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
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: –
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.