Keynes’ Liquidity Preference Theory of Interest or The monetary Theory of Interest
1. Keynes propounded the Liquidity Preference Theory of Interest in his famous book, “ The General Theory of Employment, Interest and Money “ in 1936.
2. According to Keynes, interest is purely a monetary phenomenon because the rate of interest is calculated in terms of money.
3. “Interest is the reward for parting with liquidity for a specified period of time”.
Meaning of Liquidity Preference:
1. Liquidity preference means the preference of the people to hold wealth in the form of liquid cash rather than in other nonliquid assets like bonds, securities, bills of exchange, land, building, gold etc.
2. “Liquidity Preference is the preference to have an amount of cash rather than of claims against others”. – Meyer.
Motives of Demand for Money: According to Keynes, there are three motives for liquidity preferences. They are:
1. The Transaction Motive: The transaction motive relates to the desire of the people to hold cash for the current transactions [ or-day-to-day expenses ] M = f(y)
2. The Precautionary Motive:
- The precautionary motive relates to the desire of the people to hold cash to meet unexpected or unforeseen expenditures such as sickness, accidents, fire and theft.
- The amount saved for this motive also depends on the level of Income Mp = f(y).
3. The Speculative Motive:
- The speculative motive relates to the desire of the people to hold cash in order to take advantage of market movements regarding the future changes in the price of bonds and securities in the capital market. M = f(i)
- There is inverse relation between liquidity preference and rate of interest.
