The role of liquidity preference in a framework of endogenous money

By Marco Missaglia, Alberto Botta

PKES Working Paper 2015

July 2020

In this paper we build a simple, almost pedagogical, Keynesian model about the role of liquidity preference in the determination of economic performance. We assume a world of endogenous money, where the banking system is able to fix the interest rate at a level of its own willing. Even in this framework, we show that the Keynesian theory of liquidity preference, while obviously not constituting anymore a theory for the determination of the interest rate, continues to be a fundamental piece of theory for the determination of the level and evolution of aggregate income over time, both in the short and in the medium run. However powerful, the banking system and monetary authorities are not the deus ex-machina of our economies and financial markets are likely to exert a permanent influence on our economic destiny.

Keywords: Liquidity preference, endogenous money, finance dominance

JEL classification: C62 E12 E44