Models are developed to predict two interest rates. The default-free money market security for which a model will be developed to predict the interest rate is the 90-day United States Treasury Bill. The capital market security which is characterized by some degree of risk for which a model will be developed to predict the interest rate is a 90-day certificate of deposit issued by a financial institution.
Keynes held that the rate of interest is determined, instead, by the intersection of the supply of money and the demand for money. Instead of time preference, which is involved in the classical economic theory of interest, the Keynesian theory of interest is concerned with liquidity preference. The liquidity preference schedule includes both the transactions demand and the assets demand for money.
The Keynesian theory of interest, however, suffers from the fact that the liquidity preference will shift up or down with changes in the real income level, in a manner similar to the shifting to the shifting of savings in the classical economic theory of interest. Thus, in Keynesian analysis, given the total money supply, it is not possible to determine what quantity of money will be available to hold as an asset unless the real income level (and, hence, the transactions demand for money) is first known.
Another development in interest rate theory was the loanable funds theory of interest. Loanable funds are comprised of the money which is available for lending to individuals and institutions. The principal sources of such money are the savings of individuals and businesses, increases in the money supply through actions by government and financial institutions, and dishoarding from idle balances. The loanable funds theory of interest holds that the interest rate is determined by the intersection of the demand for loanable funds and the supply of loanable funds. The loanable funds theory of interest is characterized by the sa...