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　　II

　　ThefollowingfromhisPrinciplesofPoliticalEconomyp。511

　　putsthesubstanceofRicardo\'stheoryoftherateofinterest:

　　\'TheinterestofmoneyisnotregulatedbytherateatwhichtheBankwilllend，whetheritbe5，3or2percent。，butbytherateofprofitwhichcanbemadebytheemploymentofcapital，andwhichistotallyindependentofthequantityorofthevalueofmoney。WhethertheBanklentonemillion，tenmillions，orahundredmillions，theywouldnotpermanentlyalterthemarketrateofinterest；theywouldalteronlythevalueofthemoneywhichtheythusissued。Inonecase，tenortwentytimesmoremoneymightberequiredtocarryonthesamebusinessthanwhatmightberequiredintheother。TheapplicationstotheBankformoney，then，dependonthecomparisonbetweentherateofprofitsthatmaybemadebytheemploymentofit，andtherateatwhichtheyarewillingtolendit。Iftheychargelessthanthemarketrateofinterest，thereisnoamountofmoneywhichtheymightnotlend；&frac34；iftheychargemorethanthatrate，nonebutspendthriftsandprodigalswouldbefoundtoborrowofthem。\'

　　Thisissoclear-cutthatitaffordsabetterstarting-pointforadiscussionthanthephrasesoflaterwriterswho，withoutreallydepartingfromtheessenceoftheRicardiandoctrine，areneverthelesssufficientlyuncomfortableaboutittoseekrefugeinhaziness。Theaboveis，ofcourse，asalwayswithRicardo，tobeinterpretedasalong-perioddoctrine，withtheemphasisontheword\'permanently\'half-waythroughthepassage；anditisinterestingtoconsidertheassumptionsrequiredtovalidateit。

　　[Page191]APPENDIX

　　TOCHAPTER14

　　Onceagaintheassumptionrequiredistheusualclassicalassumption，thatthereisalwaysfullemployment；sothat，assumingnochangeinthesupplycurveoflabourintermsofproduct，thereisonlyonepossiblelevelofemploymentinlong-periodequilibrium。Onthisassumptionwiththeusualceterisparibus，i。e。nochangeinpsychologicalpropensitiesandexpectationsotherthanthosearisingoutofachangeinthequantityofmoney，theRicardiantheoryisvalid，inthesensethatonthesesuppositionsthereisonlyonerateofinterestwhichwillbecompatiblewithfullemploymentinthelongperiod。Ricardoandhissuccessorsoverlookthefactthateveninthelongperiodthevolumeofemploymentisnotnecessarilyfullbutiscapableofvarying，andthattoeverybankingpolicytherecorrespondsadifferentlong-periodlevelofemployment；sothatthereareanumberofpositionsoflong-periodequilibriumcorrespondingtodifferentconceivableinterestpoliciesonthepartofthemonetaryauthority。

　　IfRicardohadbeencontenttopresenthisargumentsolelyasapplyingtoanygivenquantityofmoneycreatedbythemonetaryauthority，itwouldstillhavebeencorrectontheassumptionofflexiblemoney-wages。If，thatistosay，Ricardohadarguedthatitwouldmakenopermanentalterationtotherateofinterestwhetherthequantityofmoneywasfixedbythemonetaryauthorityattenmillionsoratahundredmillions，hisconclusionwouldhold。Butifbythepolicyofthemonetaryauthoritywemeanthetermsonwhichitwillincreaseordecreasethequantityofmoney，i。e。

　　therateofinterestatwhichitwill，eitherbyachangeinthevolumeofdiscountsorbyopen-marketoperations，increaseordecreaseitsassets&frac34；whichiswhatRicardoexpresslydoesmeanintheabovequotation&frac34；thenitisnotthecaseeitherthatthepolicyofthemonetaryauthorityisnugatoryorthatonlyonepolicyiscompatiblewithlong-periodequilibrium；

　　thoughintheextremecasewheremoney-wagesareassumedtofallwithoutlimitinfaceofinvoluntaryunemploymentthroughafutilecompetitionforemploymentbetweentheunemployedlabourers，therewill，itistrue，beonlytwopossiblelong-periodpositions&frac34；fullemploymentandthelevelofemploymentcorrespondingtotherateofinterestatwhichliquidity-preferencebecomesabsoluteintheeventofthisbeinglessthanfullemployment。Assumingflexiblemoney-wages，thequantityofmoneyassuchis，indeed，nugatoryinthelongperiod；butthetermsonwhichthemonetaryauthoritywillchangethequantityofmoneyentersasarealdeterminantintotheeconomicscheme。

　　[Page192]THE

　　GENERALTHEORYOFEMPLOYMENT

　　ItisworthaddingthattheconcludingsentencesofthequotationsuggestthatRicardowasoverlookingthepossiblechangesinthemarginalefficiencyofcapitalaccordingtotheamountinvested。Butthisagaincanbeinterpretedasanotherexampleofhisgreaterinternalconsistencycomparedwithhissuccessors。Forifthequantityofemploymentandthepsychologicalpropensitiesofthecommunityaretakenasgiven，thereisinfactonlyonepossiblerateofaccumulationofcapitaland，consequently，onlyonepossiblevalueforthemarginalefficiencyofcapital。Ricardooffersusthesupremeintellectualachievement，unattainablebyweakerspirits，ofadoptingahypotheticalworldremotefromexperienceasthoughitweretheworldofexperienceandthenlivinginitconsistently。Withmostofhissuccessorscommonsensecannothelpbreakingin&frac34；withinjurytotheirlogicalconsistency。

　　III

　　ApeculiartheoryoftherateofinteresthasbeenpropoundedbyProfessorvonMisesandadoptedfromhimbyProfessorHayekandalso，Ithink，byProfessorRobbins；namely，thatchangesintherateofinterestcanbeidentifiedwithchangesintherelativepricelevelsofconsumption-goodsandcapital-goods。[112]Itisnotclearhowthisconclusionisreached。

　　Buttheargumentseemstorunasfollows。Byasomewhatdrasticsimplificationthemarginalefficiencyofcapitalistakenasmeasuredbytheratioofthesupplypriceofnewconsumers\'goodstothesupplypriceofnewproducers\'

　　goods。[113]Thisisthenidentifiedwiththerateofinterest。Thefactiscalledtonoticethatafallintherateofinterestisfavourabletoinvestment。Ergo，afallintheratioofthepriceofconsumers\'

　　goodstothepriceofproducer\'sgoodsisfavourabletoinvestment。

　　Bythismeansalinkisestablishedbetweentncreasedsavingbyanindividualandincreasedaggregateinvestment。Foritiscommongoundthatincreasedindividualsavingwillcauseafallinthepriceofconsumers\'goods，and，quitepossibly，a[Page193]APPENDIX

　　TOCHAPTER14

　　greaterfallthaninthepriceofproducers\'goods；hence，accordingtotheabovereasoning，itmeansareductionintherateofinterestwhichwillstimulateinvestment。But，ofcourse，aloweringofthemarginalefficiencyofparticularcapitalassets，andhencealoweringofthescheduleofthemarginalefficiencyofcapitalingeneral，hasexactlytheoppositeeffecttowhattheaboveargumentassumes。Forinvestmentisstimulatedeitherbyaraisingofthescheduleofthemarginalefficiencyorbyaloweringoftherateofinterest。Asaresultofconfusingthemarginalefficiencyofcapitalwiththerateofinterest，ProfessorvonMisesandhisdiscipleshavegottheirconclusionsexactlythewrongwayround。A

　　goodexampleofaconfusionalongtheselinesisgivenbythefollowingpassagebyProfessorAlvinHansen:[114]\'Ithasbeensuggestedbysomeeconomiststhattheneteffectofreducedspendingwillbealowerpricelevelofconsumers\'goodsthanwouldotherwisehavebeenthecase，andthat，inconsequence，thestimulustoinvestmentinfixedcapitalwouldtherebytendtobeminimised。Thisviewis，however，incorrectandisbasedonaconfusionoftheeffectoncapitalformationofihigherorlowerpricesofconsumers\'goods，and2achangeintherateofinterest。Itistruethatinconsequenceofthedecreasedspendingandincreasedsaving，consumers\'priceswouldbelowrelativetothepricesofproducers\'goods。

　　Butthis，ineffect，meansalowerrateofinterest，andalowerrateofintereststimulatesanexpansionofcapitalinvestmentinfieldswhichathigherrateswouldbeunprofitable。\'IncentivestoLiquidity[Page194]

