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Cambridge Journal of Economics Advance Access published online on June 8, 2009
Cambridge Journal of Economics, doi:10.1093/cje/bep020
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© The Author 2009. Published by Oxford University Press on behalf of the Cambridge Political Economy Society. All rights reserved.

Uncertainty and money: Keynes, Tobin and Kahn and the disappearance of the precautionary demand for money from liquidity preference theory

Fernando J. Cardim de Carvalho*

* Federal University of Rio de Janeiro, Brazil

Address for correspondence: Institute of Economics, Federal University of Rio de Janeiro, Rua Pasteur 250, Rio de Janeiro 22290-080, Brazil; email: fjccarvalho{at}uol.com.br

Keynes answered to critics of the General Theory, in 1937, that they failed to realize that there were two main innovations in that work. The first, was the relationship between money demand and uncertainty; the second was the consumption multiplier. The relation between money demand and uncertainty was in fact the main reason to explain why aggregate demand could fall short of full employment income. However, this was explained by Keynes in 1937 by recourse to a form of precautionary demand for money. In The GT, Keynes had actually merged the precautionary demand into the transactions demand for money, making it very difficult for any reader, friendly or unfriendly, to actually see what he meant in 1937. As a result, Keynes liquidity preference theory of the interest rate in the GT exhibited some important shortcomings that were the subject of many reexaminations, including one by Richard Kahn and another by James Tobin. The paper evaluates Keynes's views, Kahn's and Tobin's solutions to Keynes's dilemmas. At its conclusion it is shown why these themes remain relevant today, particularly when financial systems are in turmoil.

Key Words: Liquidity preference theory • The economics of Keynes

JEL classifications: E40, E41, E43

Manuscript received July 17, 2008; final version received January 28, 2009.


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