Interest rate, savings shortage and liquidity shortage

Summary

An attempt has been made to formulate a theory of interest which meets two requirements: (a) portfolio and expenditure decisions are made simultaneously; (b) investors' expectations can produce deviations in the rate of interest from the level which corresponds to fundamental scarcity conditions. The analysis has been confined to that within one period. The main conclusions are (i) that traditional Keynesian and monetarist analyses are equilibrium analyses in the sense that expectations are fulfilled, (ii) that conventional economic tenets, such as Walras' Law, Say's Law, the equivalence of loanable funds theory and liquidity preference theory, and the equality of saving and investment, are only valid if expectations materialise, and (iii) that the concepts of liquidity shortage and savings shortage, in case expectations are not fulfilled, have a totally different meaning than is attributed to them in equilibrium theory.