　　Chapter15

　　THEPSYCHOLOGICALANDBUSINESS

　　INCENTIVESTOLIQUIDITY

　　I

　　Wemustnowdevelopinmoredetailtheanalysisofthemotivestoliquidity-preferencewhichwereintroducedinapreliminarywayinchapter13。Thesubjectissubstantiallythesameasthatwhichhasbeensometimesdiscussedundertheheadingofthedemandformoney。Itisalsocloselyconnectedwithwhatiscalledtheincome-velocityofmoney；&frac34；fortheincome-velocityofmoneymerelymeasureswhatproportionoftheirincomesthepublicchoosestoholdincash，sothatanincreasedincome-velocityofmoneymaybeasymptomofadecreasedliquidity-preference。Itisnotthesamething，however，sinceitisinrespectofhisstockofaccumulatedsavings，ratherthanofhisincome，thattheindividualcanexercisehischoicebetweenliquidityandilliquidity。And，anyhow，theterm\'income-velocityofmoney\'carrieswithitthemisleadingsuggestionofapresumptioninfavourofthedemandformoneyasawholebeingproportional，orhavingsomedeterminaterelation，toincome，whereasthispresumptionshouldapply，asweshallsee，onlytoaportionofthepublic\'scashholdings；

　　withtheresultthatitoverlooksthepartplayedbytherateofinterest。

　　InmyTreatiseonMoneyIstudiedthetotaldemandformoneyundertheheadingsofincome-deposits，[Page195]INCENTIVES

　　TOLIQUIDITY

　　business-deposits，andsavings-deposits，andIneednotrepeatheretheanalysiswhichIgaveinchapter3ofthatbook。Moneyheldforeachofthethreepurposesforms，nevertheless，asinglepool，whichtheholderisundernonecessitytosegregateintothreewater-tightcompartments；

　　fortheyneednotbesharplydividedeveninhisownmind，andthesamesumcanbeheldprimarilyforonepurposeandsecondarilyforanother。

　　Thuswecan&frac34；equallywell，and，perhaps，better&frac34；considertheindividual\'saggregatedemandformoneyingivencircumstancesasasingledecision，thoughthecompositeresultofanumberofdifferentmotives。

　　Inanalysingthemotives，however，itisstillconvenienttoclassifythemundercertainheadings，thefirstofwhichbroadlycorrespondstotheformerclassificationofincome-depositsandbusiness-deposits，andthetwolattertothatofsavings-deposits。TheseIhavebrieflyintroducedinchapter13undertheheadingsofthetransactions-motive，whichcanbefurtherclassifiedastheincome-motiveandthebusiness-motive，theprecautionary-motiveandthespeculative-motive。

　　iTheIncome-motive。Onereasonforholdingcashistobridgetheintervalbetweenthereceiptofincomeanditsdisbursement。

　　Thestrengthofthismotiveininducingadecisiontoholdagivenaggregateofcashwillchieflydependontheamountofincomeandthenormallengthoftheintervalbetweenitsreceiptanditsdisbursement。Itisinthisconnectionthattheconceptoftheincome-velocityofmoneyisstrictlyappropriate。

　　iiTheBusiness-motive。Similarly，cashisheldtobridgetheintervalbetweenthetimeofincurringbusinesscostsandthatofthereceiptofthesale-proceeds；cashheldbydealerstobridgetheintervalbetweenpurchaseandrealisationbeingincludedunderthisheading。Thestrengthofthisdemandwillchieflydependonthevalueofcurrentoutputandhenceon[Page196]THE

　　GENERALTHEORYOFEMPLOYMENT

　　currentincome，andonthenumberofhandsthroughwhichoutputpasses。

　　iiiThePrecautionary-motive。Toprovideforcontingenciesrequiringsuddenexpenditureandforunforeseenopportunitiesofadvantageouspurchases，andalsotoholdanassetofwhichthevalueisfixedintermsofmoneytomeetasubsequentliabilityfixedintermsofmoney，arefurthermotivesforholdingcash。

　　Thestrengthofallthesethreetypesofmotivewillpartlydependonthecheapnessandthereliabilityofmethodsofobtainingcash，whenitisrequired，bysomeformoftemporaryborrowing，inparticularbyoverdraftoritsequivalent。Forthereisnonecessitytoholdidlecashtobridgeoverintervalsifitcanbeobtainedwithoutdifficultyatthemomentwhenitisactuallyrequired。Theirstrengthwillalsodependonwhatwemaytermtherelativecostofholdingcash。Ifthecashcanonlyberetainedbyforgoingthepurchaseofaprofitableasset，thisincreasesthecostandthusweakensthemotivetowardsholdingagivenamountofcash。Ifdepositinterestisearnedorifbankchargesareavoidedbyholdingcash，thisdecreasesthecostandstrengthensthemotive。Itmaybe，however，thatthisislikelytobeaminorfactorexceptwherelargechangesinthecostofholdingcashareinquestion。

　　ivThereremainstheSpeculative-motive。Thisneedsamoredetailedexaminationthantheothers，bothbecauseitislesswellunderstoodandbecauseitisparticularlyimportantintransmittingtheeffectsofachangeinthequantityofmoney。

　　Innormalcircumstancestheamountofmoneyrequiredtosatisfythetransactions-motiveandtheprecautionary-motiveismainlyaresultantofthegeneralactivityoftheeconomicsystemandofthelevelofmoney-income。

　　Butitisbyplayingonthespeculative-motivethatmonetarymanagementor，intheabsenceofmanagement，chancechangesinthequantityofmoney

　　isbroughttobearontheeconomic[Page197]INCENTIVES

　　TOLIQUIDITY

　　system。Forthedemandformoneytosatisfytheformermotivesisgenerallyirresponsivetoanyinfluenceexcepttheactualoccurrenceofachangeinthegeneraleconomicactivityandthelevelofincomes；whereasexperienceindicatesthattheaggregatedemandformoneytosatisfythespeculative-motiveusuallyshowsacontinuousresponsetogradualchangesintherateofinterest，i。e。thereisacontinuouscurverelatingchangesinthedemandformoneytosatisfythespeculativemotiveandchangesintherateofinterestasgivenbychangesinthepricesofbondsanddebtsofvariousmaturities。

　　Indeed，ifthiswerenotso，\'openmarketoperations\'wouldbeimpracticable。

　　Ihavesaidthatexperienceindicatesthecontinuousrelationshipstatedabove，becauseinnormalcircumstancesthebankingsystemisinfactalwaysabletopurchaseorsellbondsinexchangeforcashbybiddingthepriceofbondsupordowninthemarketbyamodestamount；andthelargerthequantityofcashwhichtheyseektocreateorcancelbypurchasingorsellingbondsanddebts，thegreatermustbethefallorriseintherateofinterest。Where，however，asintheUnitedStates，1933-1934

　　open-marketoperationshavebeenlimitedtothepurchaseofveryshort-datedsecurities，theeffectmay，ofcourse，bemainlyconfinedtotheveryshort-termrateofinterestandhavebutlittlereactiononthemuchmoreimportantlong-termratesofinterest。

　　Indealingwiththespeculative-motiveitis，however，importanttodistinguishbetweenthechangesintherateofinterestwhichareduetochangesinthesupplyofmoneyavailabletosatisfythespeculative-motive，withouttherehavingbeenanychangeintheliquidityfunction，andthosewhichareprimarilyduetochangesinexpectationaffectingtheliquidityfunctionitself。Open-marketOperationsmay，indeed，influencetherateofinterestthroughbothchannels；sincetheymaynotonlychangethevolumeof[Page198]THE

　　GENERALTHEORYOFEMPLOYMENT

　　money，butmayalsogiverisetochangedexpectationsconcerningthefuturepolicyofthecentralbankorofthegovernment。Changesintheliquidityfunctionitself；duetoachangeinthenewswhichcausesrevisionofexpectations，willoftenbediscontinuous，andwill，therefore，giverisetoacorrespondingdiscontinuityofchangeintherateofinterest。

　　Only，indeed，insofarasthechangeinthenewsisdifferentlyinterpretedbydifferentindividualsoraffectsindividuallnterestsdifferentlywillthereberoomforanyincreasedactivityofdealinginthebondmarket。

　　Ifthechangeinthenewsaffectsthejudgmentandtherequirementsofeveryoneinpreciselythesameway，therateofinterestasindicatedbythepricesofbondsanddebtswillbeadjustedforthwithtothenewsituationwithoutanymarkettransactionsbeingnecessary。

　　Thus，inthesimplestcase，whereeveryoneissimilarandsimilarlyplaced，achangeincircumstancesorexpectationswillnotbecapableofcausinganydisplacementofmoneywhatever；&frac34；itwillsimplychangetherateofinterestinwhateverdegreeisnecessarytooffsetthedesireofeachindividual，feltatthepreviousrate，tochangehisholdingofcashinresponsetothenewcircumstancesorexpectations；

　　and，sinceeveryonewillchangehisideasastotheratewhichwouldinducehimtoalterhisholdingsofcashinthesamedegree，notransactionswillresult。Toeachsetofcircumstancesandexpectationstherewillcorrespondanappropriaterateofinterest，andtherewillneverbeanyquestionofanyonechanginghisusualholdingsofcash。

