The Misleading Function of “Liquidity Preference”
John M. Keynes proposes a liquidity preference function, M= L(i) (1936, p. 168). The function is partly true. Some of us would keep larger money in cash or bank deposits than usual when there is no opportunity whatsoever from which to expect a positive return or interest receipt. Unfortunately, however, “Half knowledge is more dangerous than ignorance.” Whose fault may it be, the equation has long been over-relied, way too much, in Cambridge macroeconomics. Particularly, the equation is one of the four pillars in the IS-LM model, which is “pretty-well working” according a famous and infamous Nobel laurate. First and foremost, there on earth is no such thing as the interest rate. As well known in elementary finance, interest rate is very specific to the investor, the asset, the time horizon, the portfolio, and the social, political and ec...