Explain Keynesian theory of demand for money.
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Keynesian Theory of Demand for Money
John Maynard Keynes, in his Keynesian theory of demand for money, proposed that the demand for money is determined by three primary motives:
Transaction Motive: This refers to the demand for money for everyday transactions. Individuals and businesses need to hold money for daily expenditures. The demand for transactional money is directly related to the level of income; as income increases, so does the need for money for transactions.
Precautionary Motive: This motive relates to holding money for unforeseen expenses. People prefer to hold a certain amount of cash to safeguard against unexpected events, such as emergencies or unplanned expenses. Like the transaction motive, the precautionary demand for money is positively related to income.
Speculative Motive: This is the demand for money as a store of wealth. According to Keynes, people hold money as a liquid asset to take advantage of future investment opportunities or to avoid losses from market fluctuations. The speculative demand for money is inversely related to the interest rate; when interest rates are low, people prefer to hold money, and when rates are high, they convert money into interest-bearing assets.
In summary, Keynes's theory suggests that the demand for money is a function of income (for transaction and precautionary motives) and the interest rate (for speculative motive). This theory highlights the role of money as a medium of exchange, a precautionary asset, and a speculative asset.