　　Ingeneral，however，achangeincircumstancesorexpectationswillcausesomerealignmentinindividualholdingsofmoney；&frac34；since，infact，achangewillinfluencetheideasofdifferentindividualsdifferentlybyreasonspartlyofdifferencesinenvironmentandthereasonforwhichmoneyisheldandpartlyofdifferencesinknowledgeandinterpretationofthe[Page199]INCENTIVES

　　TOLIQUIDITY

　　newsituation。Thusthenewequilibriumrateofinterestwillbeassociatedwitharedistributionofmoney-holdings。Neverthelessitisthechangeintherateofinterest，ratherthantheredistributionofcash，whichdeservesourmainattention。Thelatterisincidentaltoindividualdifferences，whereastheessentialphenomenonisthatwhichoccursinthesimplestcase。

　　Moreover，eveninthegeneralcase，theshiftintherateofinterestisusuallythemostprominentpartofthereactiontoachangeinthenews。

　　Themovementinbond-pricesis，asthenewspapersareaccustomedtosay，\'outofallproportiontotheactivityofdealing\'；&frac34；whichisasitshouldbe，inviewofindividualsbeingmuchmoresimilarthantheyaredissimilarintheirreactiontonews。

　　II

　　Whilsttheamountofcashwhichanindividualdecidestoholdtosatisfythetransactions-motiveandtheprecautionary-motiveisnotentirelyindependentofwhatheisholdingtosatisfythespeculative-motive，itisasafefirstapproximationtoregardtheamountsofthesetwosetsofcash-holdingsasbeinglargelyindependentofoneanother。Letus，therefore，forthepurposesofourfurtheranalysis，breakupourprobleminthisway。Lettheamountofcashheldtosatisfythetransactions-andprecautionary-motivesbeM1，andtheamountheldtosatisfythespeculative-motivebeM2。Correspondingtothesetwocompartmentsofcash，wethenhavetwoliquidityfunctionsL1andL2。L1mainlydependsonthelevelofincome，whilstL2mainlydependsontherelationbetweenthecurrentrateofinterestandthestateofexpectation。ThusM=M1M2

　　=L1YL2r，whereL1istheliquidityfunctioncorrespondingto[Page200]THE

　　GENERALTHEORYOFEMPLOYMENT

　　anincomeY，whichdeterminesM1，andL2istheliquidityfunctionoftherateofinterestr，whichdeterminesM2。Itfollowsthattherearethreematterstoinvestigate:

　　itherelationofchangesinMtoYandr，ii

　　whatdeterminestheshapeofL1，iiiwhatdeterminestheshapeofL2。

　　iTherelationofchangesinMtoYandrdepends，inthefirstinstance，onthewayinwhichchangesinMcomeabout。SupposethatMconsistsofgoldcoinsandthatchangesinMcanonlyresultfromincreasedreturnstotheactivitiesofgold-minerswhobelongtotheeconomicsystemunderexamination。InthiscasechangesinMare，inthefirstinstance，directlyassociatedwithchangesinY，sincethenewgoldaccruesassomeone\'sincome。

　　ExactlythesameconditionsholdifchangesinMareduetothegovernmentprintingmoneywherewithtomeetitscurrentexpenditure；&frac34；inthiscasealsothenewmoneyaccruesassomeone\'sincome。Thenewlevelofincome，however，willnotcontinuesufficientlyhighfortherequirementsofM1toabsorbthewholeoftheincreaseinM；

　　andsomeportionofthemoneywillseekanoutletinbuyingsecuritiesorotherassetsuntilrhasfallensoastobringaboutanincreaseinthemagnitudeofM2andatthesametimetostimulateariseinYtosuchanextentthatthenewmoneyisabsorbedeitherinM2orintheM1whichcorrespondstotheriseinYcausedbythefallinr。Thusatoneremovethiscasecomestothesamethingasthealternativecase，wherethenewmoneycanonlybeissuedinthefirstinstancebyarelaxationoftheconditionsofcreditbythebankingsystem，soastoinducesomeonetosellthebanksadebtorabondinexchangeforthenewcash。

　　Itwill，therefore，besafeforustotakethelattercaseastypical。

　　AchangeinMcanbeassumedtooperatebychangingr，andachangeinrwillleadtoanewequilibriumpartlybychangingM2andpartly[Page201]INCENTIVES

　　TOLIQUIDITY

　　bychangingYandthereforeM1。ThedivisionoftheincrementofcashbetweenM1andM2inthenewpositionofequilibriumwilldependontheresponsesofinvestmenttoareductionintherateofinterestandofincometoanincreaseininvestment。[115]SinceYpartlydependsonr，itfollowsthatagivenchangeinMhastocauseasufficientchangeinrfortheresultantchangesinM1andM2respectivelytoadduptothegivenchangeinM。

　　iiItisnotalwaysmadeclearwhethertheincome-velocityofmoneyisdefinedastheratioofYtoMorastheratioofYtoM1。Ipropose，however，totakeitinthelattersense。ThusifVistheincome-velocityofmoney，Y

　　L1Y=&frac34；&frac34；

　　=M1。

　　VThereis，ofcourse，noreasonforsupposingthatVisconstant。

　　Itsvaluewilldependonthecharacterofbankingandindustrialorganisation，onsocialhabits，onthedistributionofincomebetweendifferentclassesandontheeffectivecostofholdingidlecash。Nevertheless，ifwehaveashortperiodoftimeinviewandcansafelyassumenomaterialchangeinanyofthesefactors，wecantreatVasnearlyenoughconstant。

　　iiiFinallythereisthequestionoftherelationbetweenM2andr。Wehaveseeninchapter13thatuncertaintyastothefuturecourseoftherateofinterestisthesoleintelligibleexplanationofthetypeofliquidity-preferenceL2whichleadstotheholdingofcashM2。ItfollowsthatagivenM2willnothaveadefinitequantitativerelationtoagivenrateofinterestofr；&frac34；whatmattersisnottheabsolutelevelofrbutthedegreeofitsdivergencefromwhatisconsideredafairlysafelevelofr，havingregardtothosecalculationsofprobabilitywhicharebeingreliedon。Nevertheless，therearetworeasonsforexpectingthat，in[Page202]THE

　　GENERALTHEORYOFEMPLOYMENT

　　anygivenstateofexpectation，afallinrwillbeassociatedwithanincreaseinM2。Inthefirstplace，ifthegeneralviewastowhatisasafelevelofrisunchanged，everyfallinrreducesthemarketraterelativelytothe\'safe\'rateandthereforeincreasestheriskofilliquidity；and，inthesecondplace，everyfallinrreducesthecurrentearningsfromilliquidity，whichareavailableasasortofinsurancepremiumtooffsettheriskoflossoncapitalaccount，byanamountequaltothedifferencebetweenthesquaresoftheoldrateofinterestandthenew。Forexample，iftherateofinterestonalong-termdebtis4percent，itispreferabletosacrificeliquidityunlessonabalanceofprobabilitiesitisfearedthatthelong-termrateofinterestmayrisefasterthanby4percentofitselfperannum，i。e。

　　byanamountgreaterthan0。16percentperannum。If，however，therateofinterestisalreadyaslowas2percent，therunningyieldwillonlyoffsetariseinitofaslittleas0。04percentperannum。This，indeed，isperhapsthechiefobstacletoafallintherateofinteresttoaverylowlevel。Unlessreasonsarebelievedtoexistwhyfutureexperiencewillbeverydifferentfrompastexperience，along-termrateofinterestofsay2percentleavesmoretofearthantohope，andoffers，atthesametime，arunningyieldwhichisonlysufficienttooffsetaverysmallmeasureoffear。

　　Itisevident，then，thattherateofinterestisahighlypsychologicalphenomenon。Weshallfind，indeed，inBookVthatitcannotbeinequilibriumatalevelbelowtheratewhichcorrespondstofullemployment；

　　becauseatsuchalevelastateoftrueinflationwillbeproduced，withtheresultthatM1willabsorbever-increasingquantitiesofcash。Butatalevelabovetheratewhichcorrespondstofullemployment，thelong-termmarket-rateofinterestwilldepend，notonlyonthecurrentpolicyofthemonetaryauthority，butalsoonmarketexpectationsconcerningitsfuturepolicy。The[Page203]INCENTIVES

