# Why is Keynes attacking the (neo)classical theory of interest rates on the grounds that it is indeterminate?

I do understand that he argues that in order to draw the loanable funds supply curve, you have to already know the volume of income, i.e. production, and therefore the interest rate in advance. But why couldn't you just test for coherence in the following way? Assume a level of income. Draw the corresponding loanable funds supply curve. Calculate the interest rate at the intersection of the supply and the demand curve, i.e. the interest rate for which the capital market clears. Determine if the income level corresponding to this interest rate is indeed the income level we assumed in the first place. If it is, this interest rate is an/the equilibrium rate, if it's not, it's not. Is there anything wrong with this argument?

You can use some some initial $$Y_0$$ to find an interest rate, but this is precisely the indeterminacy problem. We would like to be able to derive the equilibrium interest rate without assuming some initial values.
• @JuliusHimmel no. Of course, once you have some $Y_0$ and calculate $i$ and then using this $i$ you calculate back Y, $Y=Y_0$. For example, if we have x-y=2 then once you choose x=2 y will be 0 and then if you ‘forget’ x and just plug 0 you found previously of course you find that x=2, but that does not help even a bit because you are still using initial values that have to be assumed to find equilibrium. We want to avoid using $Y_0$ at all. In fact the ‘solved’ $i$ in way you propose would be no different just from assuming some $i_0$ from the outset. – 1muflon1 Oct 3 '20 at 15:40
• @JuliusHimmel but in these macroeconomic models almost everything is endogenous. Finding a level of production based on some $i_0$ will introduce exactly the same circularity as above. In fact this indeterminacy problem will appear in IS-LM model without Taylor rule or some specific micro assumptions. – 1muflon1 Oct 3 '20 at 16:14