Criticisms of Loanable Theory of Interest

            J.M. Keynes and he's followers have criticized this theory on the following grounds.

(1)        Assumption of full employment.

            This theory is based on the full employment of resources but according to economist Keynes argued that economy is not found in a state of full employment in the real word. He argued that economy might be achieved only below the level of full-employment.

(2)        Indeterminate

            According to this theory rate of interest is determined by the Loan able funds. But loan able funds depend on disposable income, which depends on investment, and ultimately it depends on the rate of interest. Hence, Prof. Hansen tells us that we trapped into vicious circle and we cannot come out of it. Hence Prof. Hanson and other economists call this theory an intermediate-theory.

(3)        Assumption of Income as Given

            According to this theory, the level of income is given and fixed. Income is not influenced by the charge in the level of investment but this saying is not correct, because if rate of interest falls, the amount of investment will certainly increase and it also increases the level of income consequently.

(4)        Exaggeration of the effects of interest.

            According to this theory increase in interest rate increases the level of savings. But in fact it is an exaggeration. Because if interest rate increases it is not necessary for the poor people who can save and contrary to it even at zero interest, rate rich people prefer saving their incomes. Therefore the saying that increase in the rate of interest also increase the saving may not be always true.

(5)        Inclusion of both real and monetary forces.

            This theory combined the real forces and monetary forces to determine the rate of interest. But the real forces like savings and ductility of capital can't be joined with monetary forces like bank money and liquidity preferences.