Saturday, August 22, 2009

Criticism of Liquidity Preference Theory

Keynes theory has also met with criticism. Firstly it has been pointed out that rate of interest is not purely a monetary phenomenon. Real forces like productivity of capital and thriftiness or saving by the people also play an important role in the determination of the rate of interest. Secondly Keynes makes the rate of interest independent of demand for investment funds. Actually it is not so. The cash balances of the businessman are largely influenced by their demand for savings for capital investment.
Thirdly liquidity preference is not only factor governing the rate of interest. There are several other factors which influence the rate of interest by affecting the demand for and supply of money.
Fourthly liquidity preference theory does not explain the existence of different rate of interest prevailing in the market at the same time. Owing to the perfect homogeneity of cash balance, the rate of interest have to be uniform. Actually is it not so.
Fifthly Keynes ignores saving or waiting as a means or source of investible fund. To part with liquidity without there being any saving is meaningless.
Sixthly Keynes theory of interest is of limited value from the supply side. It is not always possible to reduce the rate of interest by increasing the supply of money. If the liquidity preference of people also increases in the same proportion in which the supply of money increase then the rate of interest shall remain unaffected.

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