-velocityofmoneymaybeasymptomofadecreasedliquidity-preference。Itisnotthesamething，however，sinceitisinrespectofhisstockofaccumulatedsavings，ratherthanofhisincome，thattheindividualcanexercisehischoicebetweenliquidityandilliquidity。And，anyhow，theterm'income-velocityofmoney'carrieswithitthemisleadingsuggestionofapresumptioninfavourofthedemandformoneyasawholebeingproportional，orhavingsomedeterminaterelation，toincome，whereasthispresumptionshouldapply，asweshallsee，onlytoaportionofthepublic'scashholdings；
withtheresultthatitoverlooksthepartplayedbytherateofinterest。
InmyTreatiseonMoneyIstudiedthetotaldemandformoneyundertheheadingsofincome-deposits，[Page195]INCENTIVES
TOLIQUIDITY
business-deposits，andsavings-deposits，andIneednotrepeatheretheanalysiswhichIgaveinchapter3ofthatbook。Moneyheldforeachofthethreepurposesforms，nevertheless，asinglepool，whichtheholderisundernonecessitytosegregateintothreewater-tightcompartments；
fortheyneednotbesharplydividedeveninhisownmind，andthesamesumcanbeheldprimarilyforonepurposeandsecondarilyforanother。
Thuswecan¾；equallywell，and，perhaps，better¾；considertheindividual'saggregatedemandformoneyingivencircumstancesasasingledecision，thoughthecompositeresultofanumberofdifferentmotives。
Inanalysingthemotives，however，itisstillconvenienttoclassifythemundercertainheadings，thefirstofwhichbroadlycorrespondstotheformerclassificationofincome-depositsandbusiness-deposits，andthetwolattertothatofsavings-deposits。TheseIhavebrieflyintroducedinchapter13undertheheadingsofthetransactions-motive，whichcanbefurtherclassifiedastheincome-motiveandthebusiness-motive，theprecautionary-motiveandthespeculative-motive。
iTheIncome-motive。Onereasonforholdingcashistobridgetheintervalbetweenthereceiptofincomeanditsdisbursement。
Thestrengthofthismotiveininducingadecisiontoholdagivenaggregateofcashwillchieflydependontheamountofincomeandthenormallengthoftheintervalbetweenitsreceiptanditsdisbursement。Itisinthisconnectionthattheconceptoftheincome-velocityofmoneyisstrictlyappropriate。
iiTheBusiness-motive。Similarly，cashisheldtobridgetheintervalbetweenthetimeofincurringbusinesscostsandthatofthereceiptofthesale-proceeds；cashheldbydealerstobridgetheintervalbetweenpurchaseandrealisationbeingincludedunderthisheading。Thestrengthofthisdemandwillchieflydependonthevalueofcurrentoutputandhenceon[Page196]THE
GENERALTHEORYOFEMPLOYMENT
currentincome，andonthenumberofhandsthroughwhichoutputpasses。
iiiThePrecautionary-motive。Toprovideforcontingenciesrequiringsuddenexpenditureandforunforeseenopportunitiesofadvantageouspurchases，andalsotoholdanassetofwhichthevalueisfixedintermsofmoneytomeetasubsequentliabilityfixedintermsofmoney，arefurthermotivesforholdingcash。
Thestrengthofallthesethreetypesofmotivewillpartlydependonthecheapnessandthereliabilityofmethodsofobtainingcash，whenitisrequired，bysomeformoftemporaryborrowing，inparticularbyoverdraftoritsequivalent。Forthereisnonecessitytoholdidlecashtobridgeoverintervalsifitcanbeobtainedwithoutdifficultyatthemomentwhenitisactuallyrequired。Theirstrengthwillalsodependonwhatwemaytermtherelativecostofholdingcash。Ifthecashcanonlyberetainedbyforgoingthepurchaseofaprofitableasset，thisincreasesthecostandthusweakensthemotivetowardsholdingagivenamountofcash。Ifdepositinterestisearnedorifbankchargesareavoidedbyholdingcash，thisdecreasesthecostandstrengthensthemotive。Itmaybe，however，thatthisislikelytobeaminorfactorexceptwherelargechangesinthecostofholdingcashareinquestion。
ivThereremainstheSpeculative-motive。Thisneedsamoredetailedexaminationthantheothers，bothbecauseitislesswellunderstoodandbecauseitisparticularlyimportantintransmittingtheeffectsofachangeinthequantityofmoney。
Innormalcircumstancestheamountofmoneyrequiredtosatisfythetransactions-motiveandtheprecautionary-motiveismainlyaresultantofthegeneralactivityoftheeconomicsystemandofthelevelofmoney-income。
Butitisbyplayingonthespeculative-motivethatmonetarymanagementor，intheabsenceofmanagement，chancechangesinthequantityofmoney
isbroughttobearontheeconomic[Page197]INCENTIVES
TOLIQUIDITY
system。Forthedemandformoneytosatisfytheformermotivesisgenerallyirresponsivetoanyinfluenceexcepttheactualoccurrenceofachangeinthegeneraleconomicactivityandthelevelofincomes；whereasexperienceindicatesthattheaggregatedemandformoneytosatisfythespeculative-motiveusuallyshowsacontinuousresponsetogradualchangesintherateofinterest，i。e。thereisacontinuouscurverelatingchangesinthedemandformoneytosatisfythespeculativemotiveandchangesintherateofinterestasgivenbychangesinthepricesofbondsanddebtsofvariousmaturities。
Indeed，ifthiswerenotso，'openmarketoperations'wouldbeimpracticable。
Ihavesaidthatexperienceindicatesthecontinuousrelationshipstatedabove，becauseinnormalcircumstancesthebankingsystemisinfactalwaysabletopurchaseorsellbondsinexchangeforcashbybiddingthepriceofbondsupordowninthemarketbyamodestamount；andthelargerthequantityofcashwhichtheyseektocreateorcancelbypurchasingorsellingbondsanddebts，thegreatermustbethefallorriseintherateofinterest。Where，however，asintheUnitedStates，1933-1934
open-marketoperationshavebeenlimitedtothepurchaseofveryshort-datedsecurities，theeffectmay，ofcourse，bemainlyconfinedtotheveryshort-termrateofinterestandhavebutlittlereactiononthemuchmoreimportantlong-termratesofinterest。
Indealingwiththespeculative-motiveitis，however，importanttodistinguishbetweenthechangesintherateofinterestwhichareduetochangesinthesupplyofmoneyavailabletosatisfythespeculative-motive，withouttherehavingbeenanychangeintheliquidityfunction，andthosewhichareprimarilyduetochangesinexpectationaffectingtheliquidityfunctionitself。Open-marketOperationsmay，indeed，influencetherateofinterestthroughbothchannels；sincetheymaynotonlychangethevolumeof[Page198]THE
GENERALTHEORYOFEMPLOYMENT
money，butmayalsogiverisetochangedexpectationsconcerningthefuturepolicyofthecentralbankorofthegovernment。Changesintheliquidityfunctionitself；duetoachangeinthenewswhichcausesrevisionofexpectations，willoftenbediscontinuous，andwill，therefore，giverisetoacorrespondingdiscontinuityofchangeintherateofinterest。
Only，indeed，insofarasthechangeinthenewsisdifferentlyinterpretedbydifferentindividualsoraffectsindividuallnterestsdifferentlywillthereberoomforanyincreasedactivityofdealinginthebondmarket。
