A Monetary Theory of the Rate of Interest

In approaching Keynes’s own theory of the rate of interest, there are four points to be kept in mind. The first is that Keynes was driven to seek a new explanation of interest once he realised that classically based theories were involved in logical error and had to be replaced. The second is that in a monetary economy the rate of interest is a monetary phenomenon and derives from the uniqueness of money. The third is that because of its monetary nature the rate of interest exerts a powerful regulatory influence on the level of economic activity. The fourth is that while on a purely mechanical level the interest rate is proximately determined by the available stock of money and the aggregate demand for money, this is so only on the understanding that ‘all influences other than the amount of money are portmanteaued in the liquidity function’.1