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　　EXPECTATION

　　ideathattheonlyriskherunsisthatofagenuinechangeinthenewsoverthenearfuture，astothelikelihoodofwhichhecanattempttoformhisownjudgment，andwhichisunlikelytobeverylarge。For，assumingthattheconventionholdsgood，itisonlythesechangeswhichcanaffectthevalueofhisinvestment，andheneednotlosehiSsleepmerelybecausehehasnotanynotionwhathisinvestmentwillbeworthtenyearshence。Thusinvestmentbecomesreasonably\'safe\'fortheindividualinvestorovershortperiods，andhenceoverasuccessionofshortperiodshowevermany，ifhecanfairlyrelyontherebeingnobreakdownintheconventionandonhisthereforehavinganopportunitytorevisehisjudgmentandchangehisinvestment，beforetherehasbeentimeformuchtohappen。

　　Investmentswhichare\'fixed\'forthecommunityarethusmade\'liquid\'

　　fortheindividual。

　　Ithasbeen，Iamsure，onthebasisofsomesuchprocedureasthisthatourleadinginvestmentmarketshavebeendeveloped。Butitisnotsurprisingthataconvention，inanabsoluteviewofthingssoarbitrary，shouldhaveitsweakpoints。Itisitsprecariousnesswhichcreatesnosmallpartofourcontemporaryproblemofsecuringsufficientinvestment。

　　V

　　Someofthefactorswhichaccentuatethisprecariousnessmaybebrieflymentioned。

　　1Asaresultofthegradualincreaseintheproportionoftheequityinthecommunity\'saggregatecapitalinvestmentwhichisownedbypersonswhodonotmanageandhavenospecialknowledgeofthecircumstances，eitheractualorprospective，ofthebusinessinquestion，theelementofrealknowledgeinthevaluationofinvestmentsbywhosewhoownthemorcontemplatepurchasingthemhasseriouslydeclined。

　　2Day-to-dayfluctuationsintheprofitsofexisting[Page154]THE

　　GENERALTHEORYOFEMPLOYMENT

　　investments，whichareobviouslyofanephemeralandnon-significantcharacter，tendtohaveanaltogetherexcessive，andevenanabsurd，influenceonthemarket。Itissaid，forexample，thatthesharesofAmericancompanieswhichmanufactureicetendtosellatahigherpriceinsummerwhentheirprofitsareseasonallyhighthaninwinterwhennoonewantsice。Therecurrenceofabank-holidaymayraisethemarketvaluationoftheBritishrailwaysystembyseveralmillionpounds。

　　3Aconventionalvaluationwhichisestablishedastheoutcomeofthemasspsychologyofalargenumberofignorantindividualsisliabletochangeviolentlyastheresultofasuddenfluctuationofopinionduetofactorswhichdonotreallymakemuchdifferencetotheprospectiveyield；sincetherewillbenostrongrootsofconvictiontoholditsteady。

　　Inabnormaltimesinparticular，whenthehypothesisofanindefinitecontinuanceoftheexistingstateofaffairsislessplausiblethanusualeventhoughtherearenoexpressgroundstoanticipateadefinitechange，themarketwillbesubjecttowavesofoptimisticandpessimisticsentiment，whichareunreasoningandyetinasenselegitimatewherenosolidbasisexistsforareasonablecalculation。

　　4Butthereisonefeatureinparticularwhichdeservesourattention。Itmighthavebeensupposedthatcompetitionbetweenexpertprofessionals，possessingjudgmentandknowledgebeyondthatoftheaverageprivateinvestor，wouldcorrectthevagariesoftheignorantindividuallefttohimself。Ithappens，however，thattheenergiesandskilloftheprofessionalinvestorandspeculatoraremainlyoccupiedotherwise。Formostofthesepersonsare，infact，largelyconcerned，notwithmakingsuperiorlong-termforecastsoftheprobableyieldofaninvestmentoveritswholelife，butwithforeseeingchangesintheconventionalbasisofvaluationashorttimeaheadofthegeneralpublic。Theyareconcerned，notwithwhataninvestmentis[Page155]LONG-TERM

　　EXPECTATION

　　reallyworthtoamanwhobuysit\'forkeeps\'，butwithwhatthemarketwillvalueitat，undertheinfluenceofmasspsychology，threemonthsorayearhence。Moreover，thisbehaviourisnottheoutcomeofawrong-headedpropensity。Itisaninevitableresultofaninvestmentmarketorganisedalongthelinesdescribed。Foritisnotsensibletopay25foraninvestmentofwhichyoubelievetheprospectiveyieldtojustifyavalueof30，ifyoualsobelievethatthemarketwillvalueitat20threemonthshence。

　　Thustheprofessionalinvestorisforcedtoconcernhimselfwiththeanticipationofimpendingchanges，inthenewsorintheatmosphere，ofthekindbywhichexperienceshowsthatthemasspsychologyofthemarketismostinfluenced。Thisistheinevitableresultofinvestmentmarketsorganisedwithaviewtoso-called\'liquidity\'。Ofthemaximsoforthodoxfinancenone，surely，ismoreanti-socialthanthefetishofliquidity，thedoctrinethatitisapositivevirtueonthepartofinvestmentinstitutionstoconcentratetheirresourcesupontheholdingof\'liquid\'securities。

　　Itforgetsthatthereisnosuchthingasliquidityofinvestmentforthecommunityasawhole。Thesocialobjectofskilledinvestmentshouldbetodefeatthedarkforcesoftimeandignorancewhichenvelopourfuture。

　　Theactual，privateobjectofthemostskilledinvestmentto-dayis\'tobeatthegun\'，astheAmericanssowellexpressit，tooutwitthecrowd，andtopassthebad，ordepreciating，half-crowntotheotherfellow。

　　Thisbattleofwitstoanticipatethebasisofconventionalvaluationafewmonthshence，ratherthantheprospectiveyieldofaninvestmentoveralongtermofyears，doesnotevenrequiregullsamongstthepublictofeedthemawsoftheprofessional；&frac34；itcanbeplayedbyprofessionalsamongstthemselves。Norisitnecessarythatanyoneshouldkeephissimplefaithintheconventionalbasisofvaluationhavinganygenuinelong-termvalidity。Foritis，sotospeak，agameofSnap，[Page156]THE

　　GENERALTHEORYOFEMPLOYMENT

　　ofOldMaid，ofMusicalChairs&frac34；apastimeinwhichheisvictorwhosaysSnapneithertoosoonnortoolate，whopassedtheOldMaidtohisneighbourbeforethegameisover，whosecuresachairforhimselfwhenthemusicstops。Thesegamescanbeplayedwithzestandenjoyment，thoughalltheplayersknowthatitistheOldMaidwhichiscirculating，orthatwhenthemusicstopssomeoftheplayerswillfindthemselvesunseated。

　　Or，tochangethemetaphorslightly，professionalinvestmentmaybelikenedtothosenewspapercompetitionsinwhichthecompetitorshavetopickoutthesixprettiestfacesfromahundredphotographs，theprizebeingawardedtothecompetitorwhosechoicemostnearlycorrespondstotheaveragepreferencesofthecompetitorsasawhole；sothateachcompetitorhastopick，notthosefaceswhichhehimselffindsprettiest，butthosewhichhethinkslikeliesttocatchthefancyoftheothercompetitors，allofwhomarelookingattheproblemfromthesamepointofview。Itisnotacaseofchoosingthosewhich，tothebestofone\'sjudgment，arereallytheprettiest，noreventhosewhichaverageopiniongenuinelythinkstheprettiest。Wehavereachedthethirddegreewherewedevoteourintelligencestoanticipatingwhataverageopinionexpectstheaverageopiniontobe。

　　Andtherearesome，Ibelieve，whopractisethefourth，fifthandhigherdegrees。

　　Ifthereaderinterjectsthattheremustsurelybelargeprofitstobegainedfromtheotherplayersinthelongrunbyaskilledindividualwho，unperturbedbytheprevailingpastime，continuestopurchaseinvestmentsonthebestgenuinelong-termexpectationshecanframe，hemustbeanswered，firstofall，thatthereare，indeed，suchserious-mindedindividualsandthatitmakesavastdifferencetoaninvestmentmarketwhetherornottheypredominateintheirinfluenceoverthegame-players。Butwemustalsoaddthatthereare[Page157]LONG-TERM