Ifthechangeinthenewsaffectsthejudgmentandtherequirementsofeveryoneinpreciselythesameway，therateofinterestasindicatedbythepricesofbondsanddebtswillbeadjustedforthwithtothenewsituationwithoutanymarkettransactionsbeingnecessary。
Thus，inthesimplestcase，whereeveryoneissimilarandsimilarlyplaced，achangeincircumstancesorexpectationswillnotbecapableofcausinganydisplacementofmoneywhatever；¾；itwillsimplychangetherateofinterestinwhateverdegreeisnecessarytooffsetthedesireofeachindividual，feltatthepreviousrate，tochangehisholdingofcashinresponsetothenewcircumstancesorexpectations；
and，sinceeveryonewillchangehisideasastotheratewhichwouldinducehimtoalterhisholdingsofcashinthesamedegree，notransactionswillresult。Toeachsetofcircumstancesandexpectationstherewillcorrespondanappropriaterateofinterest，andtherewillneverbeanyquestionofanyonechanginghisusualholdingsofcash。
Ingeneral，however，achangeincircumstancesorexpectationswillcausesomerealignmentinindividualholdingsofmoney；¾；since，infact，achangewillinfluencetheideasofdifferentindividualsdifferentlybyreasonspartlyofdifferencesinenvironmentandthereasonforwhichmoneyisheldandpartlyofdifferencesinknowledgeandinterpretationofthe[Page199]INCENTIVES
TOLIQUIDITY
newsituation。Thusthenewequilibriumrateofinterestwillbeassociatedwitharedistributionofmoney-holdings。Neverthelessitisthechangeintherateofinterest，ratherthantheredistributionofcash，whichdeservesourmainattention。Thelatterisincidentaltoindividualdifferences，whereastheessentialphenomenonisthatwhichoccursinthesimplestcase。
Moreover，eveninthegeneralcase，theshiftintherateofinterestisusuallythemostprominentpartofthereactiontoachangeinthenews。
Themovementinbond-pricesis，asthenewspapersareaccustomedtosay，'outofallproportiontotheactivityofdealing'；¾；whichisasitshouldbe，inviewofindividualsbeingmuchmoresimilarthantheyaredissimilarintheirreactiontonews。
II
Whilsttheamountofcashwhichanindividualdecidestoholdtosatisfythetransactions-motiveandtheprecautionary-motiveisnotentirelyindependentofwhatheisholdingtosatisfythespeculative-motive，itisasafefirstapproximationtoregardtheamountsofthesetwosetsofcash-holdingsasbeinglargelyindependentofoneanother。Letus，therefore，forthepurposesofourfurtheranalysis，breakupourprobleminthisway。Lettheamountofcashheldtosatisfythetransactions-andprecautionary-motivesbeM1，andtheamountheldtosatisfythespeculative-motivebeM2。Correspondingtothesetwocompartmentsofcash，wethenhavetwoliquidityfunctionsL1andL2。L1mainlydependsonthelevelofincome，whilstL2mainlydependsontherelationbetweenthecurrentrateofinterestandthestateofexpectation。ThusM=M1M2
=L1YL2r，whereL1istheliquidityfunctioncorrespondingto[Page200]THE
GENERALTHEORYOFEMPLOYMENT
anincomeY，whichdeterminesM1，andL2istheliquidityfunctionoftherateofinterestr，whichdeterminesM2。Itfollowsthattherearethreematterstoinvestigate:
itherelationofchangesinMtoYandr，ii
whatdeterminestheshapeofL1，iiiwhatdeterminestheshapeofL2。
iTherelationofchangesinMtoYandrdepends，inthefirstinstance，onthewayinwhichchangesinMcomeabout。SupposethatMconsistsofgoldcoinsandthatchangesinMcanonlyresultfromincreasedreturnstotheactivitiesofgold-minerswhobelongtotheeconomicsystemunderexamination。InthiscasechangesinMare，inthefirstinstance，directlyassociatedwithchangesinY，sincethenewgoldaccruesassomeone'sincome。
ExactlythesameconditionsholdifchangesinMareduetothegovernmentprintingmoneywherewithtomeetitscurrentexpenditure；¾；inthiscasealsothenewmoneyaccruesassomeone'sincome。Thenewlevelofincome，however，willnotcontinuesufficientlyhighfortherequirementsofM1toabsorbthewholeoftheincreaseinM；
andsomeportionofthemoneywillseekanoutletinbuyingsecuritiesorotherassetsuntilrhasfallensoastobringaboutanincreaseinthemagnitudeofM2andatthesametimetostimulateariseinYtosuchanextentthatthenewmoneyisabsorbedeitherinM2orintheM1whichcorrespondstotheriseinYcausedbythefallinr。Thusatoneremovethiscasecomestothesamethingasthealternativecase，wherethenewmoneycanonlybeissuedinthefirstinstancebyarelaxationoftheconditionsofcreditbythebankingsystem，soastoinducesomeonetosellthebanksadebtorabondinexchangeforthenewcash。
Itwill，therefore，besafeforustotakethelattercaseastypical。
AchangeinMcanbeassumedtooperatebychangingr，andachangeinrwillleadtoanewequilibriumpartlybychangingM2andpartly[Page201]INCENTIVES
TOLIQUIDITY
bychangingYandthereforeM1。ThedivisionoftheincrementofcashbetweenM1andM2inthenewpositionofequilibriumwilldependontheresponsesofinvestmenttoareductionintherateofinterestandofincometoanincreaseininvestment。[115]SinceYpartlydependsonr，itfollowsthatagivenchangeinMhastocauseasufficientchangeinrfortheresultantchangesinM1andM2respectivelytoadduptothegivenchangeinM。
iiItisnotalwaysmadeclearwhethertheincome-velocityofmoneyisdefinedastheratioofYtoMorastheratioofYtoM1。Ipropose，however，totakeitinthelattersense。ThusifVistheincome-velocityofmoney，Y
L1Y=¾；¾；
=M1。
VThereis，ofcourse，noreasonforsupposingthatVisconstant。
Itsvaluewilldependonthecharacterofbankingandindustrialorganisation，onsocialhabits，onthedistributionofincomebetweendifferentclassesandontheeffectivecostofholdingidlecash。Nevertheless，ifwehaveashortperiodoftimeinviewandcansafelyassumenomaterialchangeinanyofthesefactors，wecantreatVasnearlyenoughconstant。
iiiFinallythereisthequestionoftherelationbetweenM2andr。Wehaveseeninchapter13thatuncertaintyastothefuturecourseoftherateofinterestisthesoleintelligibleexplanationofthetypeofliquidity-preferenceL2whichleadstotheholdingofcashM2。ItfollowsthatagivenM2willnothaveadefinitequantitativerelationtoagivenrateofinterestofr；¾；whatmattersisnottheabsolutelevelofrbutthedegreeofitsdivergencefromwhatisconsideredafairlysafelevelofr，havingregardtothosecalculationsofprobabilitywhicharebeingreliedon。Nevertheless，therearetworeasonsforexpectingthat，in[Page202]THE
GENERALTHEORYOFEMPLOYMENT
anygivenstateofexpectation，afallinrwillbeassociatedwithanincreaseinM2。Inthefirstplace，ifthegeneralviewastowhatisasafelevelofrisunchanged，everyfallinrreducesthemarketraterelativelytothe'safe'rateandthereforeincreasestheriskofilliquidity；and，inthesecondplace，everyfallinrreducesthecurrentearningsfromilliquidity，whichareavailableasasortofinsurancepremiumtooffsettheriskoflossoncapitalaccount，byanamountequaltothedifferencebetweenthesquaresoftheoldrateofinterestandthenew。Forexample，iftherateofinterestonalong-termdebtis4percent，itispreferabletosacrificeliquidityunlessonabalanceofprobabilitiesitisfearedthatthelong-termrateofinterestmayrisefasterthanby4percentofitselfperannum，i。e。