　　TOLIQUIDITY

　　short-termrateofinterestiseasilycontrolledbythemonetaryauthority，bothbecauseitisnotdifficulttoproduceaconvictionthatitspolicywillnotgreatlychangeintheverynearfuture，andalsobecausethepossiblelossissmallcomparedwiththerunningyieldunlessitisapproachingvanishingpoint。Butthelong-termratemaybemorerecalcitrantwhenonceithasfallentoalevelwhich，onthebasisofpastexperienceandpresentexpectationsoffuturemonetarypolicy，isconsidered\'unsafe\'

　　byrepresentativeopinion。Forexample，inacountrylinkedtoaninternationalgoldstandard，arateofinterestlowerthanprevailselsewherewillbeviewedwithajustifiablelackofconfidence；yetadomesticrateofinterestdraggeduptoaparitywiththehighestratehighestafterallowingforriskprevailinginanycountrybelongingtotheinternationalsystemmaybemuchhigherthanisconsistentwithdomesticfullemployment。

　　Thusamonetarypolicywhichstrikespublicopinionasbeingexperimentalincharacteroreasilyliabletochangemayfailinitsobjectiveofgreatlyreducingthelong-termrateofinterest，becauseM2maytendtoincreasealmostwithoutlimitinresponsetoareductionofrbelowacertainfigure。Thesamepolicy，ontheotherhand，mayproveeasilysuccessfulifitappealstopublicopinionasbeingreasonableandpracticableandinthepublicinterest，rootedinstrongconviction，andpromotedbyanauthorityunlikelytobesuperseded。

　　Itmightbemoreaccurate，perhaps，tosaythattherateofinterestisahighlyconventional，ratherthanahighlypsychological，phenomenon。

　　Foritsactualvalueislargelygovernedbytheprevailingviewastowhatitsvalueisexpectedtobe。Anylevelofinterestwhichisacceptedwithsufficientconvictionaslikelytobedurablewillbedurable；subject，ofcourse，inachangingsocietytofluctuationsforallkindsofreasonsroundtheexpectednormal。Inparticular，whenM1

　　[Page204]THE

　　GENERALTHEORYOFEMPLOYMENT

　　isincreasingfasterthanM，therateofinterestwillrise，andviceversa。Butitmayfluctuatefordecadesaboutalevelwhichischronicallytoohighforfullemployment；&frac34；particularlyifitistheprevailingopinionthattherateofinterestisself-adjusting，sothatthelevelestablishedbyconventionisthoughttoberootedinobjectivegroundsmuchstrongerthanconvention，thefailureofemploymenttoattainanoptimumlevelbeinginnowayassociated，inthemindseitherofthepublicorofauthority，withtheprevalenceofaninappropriaterangeofratesofinterest。

　　Thedifficultiesinthewayofmaintainingeffectivedemandatalevelhighenoughtoprovidefullemployment，whichensuefromtheassociationofaconventionalandfairlystablelong-termrateofinterestwithafickleandhighlyunstablemarginalefficiencyofcapital，shouldbe，bynow，obvioustothereader。

　　Suchcomfortaswecanfairlytakefrommoreencouragingreflectionsmustbedrawnfromthehopethat，preciselybecausetheconventionisnotrootedinsecureknowledge，itwillnotbealwaysundulyresistanttoamodestmeasureofpersistenceandconsistencyofpurposebythemonetaryauthority。Publicopinioncanbefairlyrapidlyaccustomedtoamodestfallintherateofinterestandtheconventionalexpectationofthefuturemaybemodifiedaccordingly；thuspreparingthewayforafurthermovement&frac34；uptoapoint。Thefallinthelong-termrateofinterestinGreatBritainafterherdeparturefromthegoldstandardprovidesaninterestingexampleofthis；&frac34；themajormovementswereeffectedbyaseriesofdiscontinuousjumps，astheliquidityfunctionofthepublic，havingbecomeaccustomedtoeachsuccessivereduction，becamereadytorespondtosomenewincentiveinthenewsorinthepolicyoftheauthorities。

　　[Page205]INCENTIVES

　　TOLIQUIDITY

　　III

　　Wecansumuptheaboveinthepropositionthatinanygivenstateofexpectationthereisinthemindsofthepublicacertainpotentialitytowardsholdingcashbeyondwhatisrequiredbythetransactions-motiveortheprecautionary-motive，whichwillrealiseitselfinactualcash-holdingsinadegreewhichdependsonthetermsonwhichthemonetaryauthorityiswillingtocreatecash。ItisthispotentialitywhichissummedupintheliquidityfunctionL2。Correspondingtothequantityofmoneycreatedbythemonetaryauthority，therewill，therefore，becet。

　　par。adetermlnaterateofinterestor，morestrictly，adeterminatecomplexofratesofinterestfordebtsofdifferentmaturities。Thesamething，however，wouldbetrueofanyotherfactorintheeconomicsystemtakenseparately。Thusthisparticularanalysiswillonlybeusefulandsignificantinsofarasthereissomespeciallydirectorpurposiveconnectionbetweenchangesinthequantityofmoneyandchangesintherateofinterest。

　　Ourreasonforsupposingthatthereissuchaspecialconnectionarisesfromthefactthat，broadlyspeaking，thebankingsystemandthemonetaryauthorityaredealersinmoneyanddebtsandnotinassetsorconsumables。

　　Ifthemonetaryauthoritywerepreparedtodealbothwaysonspecifiedtermsindebtsofallmaturities，andevenmoresoifitwerepreparedtodealindebtsofvaryingdegreesofrisk，therelationshipbetweenthecomplexofratesofinterestandthequantityofmoneywouldbedirect。

　　Thecomplexofratesofinterestwouldsimplybeanexpressionofthetermsonwhichthebankingsystemispreparedtoacquireorpartwithdebts；

　　andthequantityofmoneywouldbetheamountwhichcanfindahomeinthepossessionofindividualswho&frac34；aftertakingaccountofallrelevantcircumstances&frac34；preferthecontrolofliquidcashtopartingwithit[Page206]THE

　　GENERALTHEORYOFEMPLOYMENT

　　inexchangeforadebtonthetermsindicatedbythemarketrateofinterest。Perhapsacomplexofferbythecentralbanktobuyandsellatstatedpricesgilt-edgedbondsofallmaturities，inplaceofthesinglebankrateforshort-termbills，isthemostimportantpracticalimprovementwhichcanbemadeinthetechniqueofmonetarymanagement。

　　To-day，however，inactualpractice，theextenttowhichthepriceofdebtsasfixedbythebankingsystemis\'effective\'inthemarket，inthesensethatitgovernstheactualmarket-price，variesindifferentsystems。

　　Sometimesthepriceismoreeffectiveinonedirectionthanintheother；

　　thatistosay，thebankingsystemmayundertaketopurchasedebtsatacertainpricebutnotnecessarilytosellthematafigurenearenoughtoitsbuying-pricetorepresentnomorethanadealer\'sturn，thoughthereisnoreasonwhythepriceshouldnotbemadeeffectivebothwayswiththeaidofopen-marketoperations。Thereisalsothemoreimportantqualificationwhicharisesoutofthemonetaryauthoritynotbeing，asarule，anequallywillingdealerindebtsofallmaturities。Themonetaryauthorityoftentendsinpracticetoconcentrateuponshort-termdebtsandtoleavethepriceoflong-termdebtstobeinfluencedbybelatedandimperfectreactionsfromthepriceofshort-termdebts；&frac34；thoughhereagainthereisnoreasonwhytheyneeddoso。Wherethesequalificationsoperate，thedirectnessoftherelationbetweentherateofinterestandthequantityofmoneyiscorrespondinglymodified。InGreatBritainthefieldofdeliberatecontrolappearstobewidening。Butinapplyingthistheoryinanyparticularcaseallowancemustbemadeforthespecialcharacteristicsofthemethodactuallyemployedbythemonetaryauthority。Ifthemonetaryauthoritydealsonlyinshort-termdebts，wehavetoconsiderwhatinfluencetheprice，actualandprospective，ofshort-termdebtsexercisesondebtsoflongermaturity。

　　[Page207]INCENTIVES

　　TOLIQUIDITY

　　Thustherearecertainlimitationsontheabilityofthemonetaryauthoritytoestablishanygivencomplexofratesofinterestfordebtsofdifferenttermsandrisks，whichcanbesummedupasfollows:

　　1Therearethoselimitationswhichariseoutofthemonetaryauthority\'sownpracticesinlimitingitswillingnesstodealtodebtsofaparticulartype。

　　2Thereisthepossibility，forthereasonsdiscussedabove，that，aftertherateofinteresthasfallentoacertainlevel，liquidity-preferencemaybecomevirtuallyabsoluteinthesensethatalmosteveryonepreferscashtoholdingadebtwhichyieldssolowarateofinterest。Inthiseventthemonetaryauthoritywouldhavelosteffectivecontrolovertherateofinterest。Butwhilstthislimitingcasemightbecomepracticallyimportantinfuture，Iknowofnoexampleofithitherto。Indeed，owingtotheunwillingnessofmostmonetaryauthoritiestodealboldlyindebtsoflongterm，therehasnotbeenmuchopportunityforatest。Moreover，ifsuchasituationweretoarise，itwouldmeanthatthepublicauthorityitselfcouldborrowthroughthebankingsystemonanunlimitedscaleatanominalrateofinterest。

