Re: Uncertainty and Liquidity Preference

[Paul Davidson <pdavidson@xxxxxxx>]

At 07:53 PM 7/11/99 -0400, Ted wrote:
>>
>
>I've read you too Paul.  I'll read you again more carefully.  My
>recollection is that you don't answer the question either, however.  The
>reference to Chap. 16 of the GT doesn't help me.


Perhaps my exposition is not clear enough- What else do you think Keynes
means when he writes "An act of individual saving means -- so to speak -- a
decision not to have dinner today. But it does NOT necessitate a decision
to have dinner or to buy a pair of boots a week hence or a year hence or to
consume any specified thing at any specified date...It is not a
substitution of future consumption-demand for present consumption demand"
[GT, chapter 16 , p. 210]  Thus when some one saves his current claims
(income) on the products of industry, he is not contractually ordering
dinner on a spot contract or a future dinner on a forward contract.  He is
searching for aa way of moving these claims forward to the indefinite future.

Why not try my Cambridge Journal of Economics article, (1988, vol 12,
especially pages 332-36 that deals with knowledge, uncertainty,:money and
explicit money contracts in aa nonergodic world.

As long as the economy's production and exchange activities  is organized
on the basis of nominal contracts, then when ever an income earner fells
very uncertain about the future and desires not to commit his earned (or
borrowed) claims on the products of industry, then he will search for what
I called a "time machine" (in my PKMT book) to store his claims till an
uncertain future date when he may wish to exercise them.

In a contractual economy, one must have money to execute spot or forwrd
purchase contracts--- hence this time machine to store claims  must EITHER
be money OR some liquid asset.
 i.e., an asset that  has the following properties : (a) durability with
very low relative low carrying  costs, (2)can be readily resold for money
on a WELL-ORGANIZED, ORDERLY market [hence illiquid assets are not good
ways of carrying forward claims if the decision maker fears the uncertain
future], and (3) has an expected nominal rate of return (i.e., expected
nominal earnings plus expected resale price relative to its spot price)
that exceeds the liquidity premium for holding money.

Money is, by definition of an entrepreneurial economy (i.e., one that
organizes economic activities on the basis of money contracts), the liquid
asset par excellence.For it is the thing that settles contracts.  Thus, in
any economy in which the law of contracts is important, then the government
which is required to enforce the civil law of contracts determines what is
money--- Money is therefore a CHARTALIST institution.

Liquidity preference occurs when there are other durable assets (besides
money) that have the above properties .

Accordingly, as I point out with the formulas on p.115 in my PKMT, and use
in my attack on the Tobin Tax in the May 1997 ECONOMIC JOURNAL, each person
that possesses claims on industrial output that does not wish to exercise
them immediately must find some time machine (liquidity) vehicle.  The
choice of which vehicle of the available liquid assets to use as a time
machine will involve comparing the expected nominal return minus carrying
cost  (q-c) accruing to the holder of the asset. plus the expected future
spot price when the asset is sold minus its current spot price plus the
transactions costs of buying and selling the asset, i.e.,

(q-c)  plus (future spot price minus current spot price) plus transactions
costs

If this sum for any specific resaleable asset > 0, the decision maker is a
bull and will buy this liquid asset rather than hold money (contractual
claiims)
If this sum <0, then the decision maker is a bear and his liquidity
preference is for money rather than for holding this particular asset.

Since I have been writing on this for at least two decades without anyone
-- including Tobin -- indicating this argument about liquidity preference
is wrong, I find it difficult to understand why, while you claim to have
read wat I wrote, you do not think I am responding to your inquiry as to
the meaning and role of liquidity preference in an entrepreneurial economy.

Perhaps you can enlighten me Ted?

Paul



I don't think Keynes treats liquidity preference as a rational way of
>dealing with fundamental uncertainty.  Like conventional forecasting
>practices, liquidity preference in this context is a way of avoiding the
>anxiety provoked by _consciousness_ of fundamental uncertainty.
>Conventional forecasting practices work by suppressing this consciousness;
>they enable us to "hide from ourselves how little we foresee."
>
>The "feeling about money" that enables anxiety to be avoided by holding
>money is, like these forecasting practices, "itself conventional or
>instinctive" but "operates, so to speak, at a deeper level of our
>motivation". "It takes charge at the moments when the higher, more
>precarious conventions have weakened.  The possession of actual money lulls
>our disquietude; and the premium which we require to make us part with
>money is the measure of the degree of our disquietude."  (XIV, p. 116)
>
>Fundamental uncertainty is invariant; what varies is _consciousness_ of
>fundamental uncertainty.  For the psychological reason just pointed to,
>liquidity preference varies with this consciousness.
>
>The discussion in Chap. 16 is fully consistent with this.  It treats the
>marginal efficiency of capital as the product of conventional forecasting
>practices, i.e. as the outcome of practices associated not with rational
>"faith" in the "optimistic hypothesis" but with an irrational need to "hide
>from ourselves how little we foresee."  Thus "the expectation of future
>consumption is so largely based on current experience of present
>consumption that a reduction in the latter is likely to depress the former,
>with the result that the act of saving will not merely depress the price of
>consumption-goods and leave the marginal efficiency of existing capital
>unaffected, but may actually tend to depress the latter also". (VII, p. 210)
>
>Another difficulty with basing an interpretation of the relation between
>uncertainty and liquidity preference on the premise that individuals are
>always fully conscious of fundamental uncertainty and act rationally in
>relation to it is raised by Keynes's claim in Chap. 16 that an "absurd"
>idea about the effect of increased saving on investment - Say's law - is
>"almost universal".  Moreover, "it is of this fallacy ['that current
>investment is promoted by individual saving to the same extent as present
>consumption is diminished'] that it is most difficult to disabuse men's
>minds."  (VII, p. 211-2)  Why would sensible people be "most difficult to
>disabuse" of an "absurd" idea?
>
>Ted
>
>
>
>
>
>Ted Winslow                          E-MAIL: WINSLOW@xxxxxxxx
>Division of Social Science           VOICE: (416) 736-5054
>York University                      FAX: (416) 736-5615
>4700 Keele St.
>North York, Ont.
>CANADA M3J 1P3
>
>
>
>
Paul Davidson
Holly Chair of Excellence in Political Economy
Economics Department -- 523 SMC
University of Tennessee
Knoxville, Tennesseee 37996-0550
email: Pdavidson@xxxxxxx;
phone: (423)974-4221;    fax: (423) 974-1686
http://econ.bus.utk.edu/Davidson.html