byanamountgreaterthan0。16percentperannum。If，however，therateofinterestisalreadyaslowas2percent，therunningyieldwillonlyoffsetariseinitofaslittleas0。04percentperannum。This，indeed，isperhapsthechiefobstacletoafallintherateofinteresttoaverylowlevel。Unlessreasonsarebelievedtoexistwhyfutureexperiencewillbeverydifferentfrompastexperience，along-termrateofinterestofsay2percentleavesmoretofearthantohope，andoffers，atthesametime，arunningyieldwhichisonlysufficienttooffsetaverysmallmeasureoffear。
Itisevident，then，thattherateofinterestisahighlypsychologicalphenomenon。Weshallfind，indeed，inBookVthatitcannotbeinequilibriumatalevelbelowtheratewhichcorrespondstofullemployment；
becauseatsuchalevelastateoftrueinflationwillbeproduced，withtheresultthatM1willabsorbever-increasingquantitiesofcash。Butatalevelabovetheratewhichcorrespondstofullemployment，thelong-termmarket-rateofinterestwilldepend，notonlyonthecurrentpolicyofthemonetaryauthority，butalsoonmarketexpectationsconcerningitsfuturepolicy。The[Page203]INCENTIVES
TOLIQUIDITY
short-termrateofinterestiseasilycontrolledbythemonetaryauthority，bothbecauseitisnotdifficulttoproduceaconvictionthatitspolicywillnotgreatlychangeintheverynearfuture，andalsobecausethepossiblelossissmallcomparedwiththerunningyieldunlessitisapproachingvanishingpoint。Butthelong-termratemaybemorerecalcitrantwhenonceithasfallentoalevelwhich，onthebasisofpastexperienceandpresentexpectationsoffuturemonetarypolicy，isconsidered'unsafe'
byrepresentativeopinion。Forexample，inacountrylinkedtoaninternationalgoldstandard，arateofinterestlowerthanprevailselsewherewillbeviewedwithajustifiablelackofconfidence；yetadomesticrateofinterestdraggeduptoaparitywiththehighestratehighestafterallowingforriskprevailinginanycountrybelongingtotheinternationalsystemmaybemuchhigherthanisconsistentwithdomesticfullemployment。
Thusamonetarypolicywhichstrikespublicopinionasbeingexperimentalincharacteroreasilyliabletochangemayfailinitsobjectiveofgreatlyreducingthelong-termrateofinterest，becauseM2maytendtoincreasealmostwithoutlimitinresponsetoareductionofrbelowacertainfigure。Thesamepolicy，ontheotherhand，mayproveeasilysuccessfulifitappealstopublicopinionasbeingreasonableandpracticableandinthepublicinterest，rootedinstrongconviction，andpromotedbyanauthorityunlikelytobesuperseded。
Itmightbemoreaccurate，perhaps，tosaythattherateofinterestisahighlyconventional，ratherthanahighlypsychological，phenomenon。
Foritsactualvalueislargelygovernedbytheprevailingviewastowhatitsvalueisexpectedtobe。Anylevelofinterestwhichisacceptedwithsufficientconvictionaslikelytobedurablewillbedurable；subject，ofcourse，inachangingsocietytofluctuationsforallkindsofreasonsroundtheexpectednormal。Inparticular，whenM1
[Page204]THE
GENERALTHEORYOFEMPLOYMENT
isincreasingfasterthanM，therateofinterestwillrise，andviceversa。Butitmayfluctuatefordecadesaboutalevelwhichischronicallytoohighforfullemployment；¾；particularlyifitistheprevailingopinionthattherateofinterestisself-adjusting，sothatthelevelestablishedbyconventionisthoughttoberootedinobjectivegroundsmuchstrongerthanconvention，thefailureofemploymenttoattainanoptimumlevelbeinginnowayassociated，inthemindseitherofthepublicorofauthority，withtheprevalenceofaninappropriaterangeofratesofinterest。
Thedifficultiesinthewayofmaintainingeffectivedemandatalevelhighenoughtoprovidefullemployment，whichensuefromtheassociationofaconventionalandfairlystablelong-termrateofinterestwithafickleandhighlyunstablemarginalefficiencyofcapital，shouldbe，bynow，obvioustothereader。
Suchcomfortaswecanfairlytakefrommoreencouragingreflectionsmustbedrawnfromthehopethat，preciselybecausetheconventionisnotrootedinsecureknowledge，itwillnotbealwaysundulyresistanttoamodestmeasureofpersistenceandconsistencyofpurposebythemonetaryauthority。Publicopinioncanbefairlyrapidlyaccustomedtoamodestfallintherateofinterestandtheconventionalexpectationofthefuturemaybemodifiedaccordingly；thuspreparingthewayforafurthermovement¾；uptoapoint。Thefallinthelong-termrateofinterestinGreatBritainafterherdeparturefromthegoldstandardprovidesaninterestingexampleofthis；¾；themajormovementswereeffectedbyaseriesofdiscontinuousjumps，astheliquidityfunctionofthepublic，havingbecomeaccustomedtoeachsuccessivereduction，becamereadytorespondtosomenewincentiveinthenewsorinthepolicyoftheauthorities。
[Page205]INCENTIVES
TOLIQUIDITY
III
Wecansumuptheaboveinthepropositionthatinanygivenstateofexpectationthereisinthemindsofthepublicacertainpotentialitytowardsholdingcashbeyondwhatisrequiredbythetransactions-motiveortheprecautionary-motive，whichwillrealiseitselfinactualcash-holdingsinadegreewhichdependsonthetermsonwhichthemonetaryauthorityiswillingtocreatecash。ItisthispotentialitywhichissummedupintheliquidityfunctionL2。Correspondingtothequantityofmoneycreatedbythemonetaryauthority，therewill，therefore，becet。
par。adetermlnaterateofinterestor，morestrictly，adeterminatecomplexofratesofinterestfordebtsofdifferentmaturities。Thesamething，however，wouldbetrueofanyotherfactorintheeconomicsystemtakenseparately。Thusthisparticularanalysiswillonlybeusefulandsignificantinsofarasthereissomespeciallydirectorpurposiveconnectionbetweenchangesinthequantityofmoneyandchangesintherateofinterest。
Ourreasonforsupposingthatthereissuchaspecialconnectionarisesfromthefactthat，broadlyspeaking，thebankingsystemandthemonetaryauthorityaredealersinmoneyanddebtsandnotinassetsorconsumables。
Ifthemonetaryauthoritywerepreparedtodealbothwaysonspecifiedtermsindebtsofallmaturities，andevenmoresoifitwerepreparedtodealindebtsofvaryingdegreesofrisk，therelationshipbetweenthecomplexofratesofinterestandthequantityofmoneywouldbedirect。
Thecomplexofratesofinterestwouldsimplybeanexpressionofthetermsonwhichthebankingsystemispreparedtoacquireorpartwithdebts；
andthequantityofmoneywouldbetheamountwhichcanfindahomeinthepossessionofindividualswho¾；aftertakingaccountofallrelevantcircumstances¾；preferthecontrolofliquidcashtopartingwithit[Page206]THE
GENERALTHEORYOFEMPLOYMENT
