An individual’s demand for money is based on the requirements of everyday transactions and it can be rightfully stated that everything that is purchased must sum up to the value of what is sold. Hence, an individual’s opportunity cost for holding money would be the income that would be generated from interest rates that would be forgone, therefore an increase in the interest rate would lead to higher savings, for a higher return and a decrease in interest rate would lead to a decrease in savings and increase in consumption. Mathematically, the total value of money required for purchases must be equal to the value of what is sold can be derived by MV=PT, where M is the stock of money, V is the velocity of circulation of money, and PT represents
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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. It was then in the early fifties where authors such as James Tobin, a Nobel laureate for economics elaborated on how the transaction and precautionary motives are also derived from the rate of interest. This essay will explain the three motives for holding money and their link with the rate of interest and James Tobin’s elaboration on the Keynesian approach will be discussed. Another theory of money demand, by Milton Friedman will be introduced as he considers money demand to be insensitive to interest rates and also recent economic activity in the UK will be discussed as the UK bond-equity correlation has turned negative for the first time …show more content…
He believed that people do not only hold money and bonds, but can invest their income in assets such as bonds, equities or goods. Friedman treated money like any other asset, with the assumption of an individual holding a certain amount of real income. He then assumes that if inflation were to arise, these agents will want to hold higher nominal balances so that their real money balances are constant. Thus, Friedman insisted that when an individual’s income increases, so will the demand for money and declines when the rate of interest on bonds, stocks or goods
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. It was then in the early fifties where authors such as James Tobin, a Nobel laureate for economics elaborated on how the transaction and precautionary motives are also derived from the rate of interest. This essay will explain the three motives for holding money and their link with the rate of interest and James Tobin’s elaboration on the Keynesian approach will be discussed. Another theory of money demand, by Milton Friedman will be introduced as he considers money demand to be insensitive to interest rates and also recent economic activity in the UK will be discussed as the UK bond-equity correlation has turned negative for the first time …show more content…
He believed that people do not only hold money and bonds, but can invest their income in assets such as bonds, equities or goods. Friedman treated money like any other asset, with the assumption of an individual holding a certain amount of real income. He then assumes that if inflation were to arise, these agents will want to hold higher nominal balances so that their real money balances are constant. Thus, Friedman insisted that when an individual’s income increases, so will the demand for money and declines when the rate of interest on bonds, stocks or goods