Welcome
to the
Presentation
Topics Name
Liquidity Preference Theory
Group Name
The 'Dominators'

Liquidity
Preference
Theory
Propounded by John
Maynard Keynes in his book
The General Theory of
Employment, Interest and
Money (1936)

What is
Liquidity
▶ Liquidity is the mobility of assets whenever it is
required.
▶ Can be termed as immediately spendable cash
▶ The amount of money that is readily available for
investment and spending.
▶ It is the factor of supply and demand for a
security or instrument and is affected by the
size of the original issue and the time since the
original issue. (most important)

Liquidity
Preference
• People usually prefer present consumption unless
they find it beneficial in the future.
• Higher cost of living mean higher demand
for cash
• Cash is considered the standard for liquidity

Motives that
determine
demand for
liquidity
1. Transaction motive arises as
people have to spend for their
daily necessaries.
2. Precautionary motive is that
people need money in case of
social unexpected problems
occur or may occur.
3. Speculative motive is the future
oriented motive for
which people retained liquidity
so that they can earn.
=f(Y)
=f(r)

Theory
implications
The theory implies that investors generally demand
higher rate of interest for long term securities than that
of short-term maturity.
The speculative demand for money are the main
determinant of interest rate in the economy if other
things remain equal.
Supply of money has impact on the interest rate
determination.
Government or monetary authority can increase or
decrease interest rate by cutting down or boosting up
money supply.

Graphical
presentation
Liquidity trap
m m1
LP
Rate of
interest m2
r
r1
r2
a
b
c
Money supply

Shortcomings
✓ Indeterminate theory like the classical model as
income changes may draw different liquidity
preference schedules.
✓ The question of parting with liquidity arises only
after we have saved money. If there are no
saving, there is no parting with liquidity either.
✓ Keynes theory of interest is applicable only to
advanced countries where money is widely in
circulation and the money market is well
organized.
✓ Keynes theory ignores productivity of capital.
According to critics, interest is not only the
reward for parting with liquidity but it arises due
to productivity of capital. Had the capital not
been productive, no one had demanded it and,
hence, paid no interest on capital.

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