inexchangeforadebtonthetermsindicatedbythemarketrateofinterest。Perhapsacomplexofferbythecentralbanktobuyandsellatstatedpricesgilt-edgedbondsofallmaturities，inplaceofthesinglebankrateforshort-termbills，isthemostimportantpracticalimprovementwhichcanbemadeinthetechniqueofmonetarymanagement。
To-day，however，inactualpractice，theextenttowhichthepriceofdebtsasfixedbythebankingsystemis'effective'inthemarket，inthesensethatitgovernstheactualmarket-price，variesindifferentsystems。
Sometimesthepriceismoreeffectiveinonedirectionthanintheother；
thatistosay，thebankingsystemmayundertaketopurchasedebtsatacertainpricebutnotnecessarilytosellthematafigurenearenoughtoitsbuying-pricetorepresentnomorethanadealer'sturn，thoughthereisnoreasonwhythepriceshouldnotbemadeeffectivebothwayswiththeaidofopen-marketoperations。Thereisalsothemoreimportantqualificationwhicharisesoutofthemonetaryauthoritynotbeing，asarule，anequallywillingdealerindebtsofallmaturities。Themonetaryauthorityoftentendsinpracticetoconcentrateuponshort-termdebtsandtoleavethepriceoflong-termdebtstobeinfluencedbybelatedandimperfectreactionsfromthepriceofshort-termdebts；¾；thoughhereagainthereisnoreasonwhytheyneeddoso。Wherethesequalificationsoperate，thedirectnessoftherelationbetweentherateofinterestandthequantityofmoneyiscorrespondinglymodified。InGreatBritainthefieldofdeliberatecontrolappearstobewidening。Butinapplyingthistheoryinanyparticularcaseallowancemustbemadeforthespecialcharacteristicsofthemethodactuallyemployedbythemonetaryauthority。Ifthemonetaryauthoritydealsonlyinshort-termdebts，wehavetoconsiderwhatinfluencetheprice，actualandprospective，ofshort-termdebtsexercisesondebtsoflongermaturity。
[Page207]INCENTIVES
TOLIQUIDITY
Thustherearecertainlimitationsontheabilityofthemonetaryauthoritytoestablishanygivencomplexofratesofinterestfordebtsofdifferenttermsandrisks，whichcanbesummedupasfollows:
1Therearethoselimitationswhichariseoutofthemonetaryauthority'sownpracticesinlimitingitswillingnesstodealtodebtsofaparticulartype。
2Thereisthepossibility，forthereasonsdiscussedabove，that，aftertherateofinteresthasfallentoacertainlevel，liquidity-preferencemaybecomevirtuallyabsoluteinthesensethatalmosteveryonepreferscashtoholdingadebtwhichyieldssolowarateofinterest。Inthiseventthemonetaryauthoritywouldhavelosteffectivecontrolovertherateofinterest。Butwhilstthislimitingcasemightbecomepracticallyimportantinfuture，Iknowofnoexampleofithitherto。Indeed，owingtotheunwillingnessofmostmonetaryauthoritiestodealboldlyindebtsoflongterm，therehasnotbeenmuchopportunityforatest。Moreover，ifsuchasituationweretoarise，itwouldmeanthatthepublicauthorityitselfcouldborrowthroughthebankingsystemonanunlimitedscaleatanominalrateofinterest。
3Themoststrikingexamplesofacompletebreakdownofstabilityintherateofinterest，duetotheliquidityfunctionflatteningoutinonedirectionortheother，haveoccurredinveryabnormalcircumstances。
InRussiaandCentralEuropeafterthewaracurrencycrisisorflightfromthecurrencywasexperienced，whennoonecouldbeinducedtoretainholdingseitherofmoneyorofdebtsonanytermswhatever，andevenahighandrisingrateofinterestwasunabletokeeppacewiththemarginalefficiencyofcapitalespeciallyofstocksofliquidgoodsundertheinfluenceoftheexpectationofanevergreaterfallinthevalueofmoney；
whilstintheUnitedStatesatcertaindatesin1932therewasacrisisoftheoppositekind¾；afinancialcrisisorcrisisofliquidation，when[Page208]THE
GENERALTHEORYOFEMPLOYMENT
scarcelyanyonecouldbeinducedtopartwithholdingsofmoneyonanyreasonableterms。
4Thereis，finally，thedifficultydiscussedinsectionIV
ofchapter11，p。144，inthewayofbringingtheeffectiverateofinterestbelowacertainfigure，whichmayproveimportantinaneraoflowinterest-rates；
namelytheintermediatecostsofbringingtheborrowerandtheultimatelendertogether，andtheallowanceforrisk，especiallyformoralrisk，whichthelenderrequiresoverandabovethepurerateofinterest。Asthepurerateofinterestdeclinesitdoesnotfollowthattheallowancesforexpenseandriskdeclineparipassu。Thustherateofinterestwhichthetypicalborrowerhastopaymaydeclinemoreslowlythanthepurerateofinterest，andmaybeincapableofbeingbrought，bythemethodsoftheexistingbankingandfinancialorganisation，belowacertainminimumfigure。Thisisparticularlyimportantiftheestimationofmoralriskisappreciable。Forwheretheriskisduetodoubtinthemindofthelenderconcerningthehonestyoftheborrower，thereisnothinginthemindofaborrowerwhodoesnotintendtobedishonesttooffsettheresultanthighercharge。Itisalsoimportantinthecaseofshort-termloanse。g。
bankloanswheretheexpensesareheavy；¾；abankmayhavetochargeitscustomers1½；to2percent。，evenifthepurerateofinteresttothelenderisnil。
IV
Atthecostofanticipatingwhatismoreproperlythesubjectofchapter21belowitmaybeinterestingbrieflyatthisstagetoindicatetherelationshipoftheabovetothequantitytheoryofmoney。
Inastaticsocietyorinasocietyinwhichforanyotherreasonnoonefeelsanyuncertaintyaboutthefutureratesofinterest，theliquidityfunctionL2，orthepropensitytohoardaswemighttermit，will[Page209]INCENTIVES
TOLIQUIDITY
alwaysbezeroinequilibrium。HenceinequilibriumM2=0andM=M1；sothatanychangeinMwillcausetherateofinteresttofluctuateuntilincomereachesalevelatwhichthechangeinM1isequaltothesupposedchangeinM。NowM1V=Y，whereVistheincome-velocityofmoneyasdefinedaboveandYistheaggregateincome。Thusifitispracticabletomeasurethequantity，O，andtheprice，P，ofcurrentoutput，wehaveY
=OP，and，therefore，MV=OP；whichismuchthesameasthequantitytheoryofmoneyinitstraditionalform。
[116]
Forthepurposesoftherealworlditisagreatfaultinthequantitytheorythatitdoesnotdistinguishbetweenchangesinpriceswhichareafunctionofchangesinoutput，andthosewhichareafunctionofchangesinthewage-unit。[117]Theexplanationofthisomissionis，perhaps，tobefoundintheassumptionsthatthereisnopropensitytohoardandthatthereisalwaysfullemployment。Forinthiscase，ObeingconstantandM2beingzero，itfollows，ifwecantakeValsoasconstant，thatboththewage-unitandtheprice-levelwillbedirectlyproportionaltothequantityofmoney。
ObservationsonNatureofCapital[Page210]
Chapter16
SUNDRYOBSERVATIONSONTHE
NATUREOFCAPITAL
I
