The Liquidity Preference

The 3 divisions of the love for future cash depend on:

• the transactions-motive, i.e. the need of cash
• the precautionary-motive as the desire for security as to the future cash equivalent
• the speculative-motive, i.e. the object of securing profit from knowing better than the market what will the future be

A debt-market allows wide fluctuations in the love for cash due to speculation.

But without such a market, the love for cash for the security of cash would be greatly increased.

If the need for cash and the need for security absorb a quantity of cash which is not very sensitive to changes in the interest rate so that there is more money for speculators, then the interest rate and bond prices have to be fixed at the level where speculators will prefer to hold cash (because they feel “bearish” of the future of bonds) and is exactly equal to the amount of cash available for speculation.

Thus, each increase in the quantity of money must raise the price of bonds enough 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 speculators, an increase in the quantity of money will have to lower the rate of interest almost immediately, in whatever degree is needed to raise employment and the wage-unit sufficiently to cause the additional cash to be absorbed by the need for cash and security.

The love for cash curve relating the quantity of money to the interest rate is given by a smooth curve which shows the interest rate falling as the quantity of cash is increased.

These are caused by;

1. As the interest rate falls, more cash will be absorbed by the love of cash due to the need for cash.

If the fall in the interest rate increases the national income, the amount of cash convenient to keep for transactions will be increased proportionally to the increase in income.

• At the same time, the cost of the convenience of ready cash in terms of loss of interest will be diminished.

Unless we measure the love of cash in terms of wage-units instead of money, similar results follow if the increased employment from a fall in the interest rate leads to an increase of wages, i.e. to an increase in the money value of the wage-unit.

2. Every fall in the interest rate may increase the quantity of cash which certain individuals will wish to hold because they think about the future rate of interest differently from the market.

Nevertheless, even a large increase in the quantity of money may exert a comparatively small influence on the rate of interest.

A large increase in the quantity of cash may cause so much uncertainty, that the love of cash due to the need for security may be strengthened.

Opinion about the future of the rate of interest may also be so unanimous that a small change in present rates may cause a mass movement into cash.

The stability of the system is so dependent on the variety of opinion about what is uncertain.

If we are to control the economic system by changing the quantity of money, it is important that opinions should differ. Thus this method of control is more precarious in the United States, where everyone tends to hold the same opinion at the same time, than in England where differences of opinion are more usual.

Why Doesn’t Cash Spur Activity Sometimes?

Cash is the drink which stimulates the system to activity. There may be several slips between the cup and the lip.

An increase in the quantity of cash might reduce the interest rate. But this will not happen if the public’s love for cash is increasing more than the quantity of cash.

A decline in the interest rate might increase the volume of investment. But this will not happen if the returns on investment are falling faster than the interest rate.

An increase in the volume of investment might increase employment. But this may not happen if the propensity to consume is falling.

Finally, if employment increases, prices will rise. Inflation will then increase the quantity of cash needed to maintain a given interest rate. When output has increased and prices have risen, the effect of this on love of cash will be to increase the

The State of Bearishness

I call the love for cash due to the speculation as “the state of bearishness”.

But these are not the