Title: Liquidity and the Term Structure of Interest Rates from Keynes to Hicks (1930-1939)
Author: Brillant Lucy

This research studies the factors determining what John Richard Hicks called at the end of the Thirties "the logic of the interest system". We intend to shed new light on the debate between Keynes and Hicks in the analysis of the term structure of interest rates. These authors are convinced there is a relation between interest rates of different maturity, but they determinate it in a different manner. The term structure of interest rates is due to actions of agents on bond market, taking advantage on spreads between interest rates of different maturity. These agents – called by Hicks in “Value and Capital” ‘lenders’, ‘borrowers’ and ‘professional investors’ –, if being liquid, bring the long term rate of interest down or up to the average of current short rate and forward short rates. The Central Bank can control the long-term interest rate through monetary policies aiming at fixing the short-term interest rate and supplying liquidity to agents on bond markets. In doing so, Keynes and Hicks show that the long term rate of interest is a monetary phenomenon more than a decade later Hawtrey’s book “Currency and Credit” (1919), considering the long term-rate of interest as a real phenomenon. We begin to study the term structure of interest rates in a context of certainty using “A Treatise On Money” (1930) where the theory appeared initially and show that Keynes and Hicks reach the same conclusion. Then, we will see that it is not the case in a context of uncertainty. First we introduce uncertainty with “The General Theory” (1936) where Keynes refers to a risk of a liquidity loss related at once to a lenders’ “disappointment risk” (Keynes). Second, we consider “Value and Capital” (1939) where Hicks refers to borrowers’ risk of a rise in spot [short-term] interest rates (Hicks) and to “professional investors” ’ liquidity risk. At last, both of these authors took into account the liquidity risk of the banking system. Agents on bond markets face liquidity constraints. Hicks gives an insight into liquidity risks affecting intermediaries on bond markets with institutional investors. Throughout these developments, Keynes and Hicks founded the risk-premium theory. (354 words)

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