Anactofindividualsavingmeans¾；sotospeak¾；adecisionnottohavedinnerto-day。Butitdoesnotnecessitateadecisiontohavedinnerortobuyapairofbootsaweekhenceorayearhenceortoconsumeanyspecifiedthingatanyspecifieddate。Thusitdepressesthebusinessofpreparingto-day'sdinnerwithoutstimulatingthebusinessofmakingreadyforsomefutureactofconsumption。Itisnotasubstitutionoffutureconsumption-demandforpresentconsumption-demand，¾；itisanetdiminutionofsuchdemand。Moreover，theexpectationoffutureconsumptionissolargelybasedoncurrentexperienceofpresentconsumptionthatareductioninthelatterislikelytodepresstheformer，withtheresultthattheactofsavingwillnotmerelydepressthepriceofconsumption-goodsandleavethemarginalefficiencyofexistingcapitalunaffected，butmayactuallytendtodepressthelatteralso。Inthiseventitmayreducepresentinvestment-demandaswellaspresentconsumption-demand。
Ifsavingconsistednotmerelyinabstainingfrompresentconsumptionbutinplacingsimultaneouslyaspecificorderforfutureconsumption，theeffectmightindeedbedifferent。Forinthatcasetheexpectationofsomefutureyieldfrominvestmentwouldbeimproved，andtheresourcesreleasedfrompreparingforpresent[Page211]OBSERVATIONS
ONNATUREOFCAPITAL
consumptioncouldbeturnedovertopreparingforthefutureconsumption。
Notthattheynecessarilywouldbe，eveninthiscase，onascaleequaltotheamountofresourcesreleased；sincethedesiredintervalofdelaymightrequireamethodofproductionsoinconveniently'roundabout'
astohaveanefficiencywellbelowthecurrentrateofinterest，withtheresultthatthefavourableeffectonemploymentoftheforwardorderforconsumptionwouldeventuatenotatoncebutatsomesubsequentdate，sothattheimmediateeffectofthesavingwouldstillbeadversetoemployment。Inanycase，however，anindividualdecisiontosavedoesnot，inactualfact，involvetheplacingofanyspecificforwardorderforconsumption，butmerelythecancellationofapresentorder。Thus，sincetheexpectationofconsumptionistheonlyraisond'ê；treofemployment，thereshouldbenothingparadoxicalintheconclusionthatadiminishedpropensitytoconsumehascet。par。adepressingeffectonemployment。
Thetroublearises，therefore，becausetheactofsavingimplies，notasubstitutionforpresentconsumptionofsomespecificadditionalconsumptionwhichrequiresforitspreparationjustasmuchimmediateeconomicactivityaswouldhavebeenrequiredbypresentconsumptionequalinvaluetothesumsaved，butadesirefor'wealth'assuch，thatisforapotentialityofconsuminganunspecifiedarticleatanunspecifiedtime。Theabsurd，thoughalmostuniversal，ideathatanactofindividualsavingisjustasgoodforeffectivedemandasanactofindividualconsumption，hasbeenfosteredbythefallacy，muchmorespeciousthantheconclusionderivedfromit，thatanincreaseddesiretoholdwealth，beingmuchthesamethingasanincreaseddesiretoholdinvestments，must，byincreasingthedemandforinvestments，provideastimulustotheirproduction；sothatcurrentinvestmentispromotedbyindividualsavingtothesameextentaspresentconsumptionisdiminished。
[Page212]THE
GENERALTHEORYOFEMPLOYMENT
Itisofthisfallacythatitismostdifficulttodisabusemen'sminds。
Itcomesfrombelievingthattheownerofwealthdesiresacapital-assetassuch，whereaswhathereallydesiresisitsprospectiveyield。
Now，prospectiveyieldwhollydependsontheexpectationoffutureeffectivedemandinrelationtofutureconditionsofsupply。If，therefore，anactofsavingdoesnothingtoimproveprospectiveyield，itdoesnothingtostimulateinvestment。Moreover，inorderthatanindividualsavermayattainhisdesiredgoaloftheownershipofwealth，itisnotnecessarythatanewcapital-assetshouldbeproducedwherewithtosatisfyhim。Themereactofsavingbyoneindividual，beingtwo-sidedaswehaveshownabove，forcessomeotherindividualtotransfertohimsomearticleofwealtholdornew。Everyactofsavinginvolvesa'forced'inevitabletransferofwealthtohimwhosaves，thoughheinhisturnmaysufferfromthesavingofothers。Thesetransfersofwealthdonotrequirethecreationofnewwealth¾；indeed，aswehaveseen，theymaybeactivelyinimicaltoit。Thecreationofnewwealthwhollydependsontheprospectiveyieldofthenewwealthreachingthestandardsetbythecurrentrateofinterest。Theprospectiveyieldofthemarginalnewinvestmentisnotincreasedbythefactthatsomeonewishestoincreasehiswealth，sincetheprospectiveyieldofthemarginalnewinvestmentdependsontheexpectationofademandforaspecificarticleataspecificdate。
Nordoweavoidthisconclusionbyarguingthatwhattheownerofwealthdesiresisnotagivenprospectiveyieldbutthebestavailableprospectiveyield，sothatanincreaseddesiretoownwealthreducestheprospectiveyieldwithwhichtheproducersofnewinvestmenthavetobecontent。Forthisoverlooksthefactthatthereisalwaysanalternativetotheownershipofrealcapital-assets，namelytheownershipofmoneyanddebts；sothattheprospectiveyieldwithwhich[Page213]OBSERVATIONS
ONNATUREOFCAPITAL
theproducersofnewinvestmenthavetobecontentcannotfallbelowthestandardsetbythecurrentrateofinterest。Andthecurrentrateofinterestdepends，aswehaveseen，notonthestrengthofthedesiretoholdwealth，butonthestrengthsofthedesirestoholditinliquidandinilliquidformsrespectively，coupledwiththeamountofthesupplyofwealthintheoneformrelativelytothesupplyofitintheother。
Ifthereaderstillfindshimselfperplexed，lethimaskhimselfwhy，thequantityofmoneybcingunchanged，afreshactofsavingshoulddiminishthesumwhichitisdesiredtokeepinliquidformattheexistingrateofinterest。
Certaindeeperperplexities，whichmayarisewhenwetrytoprobestillfurtherintothewhysandwherefores，willbeconsideredinthenextchapter。
II
Itismuchpreferabletospeakofcapitalashavingayieldoverthecourseofitslifeinexcessofitsoriginalcost，thanasbeingproductive。
Fortheonlyreasonwhyanassetoffersaprospectofyieldingduringitslifeserviceshavinganaggregatevaluegreaterthanitsinitialsupplypriceisbecauseitisscarce；anditiskeptscarcebecauseofthecompetitionoftherateofinterestonmoney。Ifcapitalbecomeslessscarce，theexcessyieldwilldiminish，withoutitshavingbecomelessproductive¾；atleastinthephysicalsense。
Isympathise，therefore，withthepre-classicaldoctrinethateverythingisproducedbylabour，aidedbywhatusedtobecalledartandisnowcalledtechnique，bynaturalresourceswhicharefreeorcostarentaccordingtotheirscarcityorabundance，andbytheresultsofpastlabour，embodiedinassets，whichalsocommandapriceaccordingtotheirscarcityorabundance。Itispreferabletoregardlabour，including，ofcourse，thepersonalservicesoftheentrepreneurandhisassistants，[Page214]THE
GENERALTHEORYOFEMPLOYMENT
asthesolefactorofproduction，operatinginagivenenvironmentoftechnique，naturalresources，capitalequipmentandeffectivedemand。Thispartlyexplainswhywehavebeenabletotaketheunitoflabourasthesolephysicalunitwhichwerequireinoureconomicsystem，apartfromunitsofmoneyandoftime。
