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11. Money and Its Purchasing Power > 17. Further Fallacies of the Keynesian System

A. Interest and Investment

Investment, though the dynamic and volatile factor in the Keynesian system, is also the Keynesian stepchild. Keynesians have differed on the causal determinants of investment. Originally, Keynes determined it by the interest rate as compared with the marginal efficiency of capital, or prospect for net return. The interest rate is supposed to be determined by the money relation; we have seen that this idea is fallacious. Actually, the equilibrium net rate of return is the interest rate, the natural rate to which the bond rate conforms. Rather than changes in the interest rate causing changes in investment, as we have seen before, changes in time preference are reflected in changes in consumption-investment decisions. Changes in the interest rate and in investment are two sides of a coin, both determined by individual valuations and time preferences.

The error of calling the interest rate the cause of investment changes, and itself determined by the money relation, is also adopted by such “critics” of the Keynesian system as Pigou, who asserts that falling prices will release enough cash to lower the interest rate, stimulate investment, and thus finally restore full employment.

Modern Keynesians have tended to abandon the intricacies of the relation between interest and investment and simply declare themselves agnostic on the factors determining investment. They rest their case on an alleged determination of consumption.70

  • 70. Some Keynesians account for investment by the “acceleration principle” (see below). The Hansen “stagnation” thesis—that investment is determined by population growth, the rate of technological improvement, etc.—seems happily to be a thing of the past.