Question

Explain Keynesian liquidity preference approach to demand for money.

Answer 1

Keynes speculated that the demand for cash is split into 3 varieties – Transactionary, preventative and Speculative.

1. Transactionary Demand

People prefer to be liquid for day-to-day expenses. The amount of liquidity required depends on the level of income, the higher the income, the more money is required for increased spending.

2. Precautionary demand

Precautionary demand is the demand for liquidity to cover unforeseen expenditure such as an accident or health emergency. The demand for this type of money increases as the income level increases.

3. Speculative demand

Speculative demand is that the demand to require advantage of future changes within the rate of interest or bond costs.