Itistruethatsomelengthyorroundaboutprocessesarephysicallyefficient。Butsoaresomeshortprocesses。Lengthyprocessesarenotphysicallyefficientbecausetheyarelong。Some，probablymost，lengthyprocesseswouldbephysicallyveryinefficient，fortherearesuchthingsasspoilingorwastingwithtime。[118]Withagivenlabourforcethereisadefinitelimittothequantityoflabourembodiedinroundaboutprocesseswhichcanbeusedtoadvantage。Apartfromotherconsiderations，theremustbeadueproportionbetweentheamountoflabouremployedinmakingmachinesandtheamountwhichwillbeemployedinusingthem。Theultimatequantityofvaluewillnotincreaseindefinitely，relativelytothequantityoflabouremployed，astheprocessesadoptedbecomemoreandmoreroundabout，eveniftheirphysicalefficiencyisstillincreasing。Onlyifthedesiretopostponeconsumptionwerestrongenoughtoproduceasituationinwhichfullemploymentrequiredavolumeofinvestmentsogreatastoinvolveanegativemarginalefficiencyofcapital，wouldaprocessbecomeadvantageousmerelybecauseitwaslengthy；inwhicheventweshouldemployphysicallyinefficientprocesses，providedtheyweresufficientlylengthyforthegainfrompostponementtooutweightheirinefficiency。Weshouldinfacthaveasituationinwhichshortprocesseswouldhavetobekeptsufficientlyscarcefortheirphysicalefficiencytooutweighthedisadvantageoftheearlydeliveryoftheirproduct。Acorrecttheory，therefore，mustbereversiblesoastobeabletocovertheeasesofthemarginalefficiencyofcapitalcorresponding[Page215]OBSERVATIONS
ONNATUREOFCAPITAL
eithertoapositiveortoanegativerateofinterest；anditis，I
think，onlythescarcitytheoryoutlinedabovewhichiscapableofthis。
Moreoverthereareallsortsofreasonswhyvariouskindsofservicesandfacilitiesarescarceandthereforeexpensiverefativelytothequantityoflabourinvolved。Forexample，smellyprocessescommandahigherreward，becausepeoplewillnotundertakethemotherwise。Sodoriskyprocesses。
Butwedonotdeviseaproductivitytheoryofsmellyorriskyprocessesassuch。Inshort，notalllabourisaccomplishedinequallyagreeableattendantcircumstances；andconditionsofequilibriumrequirethatarticlesproducedinlessagreeableattendantcircumstancescharacterisedbysmelliness，riskorthelapseoftimemustbekeptsufficientlyscarcetocommandahigherprice。Butifthelapseoftimebecomesanagreeableattendantcircumstance，whichisaquitepossiblecaseandalreadyholdsformanyindividuals，then，asIhavesaidabove，itistheshortprocesseswhichmustbekeptsufficientlyscarce。
Giventheoptimumamountofroundaboutness，weshall，ofcourse，selectthemostefficientroundaboutprocesseswhichwecanfinduptotherequiredaggregate。Buttheoptimumamountitselfshouldbesuchastoprovideattheappropriatedatesforthatpartofconsumers'demandwhichitisdesiredtodefer。Inoptimumconditions，thatistosay，productionshouldbesoorganisedastoproduceinthemostefficientmannercompatiblewithdeliveryatthedatesatwhichconsumers'demandisexpectedtobecomeeffective。
Itisnousetoproducefordeliveryatadifferentdatefromthis，eventhoughthephysicaloutputcouldbeincreasedbychangingthedateofdelivery；¾；exceptinsofarastheprospectofalargermeal，sotospeak，inducestheconsumertoanticipateorpostponethehourofdinner。If，afterhearingfullparticularsofthemealshecangetbyfixingdinnerat[Page216]THE
GENERALTHEORYOFEMPLOYMENT
differenthours，theconsumerisexpectedtodecideinfavourof8o'clock，itisthebusinessofthecooktoprovidethebestdinnerhecanforserviceatthathour，irrespectiveofwhether7。30，8o'clockor8。30isthehourwhichwouldsuithimbestiftimecountedfornothing，onewayortheother，andhisonlytaskwastoproducetheabsolutelybestdinner。Insomephasesofsocietyitmaybethatwecouldgetphysicallybetterdinnersbydininglaterthanwedo；butitisequallyconceivableinotherphasesthatwecouldgetbetterdinnersbydiningearlier。Ourtheorymust，asIhavesaidabove，beapplicabletobothcontingencies。
Iftherateofinterestwerezero，therewouldbeanoptimumintervalforanygivenarticlebetweentheaveragedateofinputandthedateofconsumption，forwhichlabourcostwouldbeaminimum；¾；ashorterprocessofproductionwouldbelessefficienttechnically，whilstalongerprocesswouldalsobelessefficientbyreasonofstoragecostsanddeterioration。If，however，therateofinterestexceedszero，anewelementofcostisintroducedwhichincreaseswiththelengthoftheprocess，sothattheoptimumintervalwillbeshortened，andthecurrentinputtoprovidefortheeventualdeliveryofthearticlewillhavetobecurtaileduntiltheprospectivepricehasincreasedsufficientlytocovertheincreasedcost¾；acostwhichwillbeincreasedbothbytheinterestchargesandalsobythediminishedefficiencyoftheshortermethodofproduction。Whilstiftherateofinterestfallsbelowzeroassumingthistobetechnicallypossible，theoppositeisthecase。Giventheprospectiveconsumers'demand，currentinputto-dayhastocompete，sotospeak，withthealternativeofstartinginputatalaterdate；and，consequently，currentinputwillonlybeworthwhilewhenthegreatercheapness，byreasonofgreatertechnicalefficiencyorprospectivepricechanges，ofproducinglateronratherthannow，isinsufficienttooffsetthesmallerreturnfromnegative[Page217]OBSERVATIONS
ONNATUREOFCAPITAL
interest。Inthecaseofthegreatmajorityofarticlesitwouldinvolvegreattechnicalinefficiencytostartuptheirinputmorethanaverymodestlengthoftimeaheadoftheirprospectiveconsumption。Thuseveniftherateofinterestiszero，thereisastrictlimittotheproportionofprospectiveconsumers'demandwhichitisprofitabletobeginprovidingforinadvance；and，astherateofinterestrises，theproportionoftheprospectiveconsumers'demandforwhichitpaystoproduceto-dayshrinksparipassu。
III
Wehaveseenthatcapitalhastobekeptscarceenoughinthelong-periodtohaveamarginalefficiencywhichisatleastequaltotherateofinterestforaperiodequaltothelifeofthecapital，asdeterminedbypsychologicalandinstitutionalconditions。Whatwouldthisinvolveforasocietywhichfindsitselfsowellequippedwithcapitalthatitsmarginalefficiencyiszeroandwouldbenegativewithanyadditionalinvestment；yetpossessingamonetarysystem，suchthatmoneywill'keep'andinvolvesnegligiblecostsofstorageandsafecustody，withtheresultthatinpracticeinterestcannotbenegative；and，inconditionsoffullemployment，disposedtosave？
If，insuchcircumstances，westartfromapositionoffullemployment，entrepreneurswillnecessarilymakelossesiftheycontinuetoofferemploymentonascalewhichwillutilisethewholeoftheexistingstockofcapital。