　　EXPECTATION

　　severalfactorswhichjeopardisethepredominanceofsuchindividualsinmoderninvestmentmarkets。Investmentbasedongenuinelong-termexpectationissodifficultto-dayastobescarcelypracticable。Hewhoattemptsitmustsurelyleadmuchmorelaboriousdaysandrungreaterrisksthanhewhotriestoguessbetterthanthecrowdhowthccrowdwillbehave；and，givenequalintelligence，hemaymakemoredisastrousmistakes。Thereisnoclearevidencefromexperiencethattheinvestmentpolicywhichissociallyadvantageouscoincideswiththatwhichismostprofitable。Itneedsmoreintelligencetodefeattheforcesoftimeandourignoranceofthefuturethantobeatthegun。Moreover，lifeisnotlongenough；&frac34；humannaturedesiresquickresults，thereisapeculiarzestinmakingmoneyquickly，andremotergainsarediscountedbytheaveragemanataveryhighrate。Thegameofprofessionalinvestmentisintolerablyboringandover-exactingtoanyonewhoisentirelyexemptfromthegamblinginstinct；

　　whilsthewhohasitmustpaytothispropensitytheappropriatetoll。

　　Furthermore，aninvestorwhoproposestoignorenear-termmarketfluctuationsneedsgreaterresourcesforsafetyandmustnotoperateonsolargeascale，ifatall，withborrowedmoney&frac34；afurtherreasonforthehigherreturnfromthepastimetoagivenstockofintelligenceandresources。Finallyitisthelong-terminvestor，hewhomostpromotesthepublicinterest，whowillinpracticecomeinformostcriticism，whereverinvestmentfundsaremanagedbycommitteesorboardsorbanks。[90]Foritisintheessenceofhisbehaviourthatheshouldbeeccentric，unconventionalandrashintheeyesofaverageopinion。Ifheissuccessful，thatwillonlyconfirmthegeneralbeliefinhisrashness；andif[Page158]THE

　　GENERALTHEORYOFEMPLOYMENT

　　intheshortrunheisunsuccessful，whichisverylikely，hewillnotreceivemuchmercy。Worldlywisdomteachesthatitisbetterforreputationtofailconventionallythantosucceedunconventionally。

　　5Sofarwehavehadchieflyinmindthestateofconfidenceofthespeculatororspeculativeinvestorhimselfandmayhaveseemedtobetacitlyassumingthat，ifhehimselfissatisfiedwiththeprospects，hehasunlimitedcommandovermoneyatthemarketrateofinterest。Thisis，ofcourse，notthecase。Thuswemustalsotakeaccountoftheotherfacetofthestateofconfidence，namely，theconfidenceofthelendinginstitutionstowardsthosewhoseektoborrowfromthem，sometimesdescribedasthestateofcredit。Acollapseinthepriceofequities，whichhashaddisastrousreactionsonthemarginalefficiencyofcapital，mayhavebeenduetotheweakeningeitherofspeculativeconfidenceorofthestateofcredit。Butwhereastheweakeningofeitherisenoughtocauseacollapse，recoveryrequirestherevivalofboth。Forwhilsttheweakeningofcreditissufficienttobringaboutacollapse，itsstrengthening，thoughanecessaryconditionofrecovery，isnotasufficientcondition。

　　VI

　　Theseconsiderationsshouldnotliebeyondthepurviewoftheeconomist。

　　Buttheymustberelegatedtotheirrightperspective。IfImaybeallowedtoappropriatethetermspeculationfortheactivityofforecastingthepsychologyofthemarket，andthetermenterprisefortheactivityofforecastingtheprospectiveyieldofassetsovertheirwholelife，itisbynomeansalwaysthecasethatspeculationpredominatesoverenterprise。

　　Astheorganisationofinvestmentmarketsimproves，theriskofthepredominanceofspeculationdoes，however，increase。Inoneofthegreatestinvestmentmarketsintheworld，namely，NewYork，the[Page159]LONG-TERM

　　EXPECTATION

　　influenceofspeculationintheabovesenseisenormous。Evenoutsidethefieldoffinance，Americansareapttobeundulyinterestedindiscoveringwhataverageopinionbelievesaverageopiniontobe；andthisnationalweaknessfindsitsnemesisinthestockmarket。Itisrare，oneistold，foranAmericantoinvest，asmanyEnglishmenstilldo，\'forincome\'；andhewillnotreadilypurchaseaninvestmentexceptinthehopeofcapitalappreciation。Thisisonlyanotherwayofsayingthat，whenhepurchasesaninvestment，theAmericanisattachinghishopes，notsomuchtoitsprospectiveyield，astoafavourablechangeintheconventionalbasisofvaluation，i。e。thatheis，intheabovesense，aspeculator。Speculatorsmaydonoharmasbubblesonasteadystreamofenterprise。Butthepositionisseriouswhenenterprisebecomesthebubbleonawhirlpoolofspeculation。

　　Whenthecapitaldevelopmentofacountrybecomesaby-productoftheactivitiesofacasino，thejobislikelytobeill-done。ThemeasureofsuccessattainedbyWallStreet，regardedasaninstitutionofwhichthepropersocialpurposeistodirectnewinvestmentintothemostprofitablechannelsintermsoffutureyield，cannotbeclaimedasoneoftheoutstandingtriumphsoflaissez-fairecapitalism&frac34；whichisnotsurprising，ifIamrightinthinkingthatthebestbrainsofWallStreethavebeeninfactdirectedtowardsadifferentobject。

　　Thesetendenciesareascarcelyavoidableoutcomeofourhavingsuccessfullyorganised\'liquid\'investmentmarkets。Itisusuallyagreedthatcasinosshould，inthepublicinterest，beinaccessibleandexpensive。Andperhapsthesameistrueofstockexchanges。ThatthesinsoftheLondonStockExchangearelessthanthoseofWallStreetmaybedue，notsomuchtodifferencesinnationalcharacter，astothefactthattotheaverageEnglishmanThrogmortonStreetis，comparedwithWallStreettotheaverageAmerican，inaccessibleandveryexpensive。Thejobber\'s\'turn\'，thehigh[Page160]THE

　　GENERALTHEORYOFEMPLOYMENT

　　brokeragechargesandtheheavytransfertaxpayabletotheExchequer，whichattenddealingsontheLondonStockExchange，sufficientlydiminishtheliquidityofthemarketalthoughthepracticeoffortnightlyaccountsoperatestheotherwaytoruleoutalargeproportionofthetrinsactioncharacteristicofWallStreet。[91]Theintroductionofasubstantialgovernmenttransfertaxonalltransactionsmightprovethemostserviceablereformavailable，withaviewtomitigatingthepredominanceofspeculationoverenterpriseintheUnitedStates。

　　Thespectacleofmoderninvestmentmarketshassometimesmovedmetowardstheconclusionthattomakethepurchaseofaninvestmentpermanentandindissoluble，likemarriage，exceptbyreasonofdeathorothergravecause，mightbeausefulremedyforourcontemporaryevils。Forthiswouldforcetheinvestortodirecthismindtothelong-termprospectsandtothoseonly。Butalittleconsiderationofthisexpedientbringsusupagainstadilemma，andshowsushowtheliquidityofinvestmentmarketsoftenfacilitates，thoughitsometimesimpedes，thecourseofnewinvestment。Forthefactthateachindividualinvestorflattershimselfthathiscommitmentis\'liquid\'

　　thoughthiscannotbetrueforallinvestorscollectivelycalmshisnervesandmakeshimmuchmorewillingtorunarisk。Ifindividualpurchasesofinvestmentswererenderedilliquid，thismightseriouslyimpedenewinvestment，solongasalternativewaysinwhichtoholdhissavingsareavailabletotheindividual。Thisisthedilemma。Solongasitisopentotheindividualtoemployhiswealthinhoardingorlendingmoney，thealternativeofpurchasingactualcapitalassetscannotberenderedsufficientlyattractiveespeciallytothemanwhodoes[Page161]LONG-TERM

　　EXPECTATION

　　notmanagethecapitalassetsandknowsverylittleaboutthem，exceptbyorganisingmarketswhereintheseassetscanbeeasilyrealisedformoney。

　　Theonlyradicalcureforthecrisesofconfidencewhichafflicttheeconomiclifeofthemodernworldwouldbetoallowtheindividualnochoicebetweenconsuminghisincomeandorderingtheproductionofthespecificcapital-assetwhich，eventhoughitbeonprecariousevidence，impresseshimasthemostpromisinginvestmentavailabletohim。Itmightbethat，attimeswhenhewasmorethanusuallyassailedbydoubtsconcerningthefuture，hewouldturninhisperplexitytowardsmoreconsumptionandlessnewinvestment。Butthatwouldavoidthedisastrous，cumulativeandfar-reachingrepercussionsofitsbeingopentohim，whenthusassailedbydoubts，tospendhisincomeneitherontheonenorontheother。

　　Thosewhohaveemphasisedthesocialdangersofthehoardingofmoneyhave，ofcourse，hadsomethingsimilartotheaboveinmind。Buttheyhaveoverlookedthepossibilitythatthephenomenoncanoccurwithoutanychange，oratleastanycommensuratechange，inthehoardingofmoney。

