Saturday, August 22, 2009

Liquidity Preference

In the words of Meyer “Liquidity Preference is the preference to have an equal amount of cash rather then to claims against others”.
According to Keynes interest is purely a monetary phenomenon people prefer to hold a part of their incomes and wealth in liquid form. People become willing to part with liquidity only when they are offered same reward in the form of interest liquidity preference means the demand for money to hold cash.
Keynes is of the view that rate of interest is determined by the demand for (liquidity preference) and supply of money.
Keynes has given three motives for holding money in liquid form.
1. Transaction Motive: The transaction motive relates to the demand for money or the need for cash for the current transactions of individual and business exchanges. Individuals hold cash in order to “bridge the internal between the receipt of income and its expenditure” the businessmen and the entrepreneurs also have to keep a proportion of their resources in ready cash in order to meet their current needs of various kinds. In the case of individuals Keynes calls it Income motive and in case of businessmen it is called by him Business motive.
2. Precautionary Motive: Precautionary motive for holding money refers to the desire of the people to hold cash balance for unforeseen contingencies. People hold a certain amount of money to provide for the danger of unemployment, sickness, accidents and other more uncertain perils. This amount of money held under this motive will depend on the nature of the individual and the conditions in which he lives.
3. Speculative Motive: The Speculative motive relates to the desire to hold one’s resources in liquid form in order to take advantage of market movements regarding the future changes in the rate of interest.

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