ON KEYNESIAN THEORIES OF LIQUIDITY PREFERENCE* by JÚRG BIBOW{ University of Hamburg This essay o¡ers a macroeconomic perspective on the interaction between the ¢nancial system and the level of economic activity, focusing on the relationship between liquidity preference, investment and the role of con¢dence. The analysis builds on the distinction between portfolio decisions on the one hand, and production and spending decisions on the other. Two prominent Keynesian theories of liquidity preference, those of Tobin and Hicks, are assessed. It is argued that while both of these theories o¡er illuminating insights into particular aspects of Keynes's monetary thought, they must be quali¢ed in respect of their bearing on the theory of liquidity preference. It might be more accurate, perhaps, to say that the rate of interest is a highly conventional, rather than a highly psychological, phenomenon. For its actual value is largely governed by the prevailing view as to what its value is expected to be. Any level of interest which is accepted with su¤cient conviction as likely to be durable will be durable; subject, of course, in a changing society to £uctuations for all kinds of reasons round the expected normal. In particular, when M 1 is increasing faster than M, the rate of interest will rise, and vice versa. (J. M. Keynes, 1936, pp. 203^204) 1 " Introduction The purpose of this essay is to o¡er a macroeconomic perspective on the interaction between the ¢nancial system and the level of economic activity, focusing on the relationship between liquidity preference, investment and the role of con¢dence. We shall proceed as follows. Section 2 discusses the role of uncertainty and interest rate determination in relation to the `liquidity preference schedule'. The analysis of interest rate determination is then extended in Section 3 in terms of Keynes's `own-rates analysis', which provides a general equilibrium framework to study the interaction between ß Blackwell Publishers Ltd and The Victoria University of Manchester, 1998. Published by Blackwell Publishers Ltd, 108 Cowley Road, Oxford OX4 1JF, UK, and 350 Main Street, Malden, MA 02148, USA. 238 The Manchester School Vol 66 No. 2 March 1998 0025^2034 238^273 * Manuscript received 28.7.95; ¢nal version received 25.11.96. { I am grateful to Geo¡ Harcourt, Michael Kuczynski, Joseph Labia, Jochen Runde, James Trevithick and an anonymous referee for helpful comments on an earlier version of this paper. I also gratefully acknowledge ESRC Research Studentship R00429324032 and a Research Scholarship from Girton College, Cambridge. 1 M is the stock of money while M 1 is that part of it which satis¢es the requirements of the transactions (and precautionary) motives for the demand for money (the author).