The Keynesian Analysis Of The Demand For

Money Essay, Research Paper

General Theory ? claimed money stock only important to the

extent that it influenced the i. rate, which led to repercussions (stimulate

inv. & consumption).? Keynesians

(not K himself) ? note: pointed to a point where increase in MS would have no

effect on i. rate & hence no effect on econ in toto. Keynesian Motives for Money Holding: Motivation for holding money/cash balances

divided in 3 component parts: i.) Transactions. ii.) Precautionary. ? both income

det. iii.) Speculative ? i rate det.?



Motive: given institutionalised

time lags between receipt of factor incomes & expenditure outlays,

a certain amount of money required for normal day-to-day transactions, and real

value of this transactions demand will be closely related to real income

of economy.? The assumption: real volume

of transactions closely related to real income of economy.? 2.


Motive: Cash balances held in

case of unforeseen outlays, essentially of a transaction nature (e.g. unforeseen

medical bill).? Though vary between

indivs, reasonable to expect that in the aggregate, related to real income

& in nominal terms to price level.? Together ? form L1. 3.


Demand: (or Asset Demand)

? for speculative financial transactions.?

(To simplify analysis, Keynes assumed existence of just 2 financial

assets ? cash & consols: interest bearing, non-redeemable bonds). Keynes

argued inverse relationship between bond prices and interest rates.? V. simplified e.g.: suppose a bond issued for

$100 paying an annual coupon of $5.? The

effective rate of interest accordingly 5%.?

If market rate were later to rise to 10%, holder of this bond would be

able to obtain only $50 when sold ? since $50 is all that?s needed to yield an

interest income of $5.? Equally, had i.

rate fallen to 2.5%, bond?s market value would approximate $200.? –

Indivs will each have their own expectations of a normal

rate of i. rate with which they will expect the market rate ultimately to

coincide. –

At a high i. rate, indivs will expect i. rates to fall and

bond prices to rise.? To benefit from

the rise in bond prices indiv.s will use their speculative balances to buy

bonds.? Thus, when i. rates are high,

speculative balances are low. –

At low i. rates, indivs will expect i. rates to rise and bond

prices to fall.? To avoid the capital

losses associated with a fall in bond prices, indivs will sell their bonds and

add to their speculative cash balances.?

Thus, when i. rates are low, speculative balances will be high.? –

Ultimately, i. rate reached where no one thinks it can go

higher ? universal expectations of a fall (point A in Fig 1b) ? idle spec cash

balances zero, as everyone will try to move into bonds? in expectation of making a capital gain. –

Ultimately, minimal i. rate such that univ. expectation of a

future rise ? here no call for bonds with demand for idle balances infinite up

to total wealth.? (liquidity trap)

Inverse relationship between rate of interest and the

speculative demand for money. (a) L1 = Transactions & Precautionary MD? (b) Speculative MD? ?????? (c) Total MD (Individual Speculative MD ? rests on

assumption that indivs have a concept of normal interest rate: if current

market i. rate > normal, expectation that i. rates will fall/bond Ps will

rise ? so All asset cash to buy bonds ? so spec cash demand zero.? If converse, spec cash demand infinite: so

implies that indivs either hold cash or bonds but not both) Money Market Equilibrium: –

Keynesian model

implies MD increases as i. rates fall.?

Also implies that increased MS (Fig 3) implies fall in i. rates, which

in turn stimulates inv & cons?n outlays, impact magnified by multiplier,

resulting in expansion of money Nat Inc.?

Whether output or P increase largely dependent on unemployed

resources/extent of spare capacity.? But

1 exception (Liquidity trap): if i. rates so low that universal belief

that they?ll rise.? So no one willing to

buy gov. bonds.? If gov. enlarges MS (=

Money Stock), would be no effect on i. rates (Fig 4).? Since money stock at any one time must be

held by somebody, it would find its way into hands of public.? But no change in income level, so no desire

to add to transaction balances.? With no

desire to purchase gov. bonds, just added to speculative money holdings ?

implies a minimum constraint on interest rates.? –

Liquidity Trap ? implies impotence of monet pol at a point,

where increased Money SK accumulated in idle balances –

So K?n Theory

suggests that impact of a MS increase will vary? (sometimes reduce i. rates, sometimes not), so, unlike trad

quantity theory, can?t make 1 generalised statement about impact of MS

hike.? ??????????? ????????? i. rates in conventional K?n theory.?????????????? of an enlarged MS upon i. rate.


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