Keynes versus Loanable Funds Theory

Colin Rogers sums it up well:

“In his correspondence with Harrod, Keynes (1973: 552) made it clear that in his opinion the classical theory of the rate of interest should be discarded in toto as it was incapable of rehabilitation in any shape or form! The classical theory of the rate of interest to which Keynes was referring is of course the theory in terms of which the forces of productivity and thrift determine the natural rate—the loanable funds theory. It is this theory which was adopted from Wicksell and which Keynes applied in the Treatise and of which Robertson remained an ardent supporter. And it is this theory which is adopted by mainstream Keynesians. With the benefit of hindsight, it is now apparent that it is this loanable funds theory of the rate of interest which collapses in the face of the capital critique.” (Rogers 1997: 42).

Now a New Keynesian like Paul Krugman can attack what he calls a “naive loanable funds view,” but New Keynesians often still use some version of loanable funds in questionable ways. For example, one can find it in Gregory Mankiw’s Principles of Macroeconomics, perhaps even in a pre-Keynesian form (Lodewijks 2012: 34).

Perhaps this is why those coming from the New Keynesian perspective will be puzzled by attacks on loanable funds theory in critiques of the Austrian business cycle theory.

BIBLIOGRAPHY
Lodewijks, J. 2012. “Bastard Keynesianism,” in J. E. King (ed.), The Elgar Companion to Post Keynesian Economics (2nd edn.). Edward Elgar, Cheltenham. 29–35.

Rogers, Colin. 1997. “Keynesian Macroeconomics and the Capital Debates,” in Philip Arestis, Gabriel Palma, and Malcolm Sawyer (eds.), Capital Controversy, Post-Keynesian Economics and the History of Economic Thought. Routledge, London and New York. 34–44.