MODERN THEORY OF INTEREST: HICKS-HANSEN SYNTHESIS

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MODERN THEORY OF INTEREST: HICKS-HANSEN SYNTHESIS
We have discussed above the various theories of the rate of interest put forward from time to lime. But we have seen that all these theories suffer from various drawbacks and are indeterminate. The Keynesian theory considered only the monetary factors and the classical theory only the real factors as determining rate of interest. Modem economists have considered both types of factors, monetary and real. The economists like Prof. Hicks and Hansen have made a synthesis between these various theories and have given an adequate and determinate theory of interest. They arc of the opinion that the classical and loanable funds theories amount to the same thing. The difference between these two theories, i.e., classical and loanable funds theories, lies only in the meaning of saving. “The Pigovian supply schedule of savings amounts to the same thing as the Robcrtsonian or Swedish supply of loanable fttflds.”11 How the modern economists make synthesis between the classical or loanable funds theory on the one hand and the Keynesian theory on the other to give an adequate and the determinate interest theory. we state in Prof. Hansen’s own words: “The classical or loanable fund formulation and the Keynesian formulation. taken together, do supply us with an adequate theory of the rate of interest. From the loanable-funds formulation we get a family of loanable-fund schedules (or saving schedules in the Pigovian sense) at various income levels. These together with the investment demand schedule give us the Hicksian IS curve. In other words, the neo-classical fonnulation can tell us what the various levels of income will he (given the investment demand schcd ule and a family of loanable-funds schedules) at differentrates of interest. But it  docs not tell us what the rate of interest will be. From the Y.eynesian formulation, we get a family of liquidity preference schedules at various income levels, These togeuier with the supply of money fixed The LM curve tells us what the various rates of
interest will be (given the quantity of money and the family of liquidity preference curves) at different levels of income. But the liquidity schedule alone cannot tell us what the rate of interest will be. It is the intersection between the IS curve and LM curve which will determine the rate of interest.curve are curves relating to the two variables: (a) income and (b) rate of interest. Income and the rate ·of interest are, therefore, determined together at the point of intersection of these two curves, i.e., the point E. Equilibrium rate of interest thus determined is OrJ and the level of income determined is OY. At this point, the income and the rate of interest stand in relation to each other such that investment and saving are in equilibrium, and that the deman for money is in equilibrium with the supply of money. It should be noted that LM curve has been drawn by taking the supply of money as fixed.

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MODERN THEORY OF INTEREST: HICKS-HANSEN SYNTHESIS