THEORIES OF INTEREST PART 2

Keynes argued that the rate of interest is determined by the demand for and supply of money, where demand arises from liquidity preference motives. It is essentially a monetary phenomenon, not a real one.

Senior's theory: interest rewards abstaining from immediate consumption.

Keynes identified three motives: the transactions motive (for day-to-day expenditures), the precautionary motive (for unforeseen contingencies), and the speculative motive (to gain from future changes in bond prices).

Interest compensates savers for waiting to use their capital later.

The speculative demand for money is inversely related to the rate of interest — when interest rates are high, people prefer bonds over money, reducing speculative demand, and vice versa.

Interest arises from the productive capacity of capital in production.

The liquidity trap occurs when the interest rate is so low that people prefer to hold all additional money rather than invest in bonds, making monetary policy ineffective in stimulating the economy.

Böhm-Bawerk's theory: present goods valued more than future goods.