　　3Themoststrikingexamplesofacompletebreakdownofstabilityintherateofinterest，duetotheliquidityfunctionflatteningoutinonedirectionortheother，haveoccurredinveryabnormalcircumstances。

　　InRussiaandCentralEuropeafterthewaracurrencycrisisorflightfromthecurrencywasexperienced，whennoonecouldbeinducedtoretainholdingseitherofmoneyorofdebtsonanytermswhatever，andevenahighandrisingrateofinterestwasunabletokeeppacewiththemarginalefficiencyofcapitalespeciallyofstocksofliquidgoodsundertheinfluenceoftheexpectationofanevergreaterfallinthevalueofmoney；

　　whilstintheUnitedStatesatcertaindatesin1932therewasacrisisoftheoppositekind&frac34；afinancialcrisisorcrisisofliquidation，when[Page208]THE

　　GENERALTHEORYOFEMPLOYMENT

　　scarcelyanyonecouldbeinducedtopartwithholdingsofmoneyonanyreasonableterms。

　　4Thereis，finally，thedifficultydiscussedinsectionIV

　　ofchapter11，p。144，inthewayofbringingtheeffectiverateofinterestbelowacertainfigure，whichmayproveimportantinaneraoflowinterest-rates；

　　namelytheintermediatecostsofbringingtheborrowerandtheultimatelendertogether，andtheallowanceforrisk，especiallyformoralrisk，whichthelenderrequiresoverandabovethepurerateofinterest。Asthepurerateofinterestdeclinesitdoesnotfollowthattheallowancesforexpenseandriskdeclineparipassu。Thustherateofinterestwhichthetypicalborrowerhastopaymaydeclinemoreslowlythanthepurerateofinterest，andmaybeincapableofbeingbrought，bythemethodsoftheexistingbankingandfinancialorganisation，belowacertainminimumfigure。Thisisparticularlyimportantiftheestimationofmoralriskisappreciable。Forwheretheriskisduetodoubtinthemindofthelenderconcerningthehonestyoftheborrower，thereisnothinginthemindofaborrowerwhodoesnotintendtobedishonesttooffsettheresultanthighercharge。Itisalsoimportantinthecaseofshort-termloanse。g。

　　bankloanswheretheexpensesareheavy；&frac34；abankmayhavetochargeitscustomers1&frac12；to2percent。，evenifthepurerateofinteresttothelenderisnil。

　　IV

　　Atthecostofanticipatingwhatismoreproperlythesubjectofchapter21belowitmaybeinterestingbrieflyatthisstagetoindicatetherelationshipoftheabovetothequantitytheoryofmoney。

　　Inastaticsocietyorinasocietyinwhichforanyotherreasonnoonefeelsanyuncertaintyaboutthefutureratesofinterest，theliquidityfunctionL2，orthepropensitytohoardaswemighttermit，will[Page209]INCENTIVES

　　TOLIQUIDITY

　　alwaysbezeroinequilibrium。HenceinequilibriumM2=0andM=M1；sothatanychangeinMwillcausetherateofinteresttofluctuateuntilincomereachesalevelatwhichthechangeinM1isequaltothesupposedchangeinM。NowM1V=Y，whereVistheincome-velocityofmoneyasdefinedaboveandYistheaggregateincome。Thusifitispracticabletomeasurethequantity，O，andtheprice，P，ofcurrentoutput，wehaveY

　　=OP，and，therefore，MV=OP；whichismuchthesameasthequantitytheoryofmoneyinitstraditionalform。

　　[116]

　　Forthepurposesoftherealworlditisagreatfaultinthequantitytheorythatitdoesnotdistinguishbetweenchangesinpriceswhichareafunctionofchangesinoutput，andthosewhichareafunctionofchangesinthewage-unit。[117]Theexplanationofthisomissionis，perhaps，tobefoundintheassumptionsthatthereisnopropensitytohoardandthatthereisalwaysfullemployment。Forinthiscase，ObeingconstantandM2beingzero，itfollows，ifwecantakeValsoasconstant，thatboththewage-unitandtheprice-levelwillbedirectlyproportionaltothequantityofmoney。

　　ObservationsonNatureofCapital[Page210]

　　Chapter16

　　SUNDRYOBSERVATIONSONTHE

　　NATUREOFCAPITAL

　　I

　　Anactofindividualsavingmeans&frac34；sotospeak&frac34；adecisionnottohavedinnerto-day。Butitdoesnotnecessitateadecisiontohavedinnerortobuyapairofbootsaweekhenceorayearhenceortoconsumeanyspecifiedthingatanyspecifieddate。Thusitdepressesthebusinessofpreparingto-day\'sdinnerwithoutstimulatingthebusinessofmakingreadyforsomefutureactofconsumption。Itisnotasubstitutionoffutureconsumption-demandforpresentconsumption-demand，&frac34；itisanetdiminutionofsuchdemand。Moreover，theexpectationoffutureconsumptionissolargelybasedoncurrentexperienceofpresentconsumptionthatareductioninthelatterislikelytodepresstheformer，withtheresultthattheactofsavingwillnotmerelydepressthepriceofconsumption-goodsandleavethemarginalefficiencyofexistingcapitalunaffected，butmayactuallytendtodepressthelatteralso。Inthiseventitmayreducepresentinvestment-demandaswellaspresentconsumption-demand。

　　Ifsavingconsistednotmerelyinabstainingfrompresentconsumptionbutinplacingsimultaneouslyaspecificorderforfutureconsumption，theeffectmightindeedbedifferent。Forinthatcasetheexpectationofsomefutureyieldfrominvestmentwouldbeimproved，andtheresourcesreleasedfrompreparingforpresent[Page211]OBSERVATIONS

　　ONNATUREOFCAPITAL

　　consumptioncouldbeturnedovertopreparingforthefutureconsumption。

　　Notthattheynecessarilywouldbe，eveninthiscase，onascaleequaltotheamountofresourcesreleased；sincethedesiredintervalofdelaymightrequireamethodofproductionsoinconveniently\'roundabout\'

　　astohaveanefficiencywellbelowthecurrentrateofinterest，withtheresultthatthefavourableeffectonemploymentoftheforwardorderforconsumptionwouldeventuatenotatoncebutatsomesubsequentdate，sothattheimmediateeffectofthesavingwouldstillbeadversetoemployment。Inanycase，however，anindividualdecisiontosavedoesnot，inactualfact，involvetheplacingofanyspecificforwardorderforconsumption，butmerelythecancellationofapresentorder。Thus，sincetheexpectationofconsumptionistheonlyraisond\'&ecirc；treofemployment，thereshouldbenothingparadoxicalintheconclusionthatadiminishedpropensitytoconsumehascet。par。adepressingeffectonemployment。

　　Thetroublearises，therefore，becausetheactofsavingimplies，notasubstitutionforpresentconsumptionofsomespecificadditionalconsumptionwhichrequiresforitspreparationjustasmuchimmediateeconomicactivityaswouldhavebeenrequiredbypresentconsumptionequalinvaluetothesumsaved，butadesirefor\'wealth\'assuch，thatisforapotentialityofconsuminganunspecifiedarticleatanunspecifiedtime。Theabsurd，thoughalmostuniversal，ideathatanactofindividualsavingisjustasgoodforeffectivedemandasanactofindividualconsumption，hasbeenfosteredbythefallacy，muchmorespeciousthantheconclusionderivedfromit，thatanincreaseddesiretoholdwealth，beingmuchthesamethingasanincreaseddesiretoholdinvestments，must，byincreasingthedemandforinvestments，provideastimulustotheirproduction；sothatcurrentinvestmentispromotedbyindividualsavingtothesameextentaspresentconsumptionisdiminished。

　　[Page212]THE

　　GENERALTHEORYOFEMPLOYMENT

　　Itisofthisfallacythatitismostdifficulttodisabusemen\'sminds。

　　Itcomesfrombelievingthattheownerofwealthdesiresacapital-assetassuch，whereaswhathereallydesiresisitsprospectiveyield。

