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A Reinterpretation of Chapter 17 of Keynes's general Theory: Effective Demand Shortage Under Dynamic Optimization
Author(s) -
Ono Yoshiyasu
Publication year - 2001
Publication title -
international economic review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.658
H-Index - 86
eISSN - 1468-2354
pISSN - 0020-6598
DOI - 10.1111/1468-2354.00107
Subject(s) - economics , liquidity preference , interest rate , futures studies , reinterpretation , consumption (sociology) , market liquidity , liquidity trap , general equilibrium theory , effective demand , time preference , mathematical economics , econometrics , microeconomics , keynesian economics , macroeconomics , mathematics , liquidity risk , social science , statistics , physics , sociology , acoustics
This article is an attempt to formalize Chapter 17 of Keynes's General Theory using a continuous dynamic optimization model with perfect foresight. I present two subjective interest rates: the time preference rate and the liquidity premium that, respectively, govern the consumption‐saving and portfolio decisions. Under optimal household behavior, they are equalized to the market rate of interest. In the monetary economy described by Keynes, however, the equality can be inconsistent with the condition of market equilibrium, in which case persistent stagnation occurs. A new analytic method based on dynamic optimization is proposed as an alternative to IS‐LM analysis.