　　VII

　　Evenapartfromtheinstabilityduetospeculation，thereistheinstabilityduetothecharacteristicofhumannaturethatalargeproportionofourpositiveactivitiesdependonspontaneousoptimismratherthanonamathematicalexpectation，whethermoralorhedonisticoreconomic。Most，probably，ofourdecisionstodosomethingpositive，thefullconsequencesofwhichwillbedrawnoutovermanydaystocome，canonlybetakenasaresultofanimalspirits&frac34；ofaspontaneousurgetoactionratherthaninaction，andnotastheoutcomeofaweightedaverageofquantitativebenefitsmultipliedbyquantitativeprobabilities。Enterprise[Page162]THE

　　GENERALTHEORYOFEMPLOYMENT

　　onlypretendstoitselftobemainlyactuatedbythestatementsinitsownprospectus，howevercandidandsincere。OnlyalittlemorethananexpeditiontotheSouthPole，isitbasedonanexactcalculationofbenefitstocome。Thusiftheanimalspiritsaredimmedandthespontaneousoptimismfalters，leavingustodependonnothingbutamathematicalexpectation，enterprisewillfadeanddie；&frac34；thoughfearsoflossmayhaveabasisnomorereasonablethanhopesofprofithadbefore。

　　Itissafetosaythatenterprisewhichdependsonhopesstretchingintothefuturebenefitsthecommunityasawhole。Butindividualinitiativewillonlybeadequatewhenreasonablecalculationissupplementedandsupportedbyanimalspirits，sothatthethoughtofultimatelosswhichoftenovertakespioneers，asexperienceundoubtedlytellsusandthem，isputasideasahealthymanputsasidetheexpectationofdeath。

　　Thismeans，unfortunately，notonlythatslumpsanddepressionsareexaggeratedindegree，butthateconomicprosperityisexcessivelydependentonapoliticalandsocialatmospherewhichiscongenialtotheaveragebusinessman。IfthefearofaLabourGovernmentoraNewDealdepressesenterprise，thisneednotbetheresulteitherofareasonablecalculationorofaplotwithpoliticalintent；&frac34；itisthemereconsequenceofupsettingthedelicatebalanceofspontaneousoptimism。Inestimatingtheprospectsofinvestment，wemusthaveregard，therefore，tothenervesandhysteriaandeventhedigestionsandreactionstotheweatherofthoseuponwhosespontaneousactivityitlargelydepends。

　　Weshouldnotconcludefromthisthateverythingdependsonwavesofirrationalpsychology。Onthecontrary，thestateoflong-termexpectationisoftensteady，and，evenwhenitisnot，theotherfactorsexerttheircompensatingeffects。Wearemerelyremindingourselvesthathumandecisionsaffectingthefuture，whetherpersonalorpoliticaloreconomic，cannot[Page163]LONG-TERM

　　EXPECTATION

　　dependonstrictmathematicalexpectation，sincethebasisformakingsuchcalculationsdoesnotexist；andthatitisourinnateurgetoactivitywhichmakesthewheelsgoround，ourrationalselveschoosingbetweenthealternativesasbestweareable，calculatingwherewecan，butoftenfallingbackforourmotiveonwhimorsentimentorchance。

　　VIII

　　Thereare，moreover，certainimportantfactorswhichsomewhatmitigateinpracticetheeffectsofourignoranceofthefuture。Owingtotheoperationofcompoundinterestcombinedwiththelikelihoodofobsolescencewiththepassageoftime，therearemanyindividualinvestmentsofwhichtheprospectiveyieldislegitimatelydominatedbythereturnsofthecomparativelynearfuture。Inthecaseofthemostimportantclassofverylong-terminvestments，namelybuildings，theriskcanbefrequentlytransferredfromtheinvestortotheoccupier，oratleastsharedbetweenthem，bymeansoflong-termcontracts，theriskbeingoutweighedinthemindoftheoccupierbytheadvantagesofcontinuityandsecurityoftenure。Inthecaseofanotherimportantclassoflong-terminvestments，namelypublicutilities，asubstantialproportionoftheprospectiveyieldispracticallyguaranteedbymonopolyprivilegescoupledwiththerighttochargesuchratesaswillprovideacertainstipulatedmargin。Finallythereisagrowingclassofinvestmentsentereduponby，orattheriskof；publicauthorities，whicharefranklyinfluencedinmakingtheinvestmentbyageneralpresumptionoftherebeingprospectivesocialadvantagesfromtheinvestment，whateveritscommercialyieldmayprovetobewithinawiderange，andwithoutseekingtobesatisfiedthatthemathematicalexpectationoftheyieldisatleastequaltothecurrentrateofinterest，&frac34；thoughtheratewhichthepublic[Page164]THE

　　GENERALTHEORYOFEMPLOYMENT

　　authorityhastopaymaystillplayadecisivepartindeterminingthescaleofinvestmentoperationswhichitcanafford。

　　Thusaftergivingfullweighttotheimportanceoftheinfluenceofshort-periodchangesinthestateoflong-termexpectationasdistinctfromchangesintherateofinterest，wearestillentitledtoreturntothelatterasexercising，atanyrate，innormalcircumstances，agreat，thoughnotadecisive，influenceontherateofinvestment。Onlyexperience，however，canshowhowfarmanagementoftherateofinterestiscapableofcontinuouslystimulatingtheappropriatevolumeofinvestment。

　　FormyownpartIamnowsomewhatscepticalofthesuccessofamerelymonetarypolicydirectedtowardsinfluencingtherateofinterest。IexpecttoseetheState，whichisinapositiontocalculatethemarginalefficiencyofcapital-goodsonlongviewsandonthebasisofthegeneralsocialadvantage，takinganevergreaterresponsibilityfordirectlyorganisinginvestment；

　　sinceitseemslikelythatthefluctuationsinthemarketestimationofthemarginalefficiencyofdifferenttypesofcapital，calculatedontheprinciplesIhavedescribedabove，willbetoogreattobeoffsetbyanypracticablechangesintherateofinterest。

　　TheGeneralTheoryofInterest[Page165]

　　Chapter13

　　THEGENERALTHEORYOFTHERATEOFINTEREST

　　I

　　Wehaveshowninchapter11that，whilstthereareforcescausingtherateofinvestmenttoriseorfallsoastokeepthemarginalefficiencyofcapitalequaltotherateofinterest，yetthemarginalefficiencyofcapitalis，initself；adifferentthingfromtherulingrateofinterest。

　　Thescheduleofthemarginalefficiencyofcapitalmaybesaidtogovernthetermsonwhichloanablefundsaredemandedforthepurposeofnewinvestment；

　　whilsttherateofinterestgovernsthetermsonwhichfundsarebeingcurrentlysupplied。Tocompleteourtheory，therefore，weneedtoknowwhatdeterminestherateofinterest。

　　Inchapter14anditsAppendixweshallconsidertheanswerstothisquestionwhichhavebeengivenhitherto。Broadlyspeaking，weshallfindthattheymaketherateofinteresttodependontheinteractionofthescheduleofthemarginalefficiencyofcapitalwiththepsychologicalpropensitytosave。Butthenotionthattherateofinterestisthebalancingfactorwhichbringsthedemandforsavingintheshapeofnewinvestmentforthcomingataivenrateofinterestintoequalitywiththesupplyofsavingwhichresultsatthatrateofinterestfromthecommunity\'spsychologicalpropensitytosave，breaksdownassoonasweperceivethatitisimpossibletodeducetherateofinterestmerelyfromaknowledgeofthesetwofactors。

　　[Page166]THE

　　GENERALTHEORYOFEMPLOYMENT

　　What，then，isourownanswertothisquestion？

　　II

　　Thepsychologicaltime-preferencesofanindividualrequiretwodistinctsetsofdecisionstocarrythemoutcompletely。Thefirstisconcernedwiththataspectoftime-preferencewhichIhavecalledthepropensitytoconsume，which，operatingundertheinfluenceofthevariousmotivessetforthinBookIII，determinesforeachindividualhowmuchofhisincomehewillconsumeandhowmuchhewillreserveinsomeformofcommandoverfutureconsumption。