　　Now，prospectiveyieldwhollydependsontheexpectationoffutureeffectivedemandinrelationtofutureconditionsofsupply。If，therefore，anactofsavingdoesnothingtoimproveprospectiveyield，itdoesnothingtostimulateinvestment。Moreover，inorderthatanindividualsavermayattainhisdesiredgoaloftheownershipofwealth，itisnotnecessarythatanewcapital-assetshouldbeproducedwherewithtosatisfyhim。Themereactofsavingbyoneindividual，beingtwo-sidedaswehaveshownabove，forcessomeotherindividualtotransfertohimsomearticleofwealtholdornew。Everyactofsavinginvolvesa\'forced\'inevitabletransferofwealthtohimwhosaves，thoughheinhisturnmaysufferfromthesavingofothers。Thesetransfersofwealthdonotrequirethecreationofnewwealth&frac34；indeed，aswehaveseen，theymaybeactivelyinimicaltoit。Thecreationofnewwealthwhollydependsontheprospectiveyieldofthenewwealthreachingthestandardsetbythecurrentrateofinterest。Theprospectiveyieldofthemarginalnewinvestmentisnotincreasedbythefactthatsomeonewishestoincreasehiswealth，sincetheprospectiveyieldofthemarginalnewinvestmentdependsontheexpectationofademandforaspecificarticleataspecificdate。

　　Nordoweavoidthisconclusionbyarguingthatwhattheownerofwealthdesiresisnotagivenprospectiveyieldbutthebestavailableprospectiveyield，sothatanincreaseddesiretoownwealthreducestheprospectiveyieldwithwhichtheproducersofnewinvestmenthavetobecontent。Forthisoverlooksthefactthatthereisalwaysanalternativetotheownershipofrealcapital-assets，namelytheownershipofmoneyanddebts；sothattheprospectiveyieldwithwhich[Page213]OBSERVATIONS

　　ONNATUREOFCAPITAL

　　theproducersofnewinvestmenthavetobecontentcannotfallbelowthestandardsetbythecurrentrateofinterest。Andthecurrentrateofinterestdepends，aswehaveseen，notonthestrengthofthedesiretoholdwealth，butonthestrengthsofthedesirestoholditinliquidandinilliquidformsrespectively，coupledwiththeamountofthesupplyofwealthintheoneformrelativelytothesupplyofitintheother。

　　Ifthereaderstillfindshimselfperplexed，lethimaskhimselfwhy，thequantityofmoneybcingunchanged，afreshactofsavingshoulddiminishthesumwhichitisdesiredtokeepinliquidformattheexistingrateofinterest。

　　Certaindeeperperplexities，whichmayarisewhenwetrytoprobestillfurtherintothewhysandwherefores，willbeconsideredinthenextchapter。

　　II

　　Itismuchpreferabletospeakofcapitalashavingayieldoverthecourseofitslifeinexcessofitsoriginalcost，thanasbeingproductive。

　　Fortheonlyreasonwhyanassetoffersaprospectofyieldingduringitslifeserviceshavinganaggregatevaluegreaterthanitsinitialsupplypriceisbecauseitisscarce；anditiskeptscarcebecauseofthecompetitionoftherateofinterestonmoney。Ifcapitalbecomeslessscarce，theexcessyieldwilldiminish，withoutitshavingbecomelessproductive&frac34；atleastinthephysicalsense。

　　Isympathise，therefore，withthepre-classicaldoctrinethateverythingisproducedbylabour，aidedbywhatusedtobecalledartandisnowcalledtechnique，bynaturalresourceswhicharefreeorcostarentaccordingtotheirscarcityorabundance，andbytheresultsofpastlabour，embodiedinassets，whichalsocommandapriceaccordingtotheirscarcityorabundance。Itispreferabletoregardlabour，including，ofcourse，thepersonalservicesoftheentrepreneurandhisassistants，[Page214]THE

　　GENERALTHEORYOFEMPLOYMENT

　　asthesolefactorofproduction，operatinginagivenenvironmentoftechnique，naturalresources，capitalequipmentandeffectivedemand。Thispartlyexplainswhywehavebeenabletotaketheunitoflabourasthesolephysicalunitwhichwerequireinoureconomicsystem，apartfromunitsofmoneyandoftime。

　　Itistruethatsomelengthyorroundaboutprocessesarephysicallyefficient。Butsoaresomeshortprocesses。Lengthyprocessesarenotphysicallyefficientbecausetheyarelong。Some，probablymost，lengthyprocesseswouldbephysicallyveryinefficient，fortherearesuchthingsasspoilingorwastingwithtime。[118]Withagivenlabourforcethereisadefinitelimittothequantityoflabourembodiedinroundaboutprocesseswhichcanbeusedtoadvantage。Apartfromotherconsiderations，theremustbeadueproportionbetweentheamountoflabouremployedinmakingmachinesandtheamountwhichwillbeemployedinusingthem。Theultimatequantityofvaluewillnotincreaseindefinitely，relativelytothequantityoflabouremployed，astheprocessesadoptedbecomemoreandmoreroundabout，eveniftheirphysicalefficiencyisstillincreasing。Onlyifthedesiretopostponeconsumptionwerestrongenoughtoproduceasituationinwhichfullemploymentrequiredavolumeofinvestmentsogreatastoinvolveanegativemarginalefficiencyofcapital，wouldaprocessbecomeadvantageousmerelybecauseitwaslengthy；inwhicheventweshouldemployphysicallyinefficientprocesses，providedtheyweresufficientlylengthyforthegainfrompostponementtooutweightheirinefficiency。Weshouldinfacthaveasituationinwhichshortprocesseswouldhavetobekeptsufficientlyscarcefortheirphysicalefficiencytooutweighthedisadvantageoftheearlydeliveryoftheirproduct。Acorrecttheory，therefore，mustbereversiblesoastobeabletocovertheeasesofthemarginalefficiencyofcapitalcorresponding[Page215]OBSERVATIONS

　　ONNATUREOFCAPITAL

　　eithertoapositiveortoanegativerateofinterest；anditis，I

　　think，onlythescarcitytheoryoutlinedabovewhichiscapableofthis。

　　Moreoverthereareallsortsofreasonswhyvariouskindsofservicesandfacilitiesarescarceandthereforeexpensiverefativelytothequantityoflabourinvolved。Forexample，smellyprocessescommandahigherreward，becausepeoplewillnotundertakethemotherwise。Sodoriskyprocesses。

　　Butwedonotdeviseaproductivitytheoryofsmellyorriskyprocessesassuch。Inshort，notalllabourisaccomplishedinequallyagreeableattendantcircumstances；andconditionsofequilibriumrequirethatarticlesproducedinlessagreeableattendantcircumstancescharacterisedbysmelliness，riskorthelapseoftimemustbekeptsufficientlyscarcetocommandahigherprice。Butifthelapseoftimebecomesanagreeableattendantcircumstance，whichisaquitepossiblecaseandalreadyholdsformanyindividuals，then，asIhavesaidabove，itistheshortprocesseswhichmustbekeptsufficientlyscarce。

　　Giventheoptimumamountofroundaboutness，weshall，ofcourse，selectthemostefficientroundaboutprocesseswhichwecanfinduptotherequiredaggregate。Buttheoptimumamountitselfshouldbesuchastoprovideattheappropriatedatesforthatpartofconsumers\'demandwhichitisdesiredtodefer。Inoptimumconditions，thatistosay，productionshouldbesoorganisedastoproduceinthemostefficientmannercompatiblewithdeliveryatthedatesatwhichconsumers\'demandisexpectedtobecomeeffective。

　　Itisnousetoproducefordeliveryatadifferentdatefromthis，eventhoughthephysicaloutputcouldbeincreasedbychangingthedateofdelivery；&frac34；exceptinsofarastheprospectofalargermeal，sotospeak，inducestheconsumertoanticipateorpostponethehourofdinner。If，afterhearingfullparticularsofthemealshecangetbyfixingdinnerat[Page216]THE

　　GENERALTHEORYOFEMPLOYMENT

　　differenthours，theconsumerisexpectedtodecideinfavourof8o\'clock，itisthebusinessofthecooktoprovidethebestdinnerhecanforserviceatthathour，irrespectiveofwhether7。30，8o\'clockor8。30isthehourwhichwouldsuithimbestiftimecountedfornothing，onewayortheother，andhisonlytaskwastoproducetheabsolutelybestdinner。Insomephasesofsocietyitmaybethatwecouldgetphysicallybetterdinnersbydininglaterthanwedo；butitisequallyconceivableinotherphasesthatwecouldgetbetterdinnersbydiningearlier。Ourtheorymust，asIhavesaidabove，beapplicabletobothcontingencies。

