12. What are the motives for holding money? Give examples.

Money is a stock. It is the quantity of circulating currency and bank deposits held at any given time. We hold money now in order to spend it later.

The distinguishing feature of money is its use as a medium of exchange, for which it must also serve as a store of value. It is in these two functions of money that we must seek the reasons why people wish to hold it.

People can hold their wealth in various forms - money, bills, bonds, equities, and property. As people earn income, they add to their wealth. As they spend, they decrease their wealth.

The opportunity cost of holding money is the interest given up by holding money rather than bonds. the liquidity preference theory developed by J.M. Keynes. He postulated that there are three motives behind the demand for money: the transactions motive, the precautionary motive and the speculative motive.

The Transactions Motive.

In a monetary economy we use money to purchase goods and services and receive money in exchange for the goods and services we sell. Without money, making transactions by direct barter would be costly in time and effort. Holding money economizes on the time and effort involved in undertaking transactions.

If all transactions were perfectly synchronized, we would earn revenue from sales of goods and income from sales of factor services at the same instant we made purchases of the goods and services we wish to consume. Except at that instant, we need hold no money at all. The transactions motive for holding money reflects the fact that payments and receipts are not perfectly synchronized. We need to hold money between receiving payments and making subsequent purchases.

How much money we need to hold depends on two things, the value of the transactions we wish to make and the degree of synchronization of our payments and receipts. Money is a nominal variable (переменная), not a real variable. We do not know how much £100 will buy until we know the price of goods. If all prices double, both our receipts and our payments will double in nominal terms. To make the same transactions as before we will need to hold twice as much money. Putting this differently: The demand for money is a demand for real money balances. We need a given amount of real money, nominal money deflated by the price level, to undertake a given quantity of total transactions. Hence when the price level doubles, other things equal we expect the demand for nominal money balances to double, leaving the demand for real money balances unaltered. People want money because of its purchasing power in terms of the goods it will buy.

The second factor affecting the transactions motive for holding money is the degree of synchronization of payments and receipts. Suppose that, instead of spreading their shopping evenly throughout the week, households do all their shopping on the day they get a salary cheque from their employers. Over the week, national income and total transactions are unaltered, but people now hold less money over the week.

A nation's habits for making payments change only slowly. In our simplified model we assume that the degree of synchronization remains constant over time. Thus we focus on real national income as the measure of the transactions motive for holding real money balances.

The Precautionary Motive.

But of course we live in an uncertain world. This uncertainty about the precise timing of receipts and payments gives rise to a precautionary motive for holding money.

Suppose you decide to buy a lot of interest-earning bonds and try to get by with only a small amount of money holdings. You are walking down the street and spot a great bargain in a shop window. But you do not have enough money to take advantage immediately of this opportunity. By the time you have arranged for some of your interest-earning bonds to be sold off in exchange for money, the sale may be over. Someone else may have snapped up the video recorder on sale at half price. This is the precautionary motive for holding money. In an uncertain world, there is a precautionary motive to hold money. In advance, we decide to hold money to meet contingencies (для покрытия непредвиденных расходов)the exact nature of which we cannot yet foresee. If we had foreseen the contingency we would have had plenty of time to cash in interest-earning bonds to have money available. If we did not have to take advantage of the transactions opportunity immediately, it would not matter that it was unforeseen: we could still cash in our bonds at our leisure and buy the half-price video recorder. We forgo interest and carry money for precautionary reasons, because having ready money allows us to snap up unforeseen bargains, or stave off unforeseen crises by making immediate payments.

Together, the transactions and precautionary motives provide the main reasons for holding the medium of exchange. They are the motives most relevant to the benefits from holding the narrow definition of money Ml.

The Asset Motive.

We think of a wealthy individual or a firm deciding in which assets to hold wealth. We want to earn a good rate of return.

Some assets, such as industrial shares, on average pay a high rate of return but are also quite risky. Some years their return is very high but in other years it is negative. When share prices fall, shareholders can make a capital loss, which swamps any dividend payment to which they are entitled. Other assets are much less risky, but their rate of return tends to be much lower than the average return on risky assets.

How should people divide their portfolios of financial investments between safe and risky assets. since people dislike risk, they will not put all their eggs in one basket. As well as holding some risky assets, they will keep some of their wealth in safe assets. Although on average this portfolio will earn a lower rate of return, it will help avoid absolute disaster in bad years. The asset motive for holding money arises because people dislike risk. People are prepared to decline a high average rate of return to obtain a portfolio with a lower but more predictable rate of return