Liquidity Theory Of Monetary Policy

1375 Words6 Pages
Monetary or monetary policy is the macroeconomic policy of monetary authorities, a set of measures aimed at managing aggregate demand through the terms of the money market (short-term interest rate, nominal exchange rate or current liquidity level of the banking sector) to achieve a combination of ultimate goals, which could include price stability, maintaining a stable exchange rate, financial stability and promoting a balanced economic growth. The history of the term "monetary policy" originates in the first half of the XIX century. It can be found in the works of British economists in connection with the activities of the Bank of England and the emission of the pound sterling. In particular, the editor of The London Magazine…show more content…
Liquidity preference refers to the relationship between the quantity of money the public wishes to hold and the interest rate. According to Keynes, money is the most liquid asset. Liquidity is an attribute to an asset. The more quickly an asset is converted into money the more liquid it is said to be. Keynes proceeded from the assumption that there are two types of assets in which households invest (invest in goods) - money and securities. The total wealth in the economy is equal to the total amount of money and securities (the sum of the market supply of money and the market supply of securities). The return on investment for cash as an alternative type of asset, in contrast to securities, is zero. With an increase in the return on investment for securities, the expected return on the ownership of cash falls, respectively, the growth in the expected return on securities. This causes the transfer of investments from the form of cash to the form of securities. Thus, demand for cash is inversely proportional to the return on investment. According to Keynes, demand for liquidity is determined by three motives: First, the transactions motive: people want to have liquidity for day-to-day needs, and the amount of liquidity demanded is determined by the level of income: the higher the income, the more money demanded for carrying out increased spending. Because, when people earn more, they consume more. Second the precautionary motive: people prefer to have liquidity in the case of social unexpected problems that need unusual costs. If the income is high, than the demand is also high. Third speculative motive: people retain liquidity to speculate that bond prices will fall. Thus, people take advantage of future changes of bond prices or

More about Liquidity Theory Of Monetary Policy

Open Document