Under-investment and the Demand for Liquid Assets

Abstract

On re-reading Hicks’s Value and Capital one is struck by the fresh ness of the ideas. The book, which somehow manages to be both magisterial and unpretentious, is surprisingly contemporary in its general outlook. The problems it poses have by no means been ‘cleared up’ by subsequent generations. In this chapter I want to reconsider what Hicks had to say about interest rates and liquidity preference. In more modern terminology, the subject is asset-pricing and the demand for liquid assets. What follows is neither an exegesis of Value and Capital nor an attempt to develop a new theory. It is simply a re-examination of some old questions from the point of view of the modern theory of asset-pricing, as developed by Lucas (1978) and others.

I am grateful to Giovanna Mossetti, Dan Peled and Ed Green for helpful discussions in the course of writing this paper, to Carlo Casarola for his discussion at the conference and to the participants for their comments. Special thanks are due to Lionel McKenzie for his editorial assistance. None of the above should be held responsible for any remaining errors. Financial support from NSF grant SES 8520224 is gratefully acknowl edged.