Comparison of Liquidity preference theory with Loan able fund theory

The loan able fund theory of interest and Keynesian liquidity theory of interest are compared on the following grounds.

  1. Definition of interest

According to Neo-classical theory (Loan able fund theory) of Interest, interest is reward for the use of loan able funds, While, according to Keynesian liquidity theory of interest, is a reward for parting with liquidity.

  1. Factors included

According to loan able fund theory of interest, both real and monetary forces of economy influence determination of interest rate. Here, saving, productivity of capital in real forces and bank money, hoarding, dishoarding in monetary forces respectively play decisive role on interest rate determination. Hence in this theory, interest is called both real and monetary phenomenon.

While in the rate of interest determination under Keynesian liquidity preference theory of interest, monetary factor like liquidity is mainly involved. Hence his theory knows as pure monetary theory of interest too.

  1. Determination of rate of interest

According to the Loan able fund theory, interest rate is determined by the equality between the demand for and supply of Loan able funds. While in the Keynesian liquidity theory. The rate of interest is determined by the equality between demand for and supply of money.

  1. Demand side

According to Neo-classical theory or loan able fund theory total demand of loan able fund means combined demand for investment, consumption and hoarding. Here, we all these three sources of demand for loan able funds have Negative relationship with interest rate.

While in the Keynesian liquidity theory of interest total demand of money is done for the three motives such as transaction motivate, precautionary motive and speculative motive. The demand for transaction and precautionary motives is constant function of income and is interest-inelastic but demand for speculative motive is a negative uncertain of rate of interest. At minimum level of interest, demand for speculative motive becomes perfectly elastic.

  1. Supply side

Under loan able funds theory of interest, total supply of loan able funds consists saving, dishoarding, bank money and disinvestments. All these elements of supply side of loan able funds are positively related to rate of the interest.

In Keynesian liquidity preference theory of interest total supply of money consist total notes, wins issued by central bank and total depositor at the bank; money supply is compelled fixed by central bank. Money supply is interest elastic.

  1. Assumption of full employment

Loan able fund theory is based on the unrealistic assumption of full employment but the Keynesian theory of interest is applicable both even in full employment and in less than fall employment conditions.

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