The Keynesian theory of Money Demand

According   to Lord John Maynard   Keynes,   individuals   demand   for money   for three major reasons

(motives).  These include;

• Transaction motive. Here,   individuals    demand   for money   in order   to meet   their day to day purchases   of commodities    (transactions).    The level of transactions    depends   on the individual’s income and the prices of commodities.
• Precautionary motive. Individuals     demand    for   money    in   order   to   meet    the   unforeseen circumstance expenditures    for example   expenditure   on sickness,   car break down   etc.  This also depends on the individual’s    income.
• Speculative motive. Individuals    demand   for money   for earning   income   through   buying   and selling government   securities.     This  depends   on  the  interest  rates  on  the  government    securities (treasury  bills  and  bonds).   When the interest rate on bonds falls, the speculators   prefer holding cash and when  interest  rates  on bonds  increases,  the speculators  prefer  holding  bonds  to cash.

From   the   graph,   when   interest    rate   is expected     to    fall     from      0r₂    to 0r₁,                   speculators    convert   bonds   to cash   and therefore   demand   more   money    m₁m₂    to           avoid   losses.   When   the   interest   rate   is expected to   increase from    0r₁ to   0r₂,                    speculators    buy   more   bonds   and hence demand less money 0m₁.

• Liquidity trap. This refers   to  the  point  below  which  the  interest   rate  is  too  low  to  encourage speculators   to invest  in bonds  and  as a result,  they  only  hold  money.   OR. It is the point below which the interest rate is too low to break the liquidity preference.