Fixing the Economists Article of the Week
by Philip Pilkington
In Keynes’ General Theory is is famously stated that the demand for money relies on three distinct functions. These are: the transactions demand for money; the precautionary demand for money; and the speculative demand for money.
Or, more formally:
M = Mt + Mp + Ms
In that work Keynes — as he regularly did in his monetary theories — laid rather a lot of emphasis on the speculative demand for money and not a great deal of emphasis on the precautionary demand for money. In chapter 13 of his General Theory
he wrote,
It may illustrate the argument to point out that, if the liquidity-preferences due to the transactions-motive and the precautionary-motive are assumed to absorb a quantity of cash which is not very sensitive to changes in the rate of interest as such and apart from its reactions on the level of income, so that the total quantity of money, less this quantity, is available for satisfying liquidity-preferences due to the speculative-motive, the rate of interest and the price of bonds have to be fixed at the level at which the desire on the part of certain individuals to hold cash (because at that level they feel “bearish” of the future of bonds) is exactly equal to the amount of cash available for the speculative-motive. Thus each increase in the quantity of money must raise the price of bonds sufficiently to exceed the expectations of some “bull” and so influence him to sell his bond for cash and join the “bear” brigade. If, however, there is a negligible demand for cash from the speculative-motive except for a short transitional interval, an increase in the quantity of money will have to lower the rate of interest almost forthwith, in whatever degree is necessary to raise employment and the wage-unit sufficiently to cause the additional cash to be absorbed by the transactions-motive and the precautionary-motive. (My Emphasis)