Hencethestockofcapitalandthelevelofemploymentwillhavetoshrinkuntilthecommunitybecomessoimpoverishedthattheaggregateofsavinghasbecomezero，thepositivesavingofsomeindividualsorgroupsbeingoffsetbythenegativesavingofothers。Thusforasocietysuchaswehavesupposed，thepositionofequilibrium，underconditionsoflaissez-faire，willbeoneinwhichemploymentislowenough[Page218]THE
GENERALTHEORYOFEMPLOYMENT
andthestandardoflifesufficientlymiserabletobringsavingstozero。Moreprobablytherewillbeacyclicalmovementroundthisequilibriumposition。Forifthereisstillroomforuncertaintyaboutthefuture，themarginalefficiencyofcapitalwilloccasionallyriseabovezeroleadingtoa'boom'，andinthesucceeding'slump'thestockofcapitalmayfallforatimebelowthelevelwhichwillyieldamarginalefficiencyofzerointhelongrun。Assumingcorrectforesight，theequilibriumstockofcapitalwhichwillhaveamarginalefficiencyofpreciselyzerowill，ofcourse，beasmallerstockthanwouldcorrespondtofullemploymentoftheavailablelabour；foritwillbetheequipmentwhichcorrespondstothatproportionofunemploymentwhichensureszerosaving。
Theonlyalternativepositionofequilibriumwouldbegivenbyasituationinwhichastockofcapitalsufficientlygreattohaveamarginalefficiencyofzeroalsorepresentsanamountofwealthsufficientlygreattosatiatetothefulltheaggregatedesireonthepartofthepublictomakeprovisionforthefuture，evenwithfullemployment，incircumstanceswherenobonusisobtainableintheformofinterest。Itwould，however，beanunlikelycoincidencethatthepropensitytosaveinconditionsoffullemploymentshouldbecomesatisfiedjustatthepointwherethestockofcapitalreachesthelevelwhereitsmarginalefficiencyiszero。If，therefore，thismorefavourablepossibilitycomestotherescue，itwillprobablytakeeffect，notjustatthepointwheretherateofinterestisvanishing，butatsomepreviouspointduringthegradualdeclineoftherateofinterest。
Wehaveassumedsofaraninstitutionalfactorwhichpreventstherateofinterestfrombeingnegative，intheshapeofmoneywhichhasnegligiblecarryingcosts。Infact，however，institutionalandpsychologicalfactorsarepresentwhichsetalimitmuchabovezerotothepracticabledeclineintherateofinterest。In[Page219]OBSERVATIONS
ONNATUREOFCAPITAL
particularthecostsofbringingborrowersandlenderstogetheranduncertaintyastothefutureoftherateofinterest，whichwehaveexaminedabove，setalowerlimit，whichinpresentcircumstancesmayperhapsbeashighas2or2½；percentonlongterm。Ifthisshouldprovecorrect，theawkwardpossibilitiesofanincreasingstockofwealth，inconditionswheretherateofinterestcanfallnofurtherunderlaissez-faire，maysoonberealisedinactualexperienceMoreoveriftheminimumleveltowhichitispracticabletobringtherateofinterestisappreciablyabovezero，thereislesslikelihoodoftheaggregatedesiretoaccumulatewealthbeingsatiatedbeforetherateofinteresthasreacheditsminimumlevel。
Thepost-warexperiencesofGreatBritainandtheUnitedStatesare，indeed，actualexamplesofhowanaccumulationofwealth，solargethatitsmarginalefficiencyhasfallenmorerapidlythantherateofinterestcanfallinthefaceoftheprevailinginstitutionalandpsychologicalfactors，caninterfere，inconditionsmainlyoflaissez-faire，withareasonablelevelofemploymentandwiththestandardoflifewhichthetechnicalconditionsofproductionarecapableoffurnishing。
Itfollowsthatoftwoequalcommunities，havingthesametechniquebutdifferentstocksofcapital，thecommunitywiththesmallerstocksofcapitalmaybeableforthetimebeingtoenjoyahigherstandardoflifethanthecommunitywiththelargerstock；thoughwhenthepoorercommunityhascaughtuptherich¾；as，presumably，iteventuallywill¾；thenbothalikewillsufferthefateofMidas。Thisdisturbingconclusiondepends，ofcourse，ontheassumptionthatthepropensitytoconsumeandtherateofinvestmentarenotdeliberatelycontrolledinthesocialinterestbutaremainlylefttotheinfluencesoflaissez-faire。
If¾；forwhateverreason¾；therateofinterestcannotfallasfastasthemarginalefficiencyofcapitalwouldfallwitharateofaccumulationcorrespondingtowhat[Page220]THE
GENERALTHEORYOFEMPLOYMENT
thecommunitywouldchoosetosaveatarateofinterestequaltothemarginalefficiencyofcapitalinconditionsoffullemployment，thenevenadiversionofthedesiretoholdwealthtowardsassets，whichwillinfactyieldnoeconomicfruitswhatever，willincreaseeconomicwell-being。
Insofarasmillionairesfindtheirsatisfactioninbuildingmightymansionstocontaintheirbodieswhenaliveandpyramidstoshelterthemafterdeath，or，repentingoftheirsins，erectcathedralsandendowmonasteriesorforeignmissions，thedaywhenabundanceofcapitalwillinterferewithabundanceofoutputmaybepostponed。'Todigholesintheground'，paidforoutofsavings，willincrease，notonlyemployment，buttherealnationaldividendofusefulgoodsandservices。Itisnotreasonable，however，thatasensiblecommunityshouldbecontenttoremaindependentonsuchfortuitousandoftenwastefulmitigationswhenonceweunderstandtheinfluencesuponwhicheffectivedemanddepends。
IV
Letusassumethatstepsaretakentoensurethattherateofinterestisconsistentwiththerateofinvestmentwhichcorrespondstofullemployment。
Letusassume，further，thatStateactionentersinasabalancingfactortoprovidethatthegrowthofcapitalequipmentshallbesuchastoapproachsaturation-pointataratewhichdoesnotputadisproportionateburdenonthestandardoflifeofthepresentgeneration。
OnsuchassumptionsIshouldguessthataproperlyruncommunityequippedwithmoderntechnicalresources，ofwhichthepopulationisnotincreasingrapidJy，oughttobeabletobringdownthemarginalefficiencyofcapitalinequilibriumapproximatelytozerowithinasinglegeneration；sothatweshouldattaintheconditionsofaquasi-stationarycommunitywherechangeandprogresswouldresultonlyfrom[Page221]OBSERVATIONS
ONNATUREOFCAPITAL
changesintechnique，taste，populationandinstitutions，withtheproductsofcapitalsellingatapriceproportionedtothelabour，etc。，embodiedinthemonjustthesameprinciplesasgovernthepricesofconsumption-goodsintowhichcapital-chargesenterinaninsignificantdegree。
IfIamrightinsupposingittobecomparativelyeasytomakecapital-goodssoabundantthatthemarginalefficiencyofcapitaliszero，thismaybethemostsensiblewayofgraduallygettingridofmanyoftheobjectionablefeaturesofcapitalism。Foralittlereflectionwillshowwhatenormoussocialchangeswouldresultfromagradualdisappearanceofarateofreturnonaccumulatedwealth。Amanwouldstillbefreetoaccumulatehisearnedincomewithaviewtospendingitatalaterdate。Buthisaccumulationwouldnotgrow。HewouldsimplybeinthepositionofPope'sfather，who，whenheretiredfrombusiness，carriedachestofguineaswithhimtohisvillaatTwickenhamandmethishouseholdexpensesfromitasrequired。