　　Iftherateofinterestwerezero，therewouldbeanoptimumintervalforanygivenarticlebetweentheaveragedateofinputandthedateofconsumption，forwhichlabourcostwouldbeaminimum；&frac34；ashorterprocessofproductionwouldbelessefficienttechnically，whilstalongerprocesswouldalsobelessefficientbyreasonofstoragecostsanddeterioration。If，however，therateofinterestexceedszero，anewelementofcostisintroducedwhichincreaseswiththelengthoftheprocess，sothattheoptimumintervalwillbeshortened，andthecurrentinputtoprovidefortheeventualdeliveryofthearticlewillhavetobecurtaileduntiltheprospectivepricehasincreasedsufficientlytocovertheincreasedcost&frac34；acostwhichwillbeincreasedbothbytheinterestchargesandalsobythediminishedefficiencyoftheshortermethodofproduction。Whilstiftherateofinterestfallsbelowzeroassumingthistobetechnicallypossible，theoppositeisthecase。Giventheprospectiveconsumers\'demand，currentinputto-dayhastocompete，sotospeak，withthealternativeofstartinginputatalaterdate；and，consequently，currentinputwillonlybeworthwhilewhenthegreatercheapness，byreasonofgreatertechnicalefficiencyorprospectivepricechanges，ofproducinglateronratherthannow，isinsufficienttooffsetthesmallerreturnfromnegative[Page217]OBSERVATIONS

　　ONNATUREOFCAPITAL

　　interest。Inthecaseofthegreatmajorityofarticlesitwouldinvolvegreattechnicalinefficiencytostartuptheirinputmorethanaverymodestlengthoftimeaheadoftheirprospectiveconsumption。Thuseveniftherateofinterestiszero，thereisastrictlimittotheproportionofprospectiveconsumers\'demandwhichitisprofitabletobeginprovidingforinadvance；and，astherateofinterestrises，theproportionoftheprospectiveconsumers\'demandforwhichitpaystoproduceto-dayshrinksparipassu。

　　III

　　Wehaveseenthatcapitalhastobekeptscarceenoughinthelong-periodtohaveamarginalefficiencywhichisatleastequaltotherateofinterestforaperiodequaltothelifeofthecapital，asdeterminedbypsychologicalandinstitutionalconditions。Whatwouldthisinvolveforasocietywhichfindsitselfsowellequippedwithcapitalthatitsmarginalefficiencyiszeroandwouldbenegativewithanyadditionalinvestment；yetpossessingamonetarysystem，suchthatmoneywill\'keep\'andinvolvesnegligiblecostsofstorageandsafecustody，withtheresultthatinpracticeinterestcannotbenegative；and，inconditionsoffullemployment，disposedtosave？

　　If，insuchcircumstances，westartfromapositionoffullemployment，entrepreneurswillnecessarilymakelossesiftheycontinuetoofferemploymentonascalewhichwillutilisethewholeoftheexistingstockofcapital。

　　Hencethestockofcapitalandthelevelofemploymentwillhavetoshrinkuntilthecommunitybecomessoimpoverishedthattheaggregateofsavinghasbecomezero，thepositivesavingofsomeindividualsorgroupsbeingoffsetbythenegativesavingofothers。Thusforasocietysuchaswehavesupposed，thepositionofequilibrium，underconditionsoflaissez-faire，willbeoneinwhichemploymentislowenough[Page218]THE

　　GENERALTHEORYOFEMPLOYMENT

　　andthestandardoflifesufficientlymiserabletobringsavingstozero。Moreprobablytherewillbeacyclicalmovementroundthisequilibriumposition。Forifthereisstillroomforuncertaintyaboutthefuture，themarginalefficiencyofcapitalwilloccasionallyriseabovezeroleadingtoa\'boom\'，andinthesucceeding\'slump\'thestockofcapitalmayfallforatimebelowthelevelwhichwillyieldamarginalefficiencyofzerointhelongrun。Assumingcorrectforesight，theequilibriumstockofcapitalwhichwillhaveamarginalefficiencyofpreciselyzerowill，ofcourse，beasmallerstockthanwouldcorrespondtofullemploymentoftheavailablelabour；foritwillbetheequipmentwhichcorrespondstothatproportionofunemploymentwhichensureszerosaving。

　　Theonlyalternativepositionofequilibriumwouldbegivenbyasituationinwhichastockofcapitalsufficientlygreattohaveamarginalefficiencyofzeroalsorepresentsanamountofwealthsufficientlygreattosatiatetothefulltheaggregatedesireonthepartofthepublictomakeprovisionforthefuture，evenwithfullemployment，incircumstanceswherenobonusisobtainableintheformofinterest。Itwould，however，beanunlikelycoincidencethatthepropensitytosaveinconditionsoffullemploymentshouldbecomesatisfiedjustatthepointwherethestockofcapitalreachesthelevelwhereitsmarginalefficiencyiszero。If，therefore，thismorefavourablepossibilitycomestotherescue，itwillprobablytakeeffect，notjustatthepointwheretherateofinterestisvanishing，butatsomepreviouspointduringthegradualdeclineoftherateofinterest。

　　Wehaveassumedsofaraninstitutionalfactorwhichpreventstherateofinterestfrombeingnegative，intheshapeofmoneywhichhasnegligiblecarryingcosts。Infact，however，institutionalandpsychologicalfactorsarepresentwhichsetalimitmuchabovezerotothepracticabledeclineintherateofinterest。In[Page219]OBSERVATIONS

　　ONNATUREOFCAPITAL

　　particularthecostsofbringingborrowersandlenderstogetheranduncertaintyastothefutureoftherateofinterest，whichwehaveexaminedabove，setalowerlimit，whichinpresentcircumstancesmayperhapsbeashighas2or2&frac12；percentonlongterm。Ifthisshouldprovecorrect，theawkwardpossibilitiesofanincreasingstockofwealth，inconditionswheretherateofinterestcanfallnofurtherunderlaissez-faire，maysoonberealisedinactualexperienceMoreoveriftheminimumleveltowhichitispracticabletobringtherateofinterestisappreciablyabovezero，thereislesslikelihoodoftheaggregatedesiretoaccumulatewealthbeingsatiatedbeforetherateofinteresthasreacheditsminimumlevel。

　　Thepost-warexperiencesofGreatBritainandtheUnitedStatesare，indeed，actualexamplesofhowanaccumulationofwealth，solargethatitsmarginalefficiencyhasfallenmorerapidlythantherateofinterestcanfallinthefaceoftheprevailinginstitutionalandpsychologicalfactors，caninterfere，inconditionsmainlyoflaissez-faire，withareasonablelevelofemploymentandwiththestandardoflifewhichthetechnicalconditionsofproductionarecapableoffurnishing。

　　Itfollowsthatoftwoequalcommunities，havingthesametechniquebutdifferentstocksofcapital，thecommunitywiththesmallerstocksofcapitalmaybeableforthetimebeingtoenjoyahigherstandardoflifethanthecommunitywiththelargerstock；thoughwhenthepoorercommunityhascaughtuptherich&frac34；as，presumably，iteventuallywill&frac34；thenbothalikewillsufferthefateofMidas。Thisdisturbingconclusiondepends，ofcourse，ontheassumptionthatthepropensitytoconsumeandtherateofinvestmentarenotdeliberatelycontrolledinthesocialinterestbutaremainlylefttotheinfluencesoflaissez-faire。

　　If&frac34；forwhateverreason&frac34；therateofinterestcannotfallasfastasthemarginalefficiencyofcapitalwouldfallwitharateofaccumulationcorrespondingtowhat[Page220]THE

　　GENERALTHEORYOFEMPLOYMENT

　　thecommunitywouldchoosetosaveatarateofinterestequaltothemarginalefficiencyofcapitalinconditionsoffullemployment，thenevenadiversionofthedesiretoholdwealthtowardsassets，whichwillinfactyieldnoeconomicfruitswhatever，willincreaseeconomicwell-being。

　　Insofarasmillionairesfindtheirsatisfactioninbuildingmightymansionstocontaintheirbodieswhenaliveandpyramidstoshelterthemafterdeath，or，repentingoftheirsins，erectcathedralsandendowmonasteriesorforeignmissions，thedaywhenabundanceofcapitalwillinterferewithabundanceofoutputmaybepostponed。\'Todigholesintheground\'，paidforoutofsavings，willincrease，notonlyemployment，buttherealnationaldividendofusefulgoodsandservices。Itisnotreasonable，however，thatasensiblecommunityshouldbecontenttoremaindependentonsuchfortuitousandoftenwastefulmitigationswhenonceweunderstandtheinfluencesuponwhicheffectivedemanddepends。

　　IV

　　Letusassumethatstepsaretakentoensurethattherateofinterestisconsistentwiththerateofinvestmentwhichcorrespondstofullemployment。

　　Letusassume，further，thatStateactionentersinasabalancingfactortoprovidethatthegrowthofcapitalequipmentshallbesuchastoapproachsaturation-pointataratewhichdoesnotputadisproportionateburdenonthestandardoflifeofthepresentgeneration。

　　OnsuchassumptionsIshouldguessthataproperlyruncommunityequippedwithmoderntechnicalresources，ofwhichthepopulationisnotincreasingrapidJy，oughttobeabletobringdownthemarginalefficiencyofcapitalinequilibriumapproximatelytozerowithinasinglegeneration；sothatweshouldattaintheconditionsofaquasi-stationarycommunitywherechangeandprogresswouldresultonlyfrom[Page221]OBSERVATIONS

