Written by Money is one of the most important concepts in economics.
It serves as a medium of exchange, a store of value, and a unit of account.
But why do people hold money?
In this blog post, we will explore the answers to the question above by examining a famous theory of money demand developed by John Maynard Keynes.
Keynes proposed that there are three main motives for holding money: transaction motive, precautionary motive, and speculative motive.
Let us see what each of these motives means and how they affect the demand for money.
Transaction Motive for Holding Money
Transaction motive for holding money means people hold money in the form of cash balances for transaction purposes because receipt of money and payments do not coincide.
It refers to the desire or inclination of people to hold money in the form of cash balances or liquid assets for the purpose of carrying out transactions.
This is because there is usually a time gap between the receipt of money and the payments that need to be made.
The transaction motive for holding money is the need to hold money to facilitate day-to-day transactions and pay for everyday expenses.
In essence, transaction demand is the demand for money to buy things, pay for goods and services, and to pay for other daily expenses.
The transaction demand for money is driven by the need for individuals and businesses to meet their day-to-day financial obligations, such as paying for food, rent, utilities, transportation, and other day-to-day transactions.
Keynes argued that the demand for money for transactional purposes is directly related to the level of income and the volume of transactions in an economy.
As people’s income increases, their transaction demand for money also increases, and vice versa.
Precautionary Motive for Holding Money
Precautionary motive means people hold money to meet unforeseen expenses or emergencies.
It is the demand for money to pay unpredictable expenses.
Precautionary motive is the amount of money that people hold to protect themselves against unexpected events or expenses.
It refers to the amount that money that individuals and businesses hold as a precautionary measure to cover unforeseen expenses or emergencies.
The precautionary motive for holding money arises from the desire to have cash reserves as a precaution against unforeseen contingencies or emergencies.
People hold money to cover unexpected or unforeseen eventualities such as illness, accident, and car breaking that may arise.
In essence, precautionary demand for money is holding cash in case of emergencies.
The precautionary demand for money depends on the level of income and the degree of uncertainty.
Generally, a higher income means higher precautionary demand for money, as people have more money to save for future contingencies.
Speculative Motive for Holding Money
The speculative motive for holding money is the demand for money to take advantage of expected changes in non-money financial assets.
It refers to the amount of money that individuals or firms hold with the intention of investing it in non-money financial assets that they believe will increase in value over time.
It is the demand for money to take advantage of unexpected opportunities.
Speculative motive arises due to the expectation of future changes in the value of these assets.
It is based on the idea that money is a store of value that can be used to purchase other financial assets that may offer higher returns in the future.
So, when people hold money for speculative purposes, they are essentially trying to maximize their wealth by anticipating the future movements of interest rates and asset prices.
For example, people may expect interest rates to fall in the future, which would increase the price of bonds.
In this case, they would hold money instead of buying bonds now, and wait for the right time to buy them at a lower price.
The speculative motive for holding money is influenced by the level of interest rate and the degree of uncertainty in the market.
The lower the interest rate, the higher the opportunity cost of holding money, and the lower the speculative demand for money.
Conclusion
To sum up, people hold money for three main reasons.
The first reason is transaction demand, which means that people need money to buy goods and services in their daily lives.
The second reason is speculative demand, which means that people hold money to take advantage of changes in interest rates or asset prices in the future.
The third reason is precautionary demand, which means that people hold money as a buffer against unexpected expenses or emergencies.
