Keynes Monetary Theory Of Interest Essay

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2.4.3 The Keynes Monetary Theory of Interest
Keynes (1936) defines the interest rate as the reward for parting with liquidity in the specified period. The interest rate represents the price which equilibrates the wealth in the form of cash and the available quantity of cash, but not the one relative to the equilibrium between the demand of resources and investment with the readiness to abstain consumption. In the other words, the interest rate in the Keynesian sense is determined by the demand and the supply of money. This theory is therefore known as the monetary theory of interest and it is distinct to the real or classical theory.
The supply of money refers to the total quantity of money in the country for all purpose at any time. Though …show more content…

The natural interest rate is the interest rate at which the demand for loan capital and supply of savings exactly agree, and which more or less corresponds to the expected yield on the newly created capital, will then be the normal or natural real rate consistent with a stable money supply and stable prices. On the other hand, market interest rate is the money prevailing in the loan market. It is the interest rate charged by banks or lenders. It depends upon the demand and supply of money. According to Wicksell (1898, 1907, 1958), the natural interest rate is essentially variable. It is partly determined by the demand for loans which, in return, depends on the expected profitability of banks. All factors which affect the expected profitability of banks bring changes in the natural interest rate. He pointed out that, the natural interest rate is not the same as the market interest rate. There are disparities between the two rates during the short run which produce changes in the price level. The market interest rate tends to be sticky and responds slowly to changes in the demand for loanable funds. In the long-run, disparities between the two rates automatically generate forces which bring their equality, Jhingan …show more content…

Brenner and Melzer believe that the interest rate level is always adjusted by the Central Bank. The lending market is influenced and the enterprises borrow money for investment and production, that will increase the national income. In addition, Modigliani said that the interest rate also has an influence on consumers spending, thereby affecting the real economy. Even though, the schools have different point of views on interest rate transmission mechanism, and we admitted that interest rates are regulated by endogenous variables such as investment, savings, money supply and demand, supply and demand of loanable funds etc. In turn, the economic variables are also influenced by interest

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