　　ONNATUREOFCAPITAL

　　changesintechnique，taste，populationandinstitutions，withtheproductsofcapitalsellingatapriceproportionedtothelabour，etc。，embodiedinthemonjustthesameprinciplesasgovernthepricesofconsumption-goodsintowhichcapital-chargesenterinaninsignificantdegree。

　　IfIamrightinsupposingittobecomparativelyeasytomakecapital-goodssoabundantthatthemarginalefficiencyofcapitaliszero，thismaybethemostsensiblewayofgraduallygettingridofmanyoftheobjectionablefeaturesofcapitalism。Foralittlereflectionwillshowwhatenormoussocialchangeswouldresultfromagradualdisappearanceofarateofreturnonaccumulatedwealth。Amanwouldstillbefreetoaccumulatehisearnedincomewithaviewtospendingitatalaterdate。Buthisaccumulationwouldnotgrow。HewouldsimplybeinthepositionofPope\'sfather，who，whenheretiredfrombusiness，carriedachestofguineaswithhimtohisvillaatTwickenhamandmethishouseholdexpensesfromitasrequired。

　　Thoughtherentierwoulddisappear，therewouldstillberoom，nevertheless，forenterpriseandskillintheestimationofprospectiveyieldsaboutwhichopinionscoulddiffer。Fortheaboverelatesprimarilytothepurerateofinterestapartfromanyallowanceforriskandthelike，andnottothegrossyieldofassetsincludingthereturninrespectofrisk。Thusunlessthepurerateofinterestweretobeheldatanegativefigure，therewouldstillbeapositiveyieldtoskilledinvestmentinindividualassetshavingadoubtfulprospectiveyield。Providedtherewassomemeasurableunwillingnesstoundertakerisk，therewouldalsobeapositivenetyieldfromtheaggregateofsuchassetsoveraperiodoftime。Butitisnotunlikelythat，insuchcircumstances，theeagernesstoobtainayieldfromdoubtfulinvestmentsmightbesuchthattheywouldshowintheaggregateanegativenetyield。PropertiesofInterestandMoney[Page222]

　　Chapter17

　　THEESSENTIALPROPERTIESOF

　　INTERESTANDMONEY

　　I

　　Itseems，then，thattherateofinterestonmoneyplaysapeculiarpartinsettingalimittothelevelofemployment，sinceitsetsastandardtowhichthemarginalefficiencyofacapital-assetmustattainifitistobenewlyproduced。Thatthisshouldbeso，is，atfirstsight，mostperplexing。Itisnaturaltoenquirewhereinthepeculiarityofmoneyliesasdistinctfromotherassets，whetheritisonlymoneywhichhasarateofinterest，andwhatwouldhappeninanon-monetaryeconomy。Untilwehaveansweredthesequestions，thefullsignificanceofourtheorywillnotbeclear。

　　Themoney-rateofinterest&frac34；wemayremindthereader&frac34；isnothingmorethanthepercentageexcessofasumofmoneycontractedforforwarddelivery，e。g。ayearhence，overwhatwemaycallthe\'spot\'orcashpriceofthesumthuscontractedforforwarddelivery。Itwouldseem，therefore，thatforeverykindofcapital-assettheremustbeananalogueoftherateofinterestonmoney。Forthereisadefinitequantityofe。g。wheattobedeliveredayearhencewhichhasthesameexchangevalueto-dayas100

　　quartersofwheatfor\'spot\'delivery。Iftheformerquantityis105quarters，wemaysaythatthewheat-rateofinterestis5percentperannum；andifjtis95quarters，thatitisminus5percentperannum。Thusforeverydurablecommoditywehavearateofinterestintermsofitself；&frac34；a[Page223]PROPERTIES

　　OFINTERESTANDMONEY

　　wheat-rateofinterest，acopper-rateofinterest，ahouse-rateofinterest，evenasteel-plant-rateofinterest。

　　Thedifferencebetweenthe\'future\'and\'spot\'contractsforacommodity，suchaswheat，whicharequotedinthemarket，bearsadefiniterelationtothewheat-rateofinterest，but，sincethefuturecontractisquotedintermsofmoneyforforwarddeliveryandnotintermsofwheatforspotdelivery，italsobringsinthemoney-rateofinterest。Theexactrelationshipisasfollows:

　　Letussupposethatthespotpriceofwheatis&pound；100per100quarters，thatthepriceofthe\'future\'contractforwheatfordeliveryayearhenceis&pound；107per100quarters，andthatthemoney-rateofinterestis5percent；whatisthewheat-rateofinterest？&pound；100spotwillbuy&pound；105forforwarddelivery，and&pound；105forforwarddeliverywillbuy105/107&times；100=98quartersforforwarddelivery。Alternatively&pound；100spotwillbuy100quartersofwheatforspotdelivery。Thus100quartersofwheatforspotdeliverywillbuy98quartersforforwarddelivery。Itfollowsthatthewheat-rateofinterestisminus2

　　percentperannum。[119]

　　Itfollowsfromthisthatthereisnoreasonwhytheirratesofinterestshouldbethesamefordifferentcommodities，&frac34；whythewheat-rateofinterestshouldbeequaltothecopper-rateofinterest。

　　Fortherelationbetweenthe\'spot\'and\'future\'contracts，asquotedinthemarket，isnotoriouslydifferentfordifferentcommodities。This，weshallfind，willleadustotheclueweareseeking。Foritmaybethatitisthegreatestoftheown-ratesofinterestaswemaycallthemwhichrulestheroostbecauseitisthegreatestoftheseratesthatthemarginalefficiencyofacapital-assetmustattainifitistobenewlyproduced；andthattherearereasonswhyitisthemoney-rateofinterestwhichisoftenthegreatestbecause，asweshallfind，certain[Page224]THE

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　　forces，whichoperatetoreducetheown-ratesofinterestofotherassets，donotoperateinthecaseofmoney。

　　Itmaybeaddedthat，justastherearedifferingcommodity-ratesofinterestatanytime，soalsoexchangedealersarefamiliarwiththefactthattherateofinterestisnoteventhesameintermsoftwodifferentmoneys，e。g。sterlinganddollars。Forherealsothedifferencebetweenthe\'spot\'and\'future\'contractsforaforeignmoneyintermsofsterlingarenot，asarule，thesamefordifferentforeignmoneys。

　　Noweachofthesecommoditystandardsoffersusthesamefacilityasmoneyformeasuringthemarginalefficiencyofcapital。Forwecantakeanycommoditywechoose，e。g。wheat；calculatethewheat-valueoftheprospectiveyieldsofanycapitalasset；andtherateofdiscountwhichmakesthepresentvalueofthisseriesofwheatannuitiesequaltothepresentsupplypriceoftheassetintermsofwheatgivesusthemarginalefficiencyoftheassetintermsofwheat。Ifnochangeisexpectedintherelativevalueoftwoalternativestandards，thenthemarginalefficiencyofacapital-assetwillbethesameinwhicheverofthetwostandardsitismeasured，sincethenumeratoranddenominatorofthefractionwhichleadsuptothemarginalefficiencywillbechangedinthesameproportion。If，however，oneofthealternativestandardsisexpectedtochangeinvalueintermsoftheother，themarginalefficienciesofcapital-assetswillbechangedbythesamepercentage，accordingtowhichstandardtheyaremeasuredin。Toillustratethisletustakethesimplestcasewherewheat，oneofthealternativestandards，isexpectedtoappreciateatasteadyrateofapercentperannumintermsofmoney；themarginalefficiencyofanasset，whichisxpercentintermsofmoney，willthenbex-apercentintermsofwheat。Sincethemarginalefficienciesofallcapital-assetswillbealteredbythesameamount，itfollowsthattheirorderofmagnitudewillbethesameirrespectiveofthestandardwhichisselected。

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　　Ifthereweresomecompositecommoditywhichcouldberegardedstrictlyspeakingasrepresentative，wecouldregardtherateofinterestandthemarginalefficiencyofcapitalintermsofthiscommodityasbeing，inasense，uniquelytherateofinterestandthemarginalefficiencyofcapital。Butthereare，ofcourse，thesameobstaclesinthewayofthisastherearetosettingupauniquestandardofvalue。

　　Sofar，therefore，themoney-rateofinteresthasnouniquenesscomparedwithotherratesofinterest，butisonpreciselythesamefooting。Wherein，then，liesthepeculiarityofthemoney-rateofinterestwhichgivesitthepredominatingpracticalimportanceattributedtoitintheprecedingchapters？Whyshouldthevolumeofoutputandemploymentbemoreintimatelyboundupwiththemoney-rateofinterestthanwiththewheat-rateofinterestorthehouse-rateofinterest？