　　Butthisdecisionhavingbeenmade，thereisafurtherdecisionwhichawaitshim，namely，inwhatformhewillholdthecommandoverfutureconsumptionwhichhehasreserved，whetheroutofhiscurrentincomeorfromprevioussavings。Doeshewanttoholditintheformofimmediate，liquidcommandi。e。inmoneyoritsequivalent？Orishepreparedtopartwithimmediatecommandforaspecifiedorindefiniteperiod，leavingittofuturemarketconditionstodetermineonwhattermshecan，ifnecessary，convertdeferredcommandoverspecificgoodsintoimmediatecommandovergoodsingeneral？Inotherwords，whatisthedegreeofhisliquidity-preference&frac34；whereanindividual\'sliquidity-preferenceisgivenbyascheduleoftheamountsofhisresources，valuedintermsofmoneyorofwage-units，whichhewillwishtoretainintheformofmoneyindifferentsetsofcircumstances？

　　Weshallfindthatthemistakeintheacceptedtheoriesoftherateofinterestliesintheirattemptingtoderivetherateofinterestfromthefirstofthesetwoconstituentsofpsychologicaltime-preferencetotheneglectofthesecond；anditisthisneglectwhichwemustendeavourtorepair。

　　Itshouldbeobviousthattherateofinterestcannot[Page167]THE

　　GENERALTHEORYOFINTEREST

　　beareturntosavingorwaitingassuch。Forifamanhoardshissavingsincash，heearnsnointerest，thoughhesavesjustasmuchasbefore。

　　Onthecontrary，themeredefinitionoftherateofinteresttellsusinsomanywordsthattherateofinterestistherewardforpartingwithliquidityforaspecifiedperiod。Fortherateofinterestis，initself；

　　nothingmorethantheinverseproportionbetweenasumofmoneyandwhatcanbeobtainedforpartingwithcontroloverthemoneyinexchangeforadebt[92]forastatedperiodoftime。[93]

　　Thustherateofinterestatanytime，beingtherewardforpartingwithliquidity，isameasureoftheunwillingnessofthosewhopossessmoneytopartwiththeirliquidcontroloverit。Therateofinterestisnotthe\'price\'whichbringsintoequilibriumthedemandforresourcestoinvestwiththereadinesstoabstainfrompresentconsumption。Itisthe\'price\'whichequilibratesthedesiretoholdwealthintheformofcashwiththeavailablequantityofcash；&frac34；whichimpliesthatiftherateofinterestwerelower，i。e。iftherewardforpartingwithcashwerediminished，theaggregateamountofcashwhichthepublicwouldwishtoholdwouldexceedtheavailablesupply，andthatiftherateofinterestwereraised，therewouldbeasurplusofcashwhichnoonewouldbewillingtohold。Ifthisexplanationiscorrect，thequantityofmoneyisthe[Page168]THE

　　GENERALTHEORYOFEMPLOYMENT

　　otherfactor，which，inconjunctionwithliquidity-preference，determinestheactualrateofinterestingivencircumstances。Liquidity-preferenceisapotentialityorfunctionaltendency，whichfixesthequantityofmoneywhichthepublicwillholdwhentherateofinterestisgiven；sothatifristherateofinterest，MthequantityofmoneyandLthefunctionofliquidity-

　　preference，wehaveM=Lr。Thisiswhere，andhow，thequantityofmoneyentersintotheeconomicscheme。

　　Atthispoint，however，letusturnbackandconsiderwhysuchathingasliquidity-preferenceexists。Inthisconnectionwecanusefullyemploytheancientdistinctionbetweentheuseofmoneyforthetransactionofcurrentbusinessanditsuseasastoreofwealth。Asregardsthefirstofthesetwouses，itisobviousthatuptoapointitisworthwhiletosacrificeacertainamountofinterestfortheconvenienceofliquidity。

　　But，giventhattherateofinterestisnevernegative，whyshouldanyoneprefertoholdhiswealthinaformwhichyieldslittleornointeresttoholdingitinaformwhichyieldsinterestassuming，ofcourse，atthisstage，thattheriskofdefaultisthesameinrespectofabankbalanceasofabond？Afullexplanationiscomplexandmustwaitforchapter15。Thereis，however，anecessaryconditionfailingwhichtheexistenceofaliquidity-preferenceformoneyasameansofholdingwealthcouldnotexist。

　　Thisnecessaryconditionistheexistenceofuncertaintyastothefutureoftherateofinterest，i。e。astothecomplexofratesofinterestforvaryingmaturitieswhichwillruleatfuturedates。Foriftheratesofinterestrulingatallfuturetimescouldbeforeseenwithcertainty，allfutureratesofinterestcouldbeinferredfromthepresentratesofinterestfordebtsofdifferentmaturities，whichwouldbeadjustedtotheknowledgeofthefuturerates。Forexample，if1dristhevaluelnthepresentyear1of&pound；1deferredryearsanditis[Page169]THE

　　GENERALTHEORYOFINTEREST

　　knownthatndrwillbethevalueintheyearnof&pound；1deferredryearsfromthatdate，wehave1dnrndr=&frac34；&frac34；&frac34；&frac34；；

　　1dnwhenceitfollowsthattherateatwhichanydebtcanbeturnedintocashnyearshenceisgivenbytwooutofthecomplexofcurrentratesofinterest。Ifthecurrentrateofinterestispositivefordebtsofeverymaturity，itmustalwaysbemoreadvantageoustopurchaseadebtthantoholdcashasastoreofwealth。

　　If，onthecontrary，thefuturerateofinterestisuncertainwecannotsafelyinferthatndrwillprovetobeequalto1dnr/1dnwhenthetimecomes。Thusifaneedforliquidcashmayconceivablyarisebeforetheexpiryofnyears，thereisariskofalossbeingincurredinpurchasingalong-termdebtandsubsequentlyturningitintocash，ascomparedwithholdingcash。Theactuarialprofitormathematicalexpectationofgaincalculatedinaccordancewiththeexistingprobabilities&frac34；ifitcanbesocalculated，whichisdoubtful&frac34；mustbesufficienttocompensatefortheriskofdisappointment。

　　Thereis，moreover，afurthergroundforliquidity-preferencewhichresultsfromtheexistenceofuncertaintyastothefutureoftherateofinterest，providedthatthereisanorganlsedmarketfordealingindebts。Fordifferentpeoplewillestimatetheprospectsdifferentlyandanyonewhodiffersfromthepredominantopinionasexpressedinmarketquotationsmayhaveagoodreasonforkeepingliquidresourcesinordertoprofit，ifheisright，fromitsturningoutinduecoursethatthe1dr\'swereinamistakenrelationshiptooneanother。[94]

　　Thisiscloselyanalogoustowhatwehavealready[Page170]THE

　　GENERALTHEORYOFEMPLOYMENT

　　discussedatsomelengthinconnectionwiththemarginalefficiencyofcapital。Justaswefoundthatthemarginalefficiencyofcapitalisfixed，notbythe\'best\'opinion，butbythemarketvaluationasdeterminedbymasspsychology，soalsoexpectationsastothefutureoftherateofinterestasfixedbymasspsychologyhavetheirreactionsonliquidity-preference；&frac34；butwiththisadditionthattheindividual，whobelievesthatfutureratesofinterestwillbeabovetheratesassumedbythemarket，hasareasonforkeepingactualliquidcash，[95]whilsttheindividualwhodiffersfromthemarketintheotherdirectionwillhaveamotiveforborrowingmoneyforshortperiodsinordertopurchasedebtsoflongerterm。Themarketpricewillbefixedatthepointatwhichthesalesofthe\'bears\'

　　andthepurchasesofthe\'bulls\'arebalanced。

　　Thethreedivisionsofliquidity-preferencewhichwehavedistinguishedabovemaybedefinedasdependingonithetransactions-motive，i。e。

　　theneedofcashforthecurrenttransactionofpersonalandbusinessexchanges；

　　iitheprecautionary-motive，i。e。thedesireforsecurityastothefuturecashequivalentofacertainproportionoftotalresources；andiiithespeculative-motive，i。e。theobjectofsecuringprofitfromknowingbetterthanthemarketwhatthefuturewillbringforth。Aswhenwewerediscussingthemarginalefficiencyofcapital，thequestionofthedesirabilityofhavingahighlyorganisedmarketfordealingwithdebtspresentsuswithadilemma。For，intheabsenceofanorganisedmarket，liquidity-preferenceduetotheprecautionary-motivewouldbegreatlyincreased；whereastheexistenceofanorganisedmarketgivesan[Page171]THE

