John Maynard Keynes mentioned the concept in his book The General Theory of Employment, Interest, and Money … The transactions demand for money l For example, both A. Meltzer in "The Demand for Money: The Evidence from the Time Series " Journal of Political Economy (June, 1963), and D. Laidler in "The Rate of Interest There may be weaknesses in Keynesian theory. Liquidity Preference Theory refers to money demand as measured through liquidity. John Maynard Keynes created the Liquidity Preference Theory in to explain the role of the interest rate by the supply and demand for money. People want to maintain their wealth and will shift into those investments. The demand for money depends on three factors: Money is more basic than the medium of exchange. According to Keynes, the higher the rate of interest, the lower the speculative demand for money, and lower the rate of interest, the higher the speculative demand for money. Keynesian Theory of Money At the core of the Keynesian Theory of Money is consumption, or aggregate demand in economic jargon. However, it made a notable contribution to economics theory. It is revolutionary theory and marks a sharp departure from classical thinking. Even, in Keynesian theory, there lies the assumption of the constant level of income in the disguised form. Moreover Keynesian economics is an economics of depression. Keynesian function lies in the specification of the relationship expressing the demand for speculative or idle balances. The Quantity Theory of Money (Theory of Exchange) looks at money largely from the supply side while Keynesian approach is from the demand perspective (the desire for people to hold their wealth in cash balances instead of interest – earning assets such as treasury bills and bonds) Early quantity theorists maintained that he quantity of money (M) is exogenously determined (eg. Increase in interest rates will cause a shift from money into bonds. Furthermore, the Keynesian theory of money demand argues that there are only three motives for holding money; transactions demand, precautionary purposes, and the speculative demand for money. Direct Relation: Keynes mistakenly took prices as fixed so that the effect of money appears in his analysis in terms of quantity of goods traded rather than their average prices. Algebraically, the speculative demand for money is: M 2 = L 2 (r) Where, L 2 is the speculative demand for money, and r is the rate of interest. Baumol-Tobin Money Demand Model(s) These are further developments on the Keynesian theory Variations in each type of money demand: transactions demand is also affected by interest rates so is precautionary demand speculative demand is affected not only by interest rates but also by relative riskiness of available assets Bottom line: demand for money is still positively According to Keynes, the demand for money is split up into three types – Transactionary, Precautionary and Speculative. This means that we have to assume that the level of income remains constant. Thirdly, Friedman treats the demand for money just like the demand for any durable consumer good. The portfolio choice theory indicates that money demand will fall because of the speculative motive. It is a temporary abode of purchasing power and hence an asset or a part of wealth. 11 3. Friedman treats the demand for money as a part of the wealth theory. 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