Thoughtherentierwoulddisappear，therewouldstillberoom，nevertheless，forenterpriseandskillintheestimationofprospectiveyieldsaboutwhichopinionscoulddiffer。Fortheaboverelatesprimarilytothepurerateofinterestapartfromanyallowanceforriskandthelike，andnottothegrossyieldofassetsincludingthereturninrespectofrisk。Thusunlessthepurerateofinterestweretobeheldatanegativefigure，therewouldstillbeapositiveyieldtoskilledinvestmentinindividualassetshavingadoubtfulprospectiveyield。Providedtherewassomemeasurableunwillingnesstoundertakerisk，therewouldalsobeapositivenetyieldfromtheaggregateofsuchassetsoveraperiodoftime。Butitisnotunlikelythat，insuchcircumstances，theeagernesstoobtainayieldfromdoubtfulinvestmentsmightbesuchthattheywouldshowintheaggregateanegativenetyield。PropertiesofInterestandMoney[Page222]
Chapter17
THEESSENTIALPROPERTIESOF
INTERESTANDMONEY
I
Itseems，then，thattherateofinterestonmoneyplaysapeculiarpartinsettingalimittothelevelofemployment，sinceitsetsastandardtowhichthemarginalefficiencyofacapital-assetmustattainifitistobenewlyproduced。Thatthisshouldbeso，is，atfirstsight，mostperplexing。Itisnaturaltoenquirewhereinthepeculiarityofmoneyliesasdistinctfromotherassets，whetheritisonlymoneywhichhasarateofinterest，andwhatwouldhappeninanon-monetaryeconomy。Untilwehaveansweredthesequestions，thefullsignificanceofourtheorywillnotbeclear。
Themoney-rateofinterest¾；wemayremindthereader¾；isnothingmorethanthepercentageexcessofasumofmoneycontractedforforwarddelivery，e。g。ayearhence，overwhatwemaycallthe'spot'orcashpriceofthesumthuscontractedforforwarddelivery。Itwouldseem，therefore，thatforeverykindofcapital-assettheremustbeananalogueoftherateofinterestonmoney。Forthereisadefinitequantityofe。g。wheattobedeliveredayearhencewhichhasthesameexchangevalueto-dayas100
quartersofwheatfor'spot'delivery。Iftheformerquantityis105quarters，wemaysaythatthewheat-rateofinterestis5percentperannum；andifjtis95quarters，thatitisminus5percentperannum。Thusforeverydurablecommoditywehavearateofinterestintermsofitself；¾；a[Page223]PROPERTIES
OFINTERESTANDMONEY
wheat-rateofinterest，acopper-rateofinterest，ahouse-rateofinterest，evenasteel-plant-rateofinterest。
Thedifferencebetweenthe'future'and'spot'contractsforacommodity，suchaswheat，whicharequotedinthemarket，bearsadefiniterelationtothewheat-rateofinterest，but，sincethefuturecontractisquotedintermsofmoneyforforwarddeliveryandnotintermsofwheatforspotdelivery，italsobringsinthemoney-rateofinterest。Theexactrelationshipisasfollows:
Letussupposethatthespotpriceofwheatis£；100per100quarters，thatthepriceofthe'future'contractforwheatfordeliveryayearhenceis£；107per100quarters，andthatthemoney-rateofinterestis5percent；whatisthewheat-rateofinterest？£；100spotwillbuy£；105forforwarddelivery，and£；105forforwarddeliverywillbuy105/107×；100=98quartersforforwarddelivery。Alternatively£；100spotwillbuy100quartersofwheatforspotdelivery。Thus100quartersofwheatforspotdeliverywillbuy98quartersforforwarddelivery。Itfollowsthatthewheat-rateofinterestisminus2
percentperannum。[119]
Itfollowsfromthisthatthereisnoreasonwhytheirratesofinterestshouldbethesamefordifferentcommodities，¾；whythewheat-rateofinterestshouldbeequaltothecopper-rateofinterest。
Fortherelationbetweenthe'spot'and'future'contracts，asquotedinthemarket，isnotoriouslydifferentfordifferentcommodities。This，weshallfind，willleadustotheclueweareseeking。Foritmaybethatitisthegreatestoftheown-ratesofinterestaswemaycallthemwhichrulestheroostbecauseitisthegreatestoftheseratesthatthemarginalefficiencyofacapital-assetmustattainifitistobenewlyproduced；andthattherearereasonswhyitisthemoney-rateofinterestwhichisoftenthegreatestbecause，asweshallfind，certain[Page224]THE
GENERALTHEORYOFEMPLOYMENT
forces，whichoperatetoreducetheown-ratesofinterestofotherassets，donotoperateinthecaseofmoney。
Itmaybeaddedthat，justastherearedifferingcommodity-ratesofinterestatanytime，soalsoexchangedealersarefamiliarwiththefactthattherateofinterestisnoteventhesameintermsoftwodifferentmoneys，e。g。sterlinganddollars。Forherealsothedifferencebetweenthe'spot'and'future'contractsforaforeignmoneyintermsofsterlingarenot，asarule，thesamefordifferentforeignmoneys。
Noweachofthesecommoditystandardsoffersusthesamefacilityasmoneyformeasuringthemarginalefficiencyofcapital。Forwecantakeanycommoditywechoose，e。g。wheat；calculatethewheat-valueoftheprospectiveyieldsofanycapitalasset；andtherateofdiscountwhichmakesthepresentvalueofthisseriesofwheatannuitiesequaltothepresentsupplypriceoftheassetintermsofwheatgivesusthemarginalefficiencyoftheassetintermsofwheat。Ifnochangeisexpectedintherelativevalueoftwoalternativestandards，thenthemarginalefficiencyofacapital-assetwillbethesameinwhicheverofthetwostandardsitismeasured，sincethenumeratoranddenominatorofthefractionwhichleadsuptothemarginalefficiencywillbechangedinthesameproportion。If，however，oneofthealternativestandardsisexpectedtochangeinvalueintermsoftheother，themarginalefficienciesofcapital-assetswillbechangedbythesamepercentage，accordingtowhichstandardtheyaremeasuredin。Toillustratethisletustakethesimplestcasewherewheat，oneofthealternativestandards，isexpectedtoappreciateatasteadyrateofapercentperannumintermsofmoney；themarginalefficiencyofanasset，whichisxpercentintermsofmoney，willthenbex-apercentintermsofwheat。Sincethemarginalefficienciesofallcapital-assetswillbealteredbythesameamount，itfollowsthattheirorderofmagnitudewillbethesameirrespectiveofthestandardwhichisselected。
[Page225]PROPERTIES
OFINTERESTANDMONEY
Ifthereweresomecompositecommoditywhichcouldberegardedstrictlyspeakingasrepresentative，wecouldregardtherateofinterestandthemarginalefficiencyofcapitalintermsofthiscommodityasbeing，inasense，uniquelytherateofinterestandthemarginalefficiencyofcapital。Butthereare，ofcourse，thesameobstaclesinthewayofthisastherearetosettingupauniquestandardofvalue。
Sofar，therefore，themoney-rateofinteresthasnouniquenesscomparedwithotherratesofinterest，butisonpreciselythesamefooting。Wherein，then，liesthepeculiarityofthemoney-rateofinterestwhichgivesitthepredominatingpracticalimportanceattributedtoitintheprecedingchapters？Whyshouldthevolumeofoutputandemploymentbemoreintimatelyboundupwiththemoney-rateofinterestthanwiththewheat-rateofinterestorthehouse-rateofinterest？