　　GENERALTHEORYOFINTEREST

　　opportunityforwidefluctuationsinliquidity-preferenceduetothespeculative-motive。

　　Itmayillustratetheargumenttopointoutthat，iftheliquidity-preferencesduetothetransactions-motiveandtheprecautionary-motiveareassumedtoabsorbaquantityofcashwhichisnotverysensitivetochangesintherateofinterestassuchandapartfromitsreactionsonthelevelofincome，sothatthetotalquantityofmoney，lessthisquantity，isavailableforsatisfyingliquidity-preferencesduetothespeculative-motive，therateofinterestandthepriceofbondshavetobefixedatthelevelatwhichthedesireonthepartofcertainindividualstoholdcashbecauseatthatleveltheyfeel\'bearish\'ofthefutureofbondsisexactlyequaltotheamountofcashavailableforthespeculative-motive。Thuseachincreaseinthequantityofmoneymustraisethepriceofbondssufficientlytoexceedtheexpectationsofsome\'bull\'andsoinfluencehimtosellhisbondforcashandjointhe\'bear\'brigade。If，however，thereisanegligibledemandforcashfromthespeculative-motiveexceptforashorttransitionalinterval，anincreaseinthequantityofmoneywillhavetolowertherateofinterestalmostforthwith，inwhateverdegreeisnecessarytoraiseemploymentandthewage-unitsufficientlytocausetheadditionalcashtobeabsorbedbythetransactions-motiveandtheprecautionary-motive。

　　Asarule，wecansupposethatthescheduleofliquidity-preferencerelatingthequantityofmoneytotherateofinterestisgivenbyasmoothcurvewhichshowstherateofinterestfallingasthequantityofmoneyisincreased。Forthereareseveraldifferentcausesallleadingtowardsthisresult。

　　Inthefirstplace，astherateofinterestfalls，itislikely，cet。

　　par。，thatmoremoneywillbeabsorbedbyliquidity-preferencesduetothetransactions-motive。Forifthefallintherateofinterestincreasesthenationalincome，theamountofmoneywhichitisconvenientto[Page172]THE

　　GENERALTHEORYOFEMPLOYMENT

　　keepfortransactionswillbeincreasedmoreorlessproportionatelytotheincreaseinincome；whilst，atthesametime，thecostoftheconvenienceofplentyofreadycashintermsoflossofinterestwillbediminished。

　　Unlesswemeasureliquidity-preferenceintermsofwage-unitsratherthanofmoneywhichisconvenientinsomecontexts，similarresultsfollowiftheincreasedemploymentensuingonafallintherateofinterestleadstoanincreaseofwages，i。e。toanincreaseinthemoneyvalueofthewage-unit。Inthesecondplace，everyfallintherateofinterestmay，aswehavejustseen，increasethequantityofcashwhichcertainindividualswillwishtoholdbecausetheirviewsastothefutureoftherateofinterestdifferfromthemarketviews。

　　Nevertheless，circumstancescandevelopinwhichevenalargeincreaseinthequantityofmoneymayexertacomparativelysmallinfluenceontherateofinterest。Foralargeincreaseinthequantityofmoneymaycausesomuchuncertaintyaboutthefuturethatliquidity-preferencesduetotheprecautionary-motivemaybestrengthened；whilstopinionaboutthefutureoftherateofinterestmaybesounanimousthatasmallchangeinpresentratesmaycauseamassmovementintocash。Itisinterestingthatthestabilityofthesystemanditssensitivenesstochangesinthequantityofmoneyshouldbesodependentontheexistenceofavarietyofopinionaboutwhatisuncertain。Bestofallthatweshouldknowthefuture。Butifnot，then，ifwearetocontroltheactivityoftheeconomicsystembychangingthequantityofmoney，itisimportantthatopinionsshoulddifferThusthismethodofcontrolismoreprecariousintheUnitedStates，whereeveryonetendstoholdthesameopinionatthesametime，thaninEnglandwheredifferencesofopinionaremoreusual。

　　[Page173]THE

　　GENERALTHEORYOFINTEREST

　　III

　　Wehavenowintroducedmoneyintoourcausalnexusforthefirsttime，andweareabletocatchafirstglimpseofthewayinwhichchangesinthequantityofmoneyworktheirwayintotheeconomicsystem。If，however，wearetemptedtoassertthatmoneyisthedrinkwhichstimulatesthesystemtoactivity，wemustremindourselvesthattheremaybeseveralslipsbetweenthecupandthelip。Forwhilstanincreaseinthequantityofmoneymaybeexpected，cet。par。，toreducetherateofinterest，thiswillnothappeniftheliquidity-preferencesofthepublicareincreasingmorethanthequantityofmoney；andwhilstadeclineintherateofinterestmaybeexpected，cet。par。，toincreasethevolumeofinvestment，thiswillnothappenifthescheduleofthemarginalefficiencyofcapitalisfallingmorerapidlythantherateofintere~t；andwhilstanincreaseinthevolumeofinvestmentmaybeexpected，cet。par。，toincreaseemployment，thismaynothappenifthepropensitytoconsumeisfallingoff。Finally，ifemploymentincreases，priceswillriseinadegreepartlygovernedbytheshapesofthephysicalsupplyfunctions，andpartlybytheliabilityofthewage-unittoriseintermsofmoney。Andwhenoutputhasincreasedandpriceshaverisen，theeffectofthisonliquidity-preferencewillbetoincreasethequantityofmoneynecessarytomaintainagivenrateofinterest。

　　IV

　　Whilstliquidity-preferenceduetothespeculative-motivecorrespondstowhatinmyTreatiseonMoneyIcalled\'thestateofbearishness\'，itisbynomeansthesamething。For\'bearishness\'istheredefinedasthefunctionalrelationship，notbetweentherateofinterestorpriceofdebtsandthequantityofmoney，butbetweenthepriceofassetsanddebts，takentogether，[Page174]THE

　　GENERALTHEORYOFEMPLOYMENT

　　andthequantityofmoney。Thistreatment，however，involvedaconfusionbetweenresultsduetoachangeintherateofinterestandthoseduetoachangeinthescheduleofthemarginalefficiencyofcapital，whichI

　　hopeIhavehereavoided。

　　V

　　Theconceptofhoardingmayberegardedasafirstapproximationtotheconceptofliquidity-preference。Indeedifweweretosubstitute\'propensitytohoard\'for\'hoarding\'，itwouldcometosubstantiallythesamething。Butifwemeanby\'hoarding\'anactualincreaseincash-holding，itisanincompleteidea&frac34；andseriouslymisleadingifitcausesustothinkof\'hoarding\'and\'not-hoarding\'assimplealternatives。Forthedecisiontohoardisnottakenabsolutelyorwithoutregardtotheadvantagesofferedforpartingwithliquidity；&frac34；itresultsfromabalancingofadvantages，andwehave，therefore，toknowwhatliesintheotherscale。Moreoveritisimpossiblefortheactualamountofhoardingtochangeasaresultofdecisionsonthepartofthepublic，solongaswemeanby\'hoarding\'theactualholdingofcash。Fortheamountofhoardingmustbeequaltothequantityofmoneyor&frac34；onsomedefinitions&frac34；tothequantityofmoneyminuswhatisrequiredtosatisfythetransactions-motive；andthequantityofmoneyisnotdeterminedbythepublic。Allthatthepropensityofthepublictowardshoardingcanachieveistodeterminetherateofinterestatwhichtheaggregatedesiretohoardbecomesequaltotheavailablecash。Thehabitofoverlookingtherelationoftherateofinteresttohoardingmaybeapartoftheexplanationwhyinteresthasbeenusuallyregardedastherewardofnot-spending，whereasinfactitistherewardofnot-hoarding。

　　TheClassicalTheoryofInterest[Page175]

　　Chapter14

　　THECLASSICALTHEORYOFTHERATEOFINTEREST

　　I

　　Whatistheclassicaltheoryoftherateofinterest？Itissomethinguponwhichwehaveallbeenbroughtupandwhichwehaveacceptedwithoutmuchreserveuntilrecently。YetIfinditdifficulttostateitpreciselyortodiscoveranexplicitaccountofitintheleadingtreatisesofthemodernclassicalschool。[96]

　　Itisfairlyclear，however，thatthistraditionhasregardedtherateofinterestasthefactorwhichbringsthedemandforinvestmentandthewillingnesstosaveintoequilibriumwithoneanother。Investmentrepresentsthedemandforinvestibleresourcesandsavingrepresentsthesupply，whilsttherateofinterestisthe\'price\'ofinvestibleresourcesatwhichthetwoareequated。Justasthepriceofacommodityisnecessarilyfixedatthatpointwherethedemandforitisequaltothesupply，sotherateofinterestnecessarilycomestorestundertheplayofmarketforcesatthepointwheretheamountofinvestmentatthatrateofinterestisequaltotheamountofsavingatthatrate。

　　TheaboveisnottobefoundinMarshall\'sPrinciplesinsomanywords。Yethistheoryseemstobethis，anditiswhatImyselfwasbroughtuponandwhatItaughtformanyyearstoothers。Take，forexample，thefollowingpassagefromhisPrinciples:\'Interest，beingthepricepaidfortheuseofcapitalinany[Page176]THE

　　GENERALTHEORYOFEMPLOYMENT

　　market，tendstowardsanequilibriumlevelsuchthattheaggregatedemandforcapitalinthatmarket，atthatrateofinterest，isequaltotheaggregatestockforthcomingatthatrate\'。[97]OragaininProfessorCassel\'sNatureandNecessityofInterestitisexplainedthatinvestmentconstitutesthe\'demandforwaiting\'andsavingthe\'supplyofwaiting\'，whilstinterestisa\'price\'whichserves，itisimplied，toequatethetwo，thoughhereagainIhavenotfoundactualwordstoquote。ChapterviofProfessorCarver\'sDistributionofWealthclearlyenvisagesinterestasthefactorwhichbringsintoequilibriumthemarginaldisutilityofwaitingwiththemarginalproductivityofcapital。[98]SirAlfredFluxEconomicPrinciples，p。95writes:\'Ifthereisjusticeinthecontentionsofourgeneraldiscussion，itmustbeadmittedthatanautomaticadjustmenttakesplacebetweensavingandtheopportunitiesforemployingcapitalprofitably……Savingwillnothaveexceededitspossibilitiesofusefulness……solongastherateofnetinterestisinexcessofzero。\'ProfessorTaussigPrinciples，vol。ii。p。29drawsasupplycurveofsavingandademandcurverepresenting\'thediminishingproductivenessoftheseveralinstalmentsofcapital\'，havingpreviouslystatedp。20

　　that\'therateofinterestsettlesatapointwherethemarginalproductivityofcapitalsufficestobringoutthemarginalinstalmentofsaving\'。[

　　99]Walras，in[Page177]THE

　　CLASSICALTHEORYOFINTEREST

　　AppendixIIIIofhis&Eacute；l&eacute；mentsd\'&eacute；conomiepure，wherehedealswith\'l\'&eacute；changed\'&eacute；pargnescontrecapitauxneufs\'，arguesexpresslythat，correspondingtoeachpossiblerateofinterest，thereisasumwhichindividualswillsaveandalsoasumwhichtheywillinvestinnewcapitalassets，thatthesetwoaggregatestendtoequalitywithoneanother，andthattherateofinterestisthevariablewhichbringsthemtoequality；sothattherateofinterestisfixedatthepointwheresaving，whichrepresentsthesupplyofnewcapital，isequaltothedemandforit。Thusheisstrictlyintheclassicaltradition。

　　Certainlytheordinaryman&frac34；banker，civilservantorpolitician&frac34；broughtuponthetraditionaltheory，andthetrainedeconomistalso，hascarriedawaywithhimtheideathatwheneveranindividualperformsanactofsavinghehasdonesomethingwhichautomaticallybringsdowntherateofinterest，thatthisautomaticallystimulatestheoutputofcapital，andthatthefallintherateofinterestisjustsomuchasisnecessarytostimulatetheoutputofcapitaltoanextentwhichisequaltotheincrementofsaving；

　　and，further，thatthisisaself-regulatoryprocessofadjustmentwhichtakesplacewithoutthenecessityforanyspecialinterventionorgrandmotherlycareonthepartofthemonetaryauthority。Similarly&frac34；andthisisanevenmoregeneralbelief，evento-day&frac34；eachadditionalactofinvestmentwillnecessarilyraisetherateofinterest，ifitisnotoffsetbyachangeinthereadinesstosave。

　　Nowtheanalysisofthepreviouschapterswillhavemadeitplainthatthisaccountofthemattermustbeerroneous。Intracingtoitssourcethereasonforthedifferenceofopinion，letus，however，beginwiththematterswhichareagreed。

　　Unliketheneo-classicalschool，whobelievethatsavingandinvestmentcanbeactuallyunequal，theclassicalschoolproperhasacceptedtheviewthattheyareequal。Marshall，forexample，surelybelieved，[Page178]THE

　　GENERALTHEORYOFEMPLOYMENT

　　althoughhedidnotexpresslysayso，thataggregatesavingandaggregateinvestmentarenecessarilyequal。Indeed，mostmembersoftheclassicalschoolcarriedthisbeliefmuchtoofar；sincetheyheldthateveryactofincreasedsavingbyanindividualnecessarilybringsintoexistenceacorrespondingactofincreasedinvestment。Noristhereanymaterialdifference，relevantinthiscontext，betweenmyscheduleofthemarginalefficiencyofcapitalorinvestmentdemand-scheduleandthedemandcurveforcapitalcontemplatedbysomeoftheclassicalwriterswhohavebeenquotedabove。Whenwecometothepropensitytoconsumeanditscorollarythepropensitytosave，wearenearertoadifferenceofopinion，owingtotheemphasiswhichtheyhaveplacedontheinfluenceoftherateofinterestonthepropensitytosave。Buttheywould，presumably，notwishtodenythatthelevelofincomealsohasanimportantinfluenceontheamountsaved；whilstI，formypart，wouldnotdenythattherateofinterestmayperhapshaveaninfluencethoughperhapsnotofthekindwhichtheysupposeontheamountsavedoutofagivenincome。AllthesepointsofagreementcanbesummedupinapropositionwhichtheclassicalschoolwouldacceptandIshouldnotdispute；namely，that，ifthelevelofincomeisassumedtobegiven，wecaninferthatthecurrentrateofinterestmustlieatthepointwherethedemandcurveforcapitalcorrespondingtodifferentratesofinterestcutsthecurveoftheamountssavedoutofthegivenincomecorrespondingtodifferentratesofinterest。

　　Butthisisthepointatwhichdefiniteerrorcreepsintotheclassicaltheory。Iftheclassicalschoolmerelyinferredfromtheabovepropositionthat，giventhedemandcurveforcapitalandtheinfluenceofchangesintherateofinterestonthereadinesstosaveoutofgivenincomes，thelevelofincomeandtherateofinterestmustbeuniquelycorrelated，therewouldbenothingtoquarrelwith。Moreover，thisproposition[Page179]THE

　　CLASSICALTHEORYOFINTEREST

　　wouldleadnaturallytoanotherpropositionwhichembodiesanimportanttruth；namely，that，iftherateofinterestisgivenaswellasthedemandcurveforcapitalandtheinfluenceoftherateofinterestonthereadinesstosaveoutofgivenlevelsofincome，thelevelofincomemustbethefactorwhichbringstheamountsavedtoequalitywiththeamountinvested。

　　But，infact，theclassicaltheorynotmerelyneglectstheinfluenceofchangesinthelevelofincome，butinvolvesformalerror。

　　Fortheclassicaltheory，ascanbeseenfromtheabovequotations，assumesthatitcanthenproceedtoconsidertheeffectontherateofinterestofe。g。ashiftinthedemandcurveforcapital，withoutabatingormodifyingitsassumptionastotheamountofthegivenincomeoutofwhichthesavingsaretobemade。Theindependentvariablesoftheclassicaltheoryoftherateofinterestarethedemandcurveforcapitalandtheinfluenceoftherateofinterestontheamountsavedoutofagivenincome；

　　andwhene。g。thedemandcurveforcapitalshifts，thenewrateofinterest，accordingtothistheory，isgivenbythepointofintersectionbetweenthenewdemandcurveforcapitalandthecurverelatingtherateofinteresttotheamountswhichwillbesavedoutofthegivenincome。Theclassicaltheoryoftherateofinterestseemstosupposethat，ifthedemandcurveforcapitalshiftsorifthecurverelatingtherateofinteresttotheamountssavedoutofagivenincomeshiftsorifboththesecurvesshift，thenewrateofinterestwillbegivenbythepointofintersectionofthenewpositionsofthetwocurves。Butthisisanonsensetheory。Fortheassumptionthatincomeisconstantisinconsistentwiththeassumptionthatthesetwocurvescanshiftindependentlyofoneanother。Ifeitherofthemshift，then，ingeneral，incomewillchange；withtheresultthatthewholeschematismbasedontheassumptionofagivenincomebreaksdown。

　　Thepositioncouldonlybesavedbysome[Page180]THE

　　GENERALTHEORYOFEMPLOYMENT

　　complicatedassumptionprovidingforanautomaticchangeinthewage-unitofanamountjustsufficientinitseffectonliquidity-preferencetoestablisharateofinterestwhichwouldjustoffsetthesupposedshift，soastoleaveoutputatthesamelevelasbefore。Infact，thereisnohinttobefoundintheabovewritersastothenecessityforanysuchassumption；

　　atthebestitwouldbeplausibleonlyinrelationtolong-periodequilibriumandcouldnotformthebasisofashort-periodtheory；andthereisnogroundforsupposingittoholdeveninthelong-period。Intruth，theclassicaltheoryhasnotbeenalivetotherelevanceofchangesinthelevelofincomeortothepossibilityofthelevelofincomebeingactuallyafunctionoftherateoftheinvestment。

　　Theabovecanbeillustratedbyadiagram[100]asfollows:

　　InthisdiagramtheamountofinvestmentorsavingIismeasuredvertically，andtherateofinterestrhorizontally。X1X1\'

　　isthefirstpositionoftheinvestmentdemand-schedule，andX2X2\'

　　isasecondpositionofthiscurve。ThecurveY1relatesthe[Page181]THE

　　CLASSICALTHEORYOFINTEREST

　　amountssavedoutofanincomeY1tovariouslevelsoftherateofinterest，thecurvesY2，Y3，etc。，beingthecorrespondingcurvesforlevelsofincomeY2，Y3，etc。LetussupposethatthecurveY1istheY-curveconsistentwithaninvestmentdemand-scheduleX1X1\'

　　andarateofinterestr1。Nowiftheinvestmentdemand-scheduleshiftsfromX1X1\'toX2X2\'，incomewill，ingeneral，shiftalso。Buttheabovediagramdoesnotcontainenoughdatatotelluswhatitsnewvaluewillbe；and，therefore，notknowingwhichistheappropriateY-curve，wedonotknowatwhatpointthenewinvestmentdemand-schedulewillcutit。If，however，weintroducethestateofliquidity-preferenceandthequantityofmoneyandthesebetweenthemtellusthattherateofinterestisr2，thenthewholepositionbecomesdeterminate。FortheY-curvewhichintersectsX2X2\'atthepointverticallyabover2，namely，thecurveY2，willbetheappropriatecurve。ThustheX-curveandtheY-curvestellusnothingabouttherateofinterest。Theyonlytelluswhatincomewillbe，iffromsomeothersourcewecansaywhattherateofinterestis。

　　Ifnothinghashappenedtothestateofliquidity-preferenceandthequantityofmoney，sothattherateofinterestisunchanged，thenthecurveY2\'

　　whichintersectsthenewinvestmentdemand-scheduleverticallybelowthepointwherethecurveY1intersectedtheoldinvestmentdemand-schedulewillbetheappropriateY-curve，andY2\'

　　willbethenewlevelofincome。

　　Thusthefunctionsusedbytheclassicaltheory，namely，theresponseofinvestmentandtheresponseoftheamountsavedoutofagivenincometochangeintherateofinterest，donotfurnishmaterialforatheoryoftherateofinterest；buttheycouldbeusedtotelluswhatthelevelofincomewillbe，givenfromsomeothersourcetherateofinterest；

　　and，alternatively，whattherateofinterestwillhavetobe，ifthelevelofincomeistobemaintainedatagivenfiguree。g。thelevelcorrespondingtofullemployment。

　　[Page182]THE

　　GENERALTHEORYOFEMPLOYMENT

　　Themistakeoriginatesfromregardinginterestastherewardforwaitingassuch，insteadofastherewardfornot-hoarding；justastheratesofreturnonloansorinvestmentsinvolvingdifferentdegreesofrisk，arequiteproperlyregardedasthereward，notofwaitingassuch，butofrunningtherisk。Thereis，intruth，nosharplinebetweentheseandtheso-called\'pure\'rateofinterest，allofthembeingtherewardforrunningtheriskofuncertaintyofonekindoranother。Onlylntheeventofmoneybeingusedsolelyfortransactionsandneverasastoreofvalue，wouldadifferenttheorybecomeappropriate。[101]

　　Thereare，however，twofamiliarpointswhichmight，perhaps，havewarnedtheclassicalschoolthatsomethingwaswrong。Inthefirstplace，ithasbeenagreed，atanyratesincethepublicationofProfessorCassel\'sNatureandNecessityofInterest，thatitisnotcertainthatthesumsavedoutofagivenincomenecessarilyincreaseswhentherateofinterestisincreased；whereasnoonedoubtsthattheinvestmentdemand-schedulefallswitharisingrateofinterest。ButiftheY-curvesandtheX-curvesbothfallastherateofinterestrises，thereisnoguaranteethatagivenY-curvewillintersectagivenX-curveanywhereatall。ThissuggeststhatitcannotbetheY-curveandtheX-curvealonewhichdeterminetherateofinterest。

　　Inthesecondplace，ithasbeenusualtosupposethatanincreaseinthequantityofmoneyhasatendencytoreducetherateofinterest，atanyrateinthefirstinstanceandintheshortperiod。Yetnoreasonhasbeengivenwhyachangeinthequantityofmoneyshouldaffecteithertheinvestmentdemand-scheduleorthereadinesstosaveoutofagivenincome。

　　ThustheclassicalschoolhavehadquiteadifferenttheoryoftherateofinterestinvolumeIdealingwiththetheoryofvaluefromwhattheyhavehadinvolumeIIdealingwiththetheoryofmoney。Theyhaveseemedun-

　　[Page183]THE

　　CLASSICALTHEORYOFINTEREST

　　disturbedbytheconflictandhavemadenoattempt，sofarasIknow，tobuildabridgebetweenthetwotheories。Theclassicalschoolproper，thatistosay；sinceitistheattempttobuildabridgeonthepartoftheneo-classicalschoolwhichhasledtotheworstmuddlesofall。Forthelatterhaveinferredthattheremustbetwosourcesofsupplytomeettheinvestmentdemand-schedule；namely，savingsproper，whicharethesavingsdealtwithbytheclassicalschool，plusthesummadeavailablebyanyincreaseinthequantityofmoneythisbeingbalancedbysomespeciesoflevyonthepublic，called\'forcedsaving\'orthelike。

　　Thisleadsontotheideathatthereisa\'natural\'or\'neutral\'[102

　　]orequilibrium\'rateofinterest，namely，thatrateofinterestwhichequatesinvestmenttoclassicalsavingsproperwithoutanyadditionfrom\'forcedsavings\'；andfinallytowhat，assumingtheyareontherighttrackatthestart，isthemostobvioussolutionofall，namely，that，ifthequantityofmoneycouldonlybekeptconstantinallcircumstances，noneofthesecomplicationswouldarise，sincetheevilssupposedtoresultfromthesupposedexcessofinvestmentoversavingsproperwouldceasetobepossible。Butatthispointweareindeepwater。\'Thewildduckhasdiveddowntothebottom&frac34；asdeepasshecanget&frac34；andbittenfastholdoftheweedandtangleandalltherubbishthatisdownthere，anditwouldneedanextraordinarilycleverdogtodiveafterandfishherupagain。\'

　　Thusthetraditionalanalysisisfaultybecauseithasfailedtoisolatecorrectlytheindependentvariablesofthesystem。Savingandinvestmentarethedeterminatesofthesystem，notthedeterminants。Theyarethetwinresultsofthesystem\'sdeterminants，namely，thepropensitytoconsume，thescheduleofthemarginalefficiencyofcapitalandtherateofinterest。

　　These[Page184]THE

　　GENERALTHEORYOFEMPLOYMENT

　　determinantsare，indeed，themselvescomplexandeachiscapableofbeingaffectedbyprospectivechangesintheothers。Buttheyremainindependentinthesensethattheirvaluescannotbeinferredfromoneanother。Thetraditionalanalysishasbeenawarethatsavingdependsonincomebutithasoverlookedthefactthatincomedependsoninvestment，insuchfashionthat，wheninvestmentchanges，incomemustnecessarilychangeinjustthatdegreewhichisnecessarytomakethechangeinsavingequaltothechangeininvestment。

　　Norarethosetheoriesmoresuccessfulwhichattempttomaketherateofinterestdependon\'themarginalefficiencyofcapital\'。Itistruethatinequilibriumtherateofinterestwillbeequaltothemarginalefficiencyofcapital，sinceitwillbeprofitabletoincreaseordecrease

　　thecurrentscaleofinvestmentuntilthepointofequalityhasbeenreached。

　　Buttomakethisintoatheoryoftherateofinterestortoderivetherateofinterestfromitinvolvesacircularargument，asMarshalldiscoveredafterhehadgothalf-wayintogivinganaccountoftherateofinterestalongtheselines。[103]Forthe\'marginalefficiencyofcapital\'partlydependsonthescaleofcurrentinvestment，andwemustalreadyknowtherateofinterestbeforewecancalculatewhatthisscalewillbe。Thesignificantconclusionisthattheoutputofnewinvestmentwillbepushedtothepointatwhichthemarginalefficiencyofcapitalbecomesequaltotherateofinterest；andwhatthescheduleofthemarginalefficiencyofcapitaltellsus，is，notwhattherateofinterestis，butthepointtowhichtheoutputofnewinvestmentwillbepushed，giventherateofinterest。

　　Thereaderwillreadilyappreciatethattheproblemhereunderdiscussionisamatterofthemostfundamentaltheoreticalsignificanceandofoverwhelmingpracticalimportance。Fortheeconomicprinciple，[Page185]THE

　　CLASSICALTHEORYOFINTEREST

　　onwhichthepracticaladviceofeconomistshasbeenalmostinvariablybased，hasassumed，ineffect，that，cet。par。，adecreaseinspendingwilltendtolowertherateofinterestandanincreaseininvestmenttoraiseit。Butifwhatthesetwoquantitiesdetermineis，nottherateofinterest，buttheaggregatevolumeofemployment，thenouroutlookonthemechanismoftheeconomicsystemwillbeprofoundlychanged。AdecreasedreadinesstospendwillbelookedoninquiteadifferentlightIf，insteadofbeingregardedasafactorwhichwill，cet。par。，increaseinvestment，itisseenasafactorwhichwill，cet。par。，diminishemployment。

　　AppendixtoChapter14[Page186]

　　AppendixtoChapter14

　　APPENDIXONTHERATEOFINTERESTINMARSHALL\'S

　　PRINCIPLESOFECONOMICS，RICARDO\'SPRINCIPLES

　　OFPOLITICALECONOMY，ANDELSEWHERE

　　I

　　ThereisnoconsecutivediscussionoftherateofinterestintheworksofMarshall，EdgeworthorProfessorPigou，&frac34；nothingmorethanafewobiterdicta。Apartfromthepassagealreadyquotedabovep。139theonlyimportantcluestoMarshall\'spositionontherateofinterestaretobefoundinhisPrinciplesofEconomics6thedn。，BookVI。p。534andp。593，thegistofwhichisgivenbythefollowingquotations:

　　\'Interest，beingthepricepaidfortheuseofcapitalinanymarket，tendstowardsanequilibriumlevelsuchthattheaggregatedemandforcapitalinthatmarket，atthatrateofinterest，isequaltotheaggregatestock[104]forthcomingthereatthatrate。Ifthemarket，whichweareconsidering，isasmallone&frac34；sayasingletown，orasingletradeinaprogressivecountry&frac34；anincreaseddemandforcapitalinitwillbepromptlymetbyanincreasedsupplydrawnfromsurroundingdistrictsortrades。Butifweareconsideringthewholeworld，oreventhewholeofalargecountry，asonemarketforcapital，wecannotregardtheaggregatesupplyofitasalteredquicklyandtoaconsiderableextentbyachangeintherateofinterest。Forthegeneralfundofcapitalistheproductoflabourandwaiting；andtheextra[Page187]APPENDIX

　　TOCHAPTER14

　　work，[105]andtheextrawaiting，towhichariseintherateofinterestwouldactasanincentive，wouldnotquicklyamounttomuch，ascomparedwiththeworkandwaiting，ofwhichthetotalexistingstockofcapitalistheresult。Anextensiveincreaseinthedemandforcapitalingeneralwillthereforebemetforatimenotsomuchbyanincreaseofsupply，asbyariseintherateofinterest；[106]whichwillcausecapitaltowithdrawitselfpartiallyfromthoseusesinwhichitsmarginalutilityislowest。Itisonlyslowlyandgraduallythattheriseintherateofinterestwillincreasethetotalstockofcapital\'p。534。

　　\'Itcannotberepeatedtoooftenthatthephrase\"therateofinterest\"

　　isapplicabletooldinvestmentsofcapitalonlyinaverylimitedsense。

　　[107]Forinstance，wemayperhapsestimatethatatradecapitalofsomeseventhousandmillionsisinvestedinthedifferenttradesofthiscountryatabout3percentnetinterest。Butsuchamethodofspeaking，thoughconvenientandjustifiableformanypurposes，isnotaccurate。Whatought[Page188]THE

　　GENERALTHEORYOFEMPLOYMENT

　　tobesaidisthat，takingtherateofnetinterestontheinvestmentsofnewcapitalineachofthosetrades[i。e。onmarginalinvestments]tobeabout3percent；thentheaggregatenetincomerenderedbythewholeofthetrade-capitalinvestedinthevarioustradesissuchthat，ifcapitalisedat33years\'purchasethatis，onthebasisofinterestat3percent，itwouldamounttosomeseventhousandmillionpounds。Forthevalueofthecapitalalreadyinvestedinimprovinglandorerectingabuilding，inmakingarailwayoramachine，istheaggregatediscountedvalueofitsestimatedfuturenetincomes[orquasi-rents]；andifitsprospectiveincome-yieldingpowershoulddiminish，itsvaluewouldfallaccordinglyandwouldbethecapitalisedvalueofthatsmallerincomeafterallowingfordepreciation\'p。593。

　　InhisEconomicsofWelfare3rdedn。，p。163，ProfessorPigouwrites:\'Thenatureoftheserviceof\"waiting\"hasbeenmuchmisunderstood。

　　Sometimesithasbeensupposedtoconsistintheprovisionofmoney，sometimesintheprovisionoftime，and，onbothsuppositions，ithasbeenarguedthatnocontributionwhateverismadebyittothedividend。Neithersuppositioniscorrect。\"Waiting\"simplymeanspostponingconsumptionwhichapersonhaspowertoenjoyimmediately，thusallowingresources，whichmighthavebeendestroyed，toassumetheformofproductioninstruments[108]……Theunitof\"waiting\"is，therefore，theuseofagivenquantityofresources[109]&frac34；forexample，labourormachinery&frac34；foragiventime……Inmoregeneraltermswemaysaythattheunitofwaitingisayear-value-unit，or，inthesimpler，iflessaccurate，languageofDrCassel，ayear-pound……Acautionmaybeaddedagainstthecommonviewthattheamountofcapitalaccumulatedinanyyearisnecessarilyequaltotheamountof\"savings\"madeinit。Thisisnotso，evenwhensavingsareinterpretedtomeannetsavings，thuseliminatingthesavingsofonemanthatarelenttoincreasetheconsumptionofanother，andwhentemporaryaccumulationsofunusedclaimsuponservicesintheformofbank-moneyareignored；formanysavingswhicharemeanttobecomecapital[Page189]APPENDIX

　　TOCHAPTER14

　　infactfailoftheirpurposethroughmisdirectionintowastefuluses。\'

　　[110]

　　ProfessorPigou\'sonlysignificantreferencetowhatdeterminestherateofinterestis，Ithink，tobefoundinhisIndustrialFluctuations1stedn。，pp。251-3，wherehecontrovertstheviewthattherateofinterest，beingdeterminedbythegeneralconditionsofdemandandsupplyofrealcapital，liesoutsidethecentraloranyotherbank\'scontrol。Againstthisviewhearguesthat:\'Whenbankerscreatemorecreditforbusinessmen，theymake，intheirinterest，subjecttotheexplanationsgiveninchapterxiii。ofparti。，[111]aforcedlevyofrealthingsfromthepublic，thusincreasingthestreamofrealcapitalavailableforthem，andcausingafallintherealrateofinterestonlongandshortloansalike。Itistrue，inshort，thatthebankers\'rateformoneyisboundbyamechanicaltietotherealrateofinterestonlongloans；butitisnottruethatthisrealrateisdeterminedbyconditionswhollyoutsidebankers\'control。\'

　　Myrunningcommentsontheabovehavebeenmadeinthefootnotes。TheperplexitywhichIfindinMarshall\'saccountofthematterisfundamentallydue，Ithink，totheincursionoftheconcept\'interest\'，whichbelongstoamonetaryeconomy，intoatreatisewhichtakesnoaccountofmoney。

　　\'Interest\'hasreallynobusinesstoturnupatallinMarshall\'sPrinciplesofEconomics，&frac34；itbelongstoanotherbranchofthesubject。

　　[Page190]THE

　　GENERALTHEORYOFEMPLOYMENT

　　ProfessorPigou，conformablywithhisothertacitassumptions，leadsusinhisEconomicsofWelfaretoinferthattheunitofwaitingisthesameastheunitofcurrentinvestmentandthattherewardofwaitingisquasi-rent，andpracticallynevermentionsinterest，whichisasitshouldbe。Neverthelessthesewritersarenotdealingwithanon-monetaryeconomyifthereissuchathing。Theyquiteclearlypresumethatmoneyisusedandthatthereisabankingsystem。Moreover，therateofinterestscarcelyplaysalargerpartinProfessorPigou\'sIndustrialFluctuationswhichismainlyastudyoffluctuationsinthemarginalefficiencyofcapitalorinhisTheoryofUnemploymentwhichismainlyastudyofwhatdetermineschangesinthevolumeofemployment，assumingthatthereisnoinvoluntaryunemploymentthaninhisEconomicsofWelfare。