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"Asset Prices, Liquidity Preference, and the Business Cycle"

By Korkut A. Erturk


In his Treatise on Money, Keynes relied on two different premises to argue that the interest rate need not rise with rising levels of expenditure. One of these was the elasticity of the money supply, and the other was the interaction between financial and industrial circulation. A decrease (increase) in what Keynes called the bear position was similar in its impact to that of a policy-induced increase (decrease) in the money supply. In his General Theory, this second line of argument lost much of its force as it became reformulated under the rubric of Keynes's liquidity preference theory of interest. Assuming that the interest rate sets the return on capital, Keynes dismissed the effect of bull or bear sentiment in equity markets as a second-order complication that can be ignored in analyzing the equilibrium level of investment and output. The objective of this paper is to go back to this old theme from the Treatise and underscore its importance for the Keynesian theory of the business cycle.

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  2. (1996). discuss the main contours of this shift in detail and argue that along the way Keynes's notion of equilibrium/disequilibrium has changed as well (Erturk
  3. (1954). For the early discussions on the possible instability of speculative demand for money, see Kahn
  4. he returned to it in his exchanges with his critics after the publication of the General Theory (see below).
  5. (1986). Noise."
  6. (1998). on noise trading and the efficient market hypothesis.
  7. The volume of financial circulation also reflects the volume of trading times the average value of instruments traded.
  8. We can lump bonds and shares together as Keynes does in the Treatise, and define the supply of money coextensively with bank money.

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