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•THEORY OF LIQUIDITY PREFERENCE
The theory of liquidity preference is a macroeconomic theory revolving around liquidity and the publics' desire and preference to hold their money as liquid, in either straight dollar bills or as a liquid asset that is quickly convertible to dollars. Liquidity preference means the desire of the public to hold cash. Developed by Keynes in 1936 in his General Theory of Employment, Interest and Money, Keynes states that there are, in total, three motives behind the desire to hold liquid cash: (1) the transaction motive, (2) the precautionary motive, and (3) the speculative motive. First, there is the transaction motive. People generally prefer liquidity for basic transactions, mainly because the entirety of their income is not available. Essentially what this means is that the level of liquidity of liquidity relies on the income size. For example, the higher the income the more amount of money needed and demanded for carrying out spending. Secondly, Keynes stated there is the precautionary motive. In case of emergency and unexpected circumstances, people prefer to have their savings in liquid form, simply because they never know what or can happen to them. Just like transaction motives, the money demanded increases as income increases. Finally, there is the speculative motive. What this states is that people prefer to hold liquidity because of the speculation that bonds will fall. As, or when, interest rates decrease consumers demand more money until the interest rate diminishes. This would drop down the prices of existing bonds to keep it in line with the interest rate. Because of such, this means the lower the interest, the more liquid money demanded and vice versa. Keynes states that the higher the interest rate, the lower the speculative demand, and vice versa. Keynes expressed the speculative demand for money as
M2 = L2 (r)
Where, L2 is the speculative demand for money, and (r) is the rate of interest. On a graph it is a smooth curve which slopes downward from left to right.