1. Introduction

The demand for money is defined as the desired holding of certain cash and other financial assets in monetary form. M1 is assets that are the most liquid of assets, and those that can most quickly be converted to cash. Those funds that are M1 include paper currency, coins, Traveler’s checks, demand deposits, negotiable order of withdrawal at depository institutions and shared draft accounts with credit unions. M1 does not include savings accounts, money market accounts, or CD’s. M1 is the most often referenced money supply by economists who use it to show the amount of money that is circulating through the economy. Inflation, supply and demand, interest rates and the state of the economy all play a factor in how and where people choose to hold their assets as well as how they decide to use those assets. This paper will look at an economic concept related to money demand through the review of scholarly articles. This concept is the Liquidity Preference Theory. Through the examination of scholarly articles, we will examine the validity of the Liquidity Preference Theory.

2. Literature Review

The Liquidity Preference Theory was introduced was economist John Keynes. His theory argued there was a relationship between interest rates and the demand for money. Keynes theory is also called a demand-for-money theory. The theory argues that consumers prefer cash over the other asset types for three reasons (Intelligent Economist, 2018). Keynes argued in his theory, that when interest is at a lower rate, people will be encouraged to increase money rather than increase the investment. People are not as willing to have a less liquid type of wealth when interest rates are low as they are when interest rates are higher. Instead, people will wait for interest rates to rise. Keynes’s theory argued that the interest rate in the demand for money is affected by supply and demand (Intelligent Economist, 2018). The Liquidity Preference Theory has a goal of remaining liquid and in order to remain most liquid people should not borrow money, so the interest rate is the cost for having to borrow money and not remaining liquid. Keynes states in his Liquidity Preference theory that there are three motives that drive people’s desire for liquidity. Those motives are the transaction motive, the precautionary motive, and the speculative motive (Pal, n.d.).

The transaction motive involves our daily purchasing habits. The money supply and the demand presented for the transaction motive can depend on how frequently a person is paid and the person’s income. Those that have higher income usually have a higher level of liquid money and can meet their daily transaction demands. Transaction demand (T_dm) for money is an increasing function of money income. It is stated by the following function: T_dm = f (Y), where Y represents the money income (Muley, n.d.).

The precautionary motive looks toward an uncertain future. This motive focuses on income that is available for any wanted or necessary convenient purchases. The need for these uncertainties can arise from illness, injuries, loss of jobs and death (Muley, n.d). Keynes argued that those that have larger incomes will be more prepared with greater amounts of cash and assets set aside to meet the emergencies noted above. Those with smaller incomes will not have as large amounts of cash set aside for these emergencies and uncertainties that drive the precautionary motive. The precautionary motive demand for money is also an increasing function of money income (Muley, n.d.). Precautionary demand for money (P_dm) and the volume of income have a direct relationship and is illustrated with the function P_dm = f (Y) where Y stands for money income.

The speculative motive involves the income that can be gained by trading bonds and securities as the prices and interest rates fluctuate. This motive involves more uncertainty because of the fluctuating interest rates that can be affected by external factors (Muley, n.d.). People will spend speculative income when prices rise, or when interest rates fall. Alternatively, consumers will sell securities when prices fall, or when interest rates rise. So, the speculative motive shows that when interest rates are high, the demand for money is low. People who are earning money and wealth through the speculative motive likely have a preference to earn the bigger interest rates instead of having their assets having a more liquid status like cash and n