Ludwig Lachmann, Uncertainty and Liquidity-Preference (1937)

Ludwig Lachmann’s journal article examines what uncertainty must mean if it is to explain the demand for money. Its six sections move from methodological questions through criticisms of Rosenstein-Rodan and Keynes to an institutional account of cash holdings, then apply that account to business transactions and secondary depression. The central claim is that uncertainty explains liquidity-preference chiefly through the creditor–debtor relationship: money is held because liabilities must be discharged in money, and debtors cannot know when creditors will demand repayment or refuse further credit.

Lachmann begins by questioning whether monetary theory can treat preferences as ultimate explanatory facts. Unlike a preference for one painter over another, the preference for cash over other assets requires explanation if economists are to understand monetary fluctuations and assess policy. Enumerating motives for holding money does not establish their causes. Since the relevant phenomena involve many individuals acting similarly, he seeks the common conditions underlying their conduct:

Men may act identically, either because they are all subject to the same mass-psychological influences or because they all have to operate within the same institutional framework.

This distinction sets the article’s methodological direction. Lachmann gives institutional explanations priority because economists understand institutions better than mass psychology. He does not exclude psychological explanations; he asks whether shared contractual conditions can explain movements otherwise attributed to collective optimism or pessimism.

Section II tests Rosenstein-Rodan’s conception of uncertainty as a general feeling of not knowing. Contrasting imperfect foresight with perfect foresight may establish a functional relationship between uncertainty and cash balances, but it cannot determine the direction of that relationship. Fear about a currency’s future can prompt people to exchange money for illiquid goods, while confidence that prices will fall can encourage cash accumulation. General uncertainty therefore supplies neither a definite causal explanation nor a useful policy criterion. Lachmann distinguishes the legitimate task of inserting interdependent variables into an equilibrium system from his own task of explaining how a particular change produces particular conduct.

Section III considers Keynes’s more specific uncertainty about future interest rates. Lachmann first questions why a speculator confident enough to act against the market should be described as uncertain. His more consequential objection concerns market organisation:

In other words, it is just because Mr. Keynes’ market is not an organised forward-market that here “bearishness” entails liquidity-preference!

An organised forward market would allow bondholders expecting interest rates to rise to hedge rather than exchange their securities for cash. Within Lachmann’s argument, expectations would still affect forward prices and, through arbitrage, spot prices; they would not necessarily increase cash holdings. He thus separates an expectation’s effect on asset valuation from its effect on liquidity-preference. The latter depends on available trading arrangements, not simply on beliefs about future rates. His eventual conclusion retains a qualification for effects arising from imperfect intertemporal markets.

Section IV develops the positive explanation from the precautionary motive. Vague provision for unforeseen circumstances cannot explain why money is preferred to every alternative asset. A liability fixed in money, however, gives cash a distinctive use:

If by Uncertainty we understand the anxiety of the debtor, whose debt is due on demand, regarding the future actions of his creditor, then, at last, we can say that Uncertainty is the cause of liquidity-preference.

The crucial distinction is between what money does and what only money can do. As a store of value, it has substitutes; as a medium of exchange, its utility derives from the goods it purchases. Its legally established capacity to discharge debts supplies the exclusive service Lachmann seeks. Even when banks and markets close and normally liquid assets become unsaleable, money can still settle a monetary obligation, although it may no longer purchase necessities. He advances this institutional claim as an explanation of recurrent mass behaviour, rather than pretending to demonstrate it by deduction. Falling asset values weaken debtors’ financial positions, encourage creditors to seek repayment, and induce precautionary cash accumulation.

Section V extends the argument to business funds, challenging Robertson’s proposed connection between profitable activity and demand for money. Commercial expansion can be financed through supplier credit, bills, and other assets accepted as means of payment. Greater output therefore need not require proportionately greater cash balances:

What therefore affects their liquidity-preference is not the absolute level of output, but the rate of increase in their short-term-liabilities.

The relevant connection runs through obligations approaching maturity and the conditions of credit renewal. An expected deterioration in access to credit can increase liquidity-preference even without a change in output. This brings the transactions motive within the same institutional explanation rather than treating it as an independent income-based determinant.

The final section applies the argument to the cumulative contraction Lachmann calls secondary depression. Banks are especially important debtors because deposits are repayable on demand. Losses during the primary crisis impair deposit security. Immediate recognition of losses and reconstruction of bank capital could restore that security, but expensive capital gives bank owners a reason to postpone reconstruction. Meanwhile, they may compensate depositors for reduced safety by increasing liquidity. Here, contrary to Keynes’s speculative mechanism, an expectation of lower future interest rates encourages present cash accumulation.

Lachmann suggests that banks’ pursuit of liquidity can raise interest rates above the marginal efficiency of capital and intensify deflation. He acknowledges that the subsequent stages require further investigation. His policy conclusion nevertheless favours prompt bank reconstruction, including closure where reconstruction is impossible, over cheap money as a general remedy. The article’s enduring conceptual contribution is to make liquidity-preference depend on specified uncertainties, contractual obligations, and market institutions—not on uncertainty treated as an undifferentiated psychological state.