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Spahn, Heinz-Peter
Year of Publication: 
Series/Report no.: 
ROME Discussion Paper Series 10-13
Abstract (Translated): 
Liquidity preference theory had a hard time to defeat the loanable funds approach because Keynes himself failed to elucidate the financing of investment in the General Theory. Liquidity preference is a key element in the credit supply decision of the banking system. Liquidity premium is an equilibrium shadow price of staying liquid in a market economy. The debate on endogenous money tended to blur the distinction between base money and bank deposits. Post-war trends in central banking established the norm of avoiding quantity constraints in refinancing the commercial banking system. This reduced individual motives of keeping liquid reserves, contributed to the lengthening of the chain of financial intermediation, and helped to build up a fragile structure of high-risk investment strategies in financial markets. A re-introduction of quantity constraints in central bank money supply is apt to produce a liquidity preference effect upon interest rates and might help to prevent the emergence of asset price bubbles.
Liquidity preference
loanable funds
money supply
financial market instability
Document Type: 
Working Paper
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