What Are the Principal Limitations of the Liquidity Preference Theory

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The Answer is The liquidity preference theory is a short-term approach to interest rate determination unless modified because it assumes that in-come remains stable. In the longer term, interest rates are affected by changes in the level of income and by inflationary expectations. Indeed, it is impossible to have a stable equilibrium interest rate without also reaching an equilibrium level of income, saving and investment in the economy. Also, liquidity preference considers only the supply and demand for the stock of money, whereas business, consumer and government demands for credit clearly have an impact on the cost of credit. A more comprehensive view of interest rates is needed that considers the important roles played by all actors in the financial system: businesses, households and governments.

What Are the Principal Limitations of the Liquidity Preference Theory

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What Are the Principal Limitations of the Liquidity Preference Theory

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