What are the main implications of the liquidity preference theory of interest?
A distinction between the short-term and the long-term rate of interest constitutes an important implication of Keynes’ liquidity preference theory. Interest is a reward for parting with liquidity and is given to the wealth holder who surrenders control over money (liquidity) in exchange for a debt, bond or a security.
What are the three basic motives to hold liquid money according to Keynes?
According to Keynes, people hold money (M) in cash for three motives: (i) Transactions motive , (ii) Precautionary motive, and (iii) Speculative motive.
What is the theory of liquidity preference How does it help explain the downward slope of the aggregate demand curve?
The theory of liquidity preference explains the downward slope of aggregate demand and supply as well as the role of monetary policy in shifting aggregate demand curve. According to Keynes the interest rate adjusts to bring money supply and money demand into balance.
What are the main defects of liquidity preference?
Keynes’ theory of liquidity preference has been criticized on the ground that it is too narrow as an explanation of the rate of interest, because it unduly treats interest rate as the price necessary to overcome the desire for liquidity.
What according to Keynes are the factors that lead to the preference for liquidity?
Demand for money: Liquidity preference means the desire of the public to hold cash. According to Keynes, there are three motives behind the desire of the public to hold liquid cash: (1) the transaction motive, (2) the precautionary motive, and (3) the speculative motive.
Is LM model criticism?
Without a reference to time, the effects of the “store of value” function of money cannot be represented in an IS–LM model. However, the most enduring criticism of the IS–LM model is that its structural equations are postulated and are not derived from utility or profit maximization.
What do you mean by liquidity preference explain the Keynesian theory of demand for money?
The liquidity preference theory of Keynes states the relationship between interest rate, liquidity preferences, and the quantity or supply of money. It explains the preference for money or liquidity and the reason to demand and get a high-interest rate for long-term financial assets.
What motives did Keynes think determines money demand?
In the latter, Keynes formally defined three motives to demand money: (i) the transactions motive, comprising the income motive and the business motive; (ii) the precautionary motive; and (iii) the speculative motive. velocity of circulation of money.
Which curve is also the demand for money curve in Keynesian theory of interest?
The LM curve depicts the set of all levels of income (GDP) and interest rates at which money supply equals money (liquidity) demand.
What is Keynesian liquidity trap?
A liquidity trap is a situation, described in Keynesian economics, in which, “after the rate of interest has fallen to a certain level, liquidity preference may become virtually absolute in the sense that almost everyone prefers holding cash rather than holding a debt (financial instrument) which yields so low a rate …
IS-LM conclusion?
The initial IS/LM model concludes that the government can influence the economy via inflation and unemployment, through a rightward shift of the IS curve by the fiscal policy or by a shift of the LM curve by the monetary policy.
Why did Keynes think that money demand is affected by changes in interest rates?
Why did Keynes think that money demand is affected by changes in interest rates? In Keynes’s view, a rise in interest rates leads to a lower relative expected return of money and hence a lower demand for money.
What is the main difference between the classical and the Keynesian theory of demand for money?
In the classical model, money is neutral. An increase in the supply of money affects only the price level and the money wage rate, keeping the real variables unaffected. But, in the Keynesian model, money is not neutral. A change in the quantity of money affects both the real and monetary variables.
What are the criticism of Keynesian theory of employment?
(i) Keynesian theory is not a complete theory of employment in the sense that it does not provide a comprehensive treatment of unemployment, (a) It deals only with cyclical unemployment and ignores other forms of unemployment, such as, frictional unemployment, technological unemployment, etc.
What is the liquidity preference theory of Keynes?
The liquidity preference theory of Keynes states the relationship between interest rate, liquidity preferences, and the quantity or supply of money. It explains the preference for money or liquidity and the reason to demand and get a high-interest rate for long-term financial assets.
What are the facts that go against Keynes’s theory?
During depression, people have a high liquidity preference but the rate of interest is extremely low. In times of inflation people have low liquidity preference but the rate of interest is very high. Thus facts go against Keynes’s theory.
Is liquidity preference theory of interest determinate or indeterminate?
Indeterminate: Most economists have pointed out that like the classical and the neoclassical theories of interest, the liquidity preference theory is also indeterminate. According to Keynes, rate of interest is determined by the speculative demand for money and the supply of money available for speculative purposes.
Is Keynes’s rate of interest determinate or indeterminate?
What the Keynesian formulation regarding the rate of interest tells us is the various schedules of liquidity preference at various levels of income and not what the rate of interest is. Hence, Keynes’ own theory becomes indeterminate.