Liquidity demand and investment^∗

^∗I would like to thank two anonymous referees for their very helpful comments

Abstract

This article analyses the influence of liquidity preference on investment theory. The previous neglect of this subject is due to a more general tendency to overlook replacement investment, even though depreciation estimates imply that most investment is replacement investment. A key finding of this analysis suggests that Tobin’s q–ratio should be seen as the product of two ratios: 1) the price of equities divided by the value of used capital goods; 2) the price of used capital goods divided by the price of new capital goods. This article demonstrates how shifts in liquidity preference lead to a significant instability in used capital goods prices. It also shows that policies designed to maintain aggregate demand, keeping used capital goods prices high and discouraging replacement investment create problems. This theory implies that unless a market economy experiences periodic depressions, its capital structure will age, leaving the economy less and less competitive.

^∗I would like to thank two anonymous referees for their very helpful comments

^∗I would like to thank two anonymous referees for their very helpful comments

Notes

^∗I would like to thank two anonymous referees for their very helpful comments