Portfolio Allocation, Liquidity-Preference and the q Ratio: A Reassessment of the Contributions of Tobin and Kahn

This paper compares the implications of Tobin's q theory and Kahn's Post-Keynesian monetary analysis for monetary policy formulation. In recent years, monetary policy formation has taken account of expected market evaluations of equity as well as the effect of long-term government bonds. These evaluations are suggestive of Tobin's q theory as well as Kahn's monetary theory. In contrast to the disparity of views between Keynes and Hicks in 1937, the analysis conducted by Kahn and Tobin in the 1950s and 1960s was set in a multi-asset portfolio context that exhibited a broader disagreement with regard to the influence of liquidity preference. Thus, although q is an important variable in Tobin's analysis, Kahn's introduction of the influence of liquidity premia of various assets in asset demand and the effect of portfolio flows in response to changes in relative liquidity preference across assets undermines the usefulness of this ratio. The implications of Kahn's monetary theory are developed in an analysis that presents them in terms of a comparable ratio to q. We find that there are circumstances in which the adjustment of monetary yields across assets and the underlying expectations reveal important information for the formation of monetary policy. In addition, the term structure of interest rates can convey substantial information when it deviates from historical averages and it should be considered separately from the q ratio. Moreover, if the assumptions associated with a monetary theory of interest and production are retained, the q ratio does not need to converge to unity in the long run.