Interest and Money

Abstract

One of the biggest controversies sparked by the General Theory concerned the determination of the rate of interest. Until the General Theory, the generally accepted view was that the rate of interest was determined in the capital market, defined in terms of the demand and supply of savings. The demand for savings was represented by the investment demand function, which depicted a negative relationship between investment and the rate of interest, while the supply of savings was represented by the savings function, which described a positive relationship between the interest rate and the amount saved out of income. The market was assumed to clear at the point where supply equals demand, thereby establishing investment, saving, and the market rate of interest.