No abstract

This paper revisits Keynes’s theory of liquidity preference to emphasise its reliance on liquidity. By clarifying the meaning of ‘liquidity’ in the context of the theory, it is argued that liquidity preference is not based on the demand for money, the most tradable asset, or a theory of bearishness. Instead, liquidity preference represents a demand for price-protected (capital-safe) assets, most directly inside and outside money, but also cash-equivalent quasi-money such as self-liquidating assets and security repurchase agreements (repo). The theory of liquidity preference explains that the public is willing to forgo interest income to hold short-term price-protected assets due to the capital and price uncertainty associated with relying on market liquidity, or how easy it is to convert an asset into money. It follows that the rate of interest is a monetary phenomenon and is determined independently of saving and investment.

Disagreements over the nature of money and consequent confusions regarding liquidity contribute to difficulties integrating monetary theory into the theory of value. For example, an abundance of market liquidity is assumed in asset pricing, whereas a scarcity of monetary liquidity is deemed necessary for consumer price-level determinacy. This paper builds on the insights gained from the evolution of finance to introduce a distinction between exchange liquidity and redemption liquidity as a means of resolving this conceptual dissonance. Both exchange and redemption liquidity can be conceptualised as types of financial option differing in the exercise mechanism offered to the option holder by the option-writer.

The term "liquidity" covers many concepts, but is generally taken to refer to the ease of convertibility into money. The literature classifies this ease of convertibility as "market liquidity" to distinguish it from "funding liquidity" which represents the ease of obtaining funding. Many other forms of liquidity can be identified that do not receive their own specific classification. A more granular taxonomy that clarifies and distinguishes each form would permit greater analytical precision when investigating empirical evidence. This paper offers such a taxonomy.

The philosophy of Henri Bergson can lend fresh perspectives on some central aspects of post-Keynesian economic thought. Bergson’s concept of duration offers philosophical reinforcement for Joan Robinson’s criticisms of the treatment of time, equilibrium and uncertainty in economics. When the economy is recognised to be a dynamic living system, in which the accumulation of capital is an historical process inseparable from technical innovation, the effect of time is of utmost importance. Duration provides greater understanding of an economy moving through historical time, while adding depth to Robinson’s doubts about the validity of utility, and consequently expected utility theory. Bergson’s philosophy of evolution and duration provides a valuable basis for understanding many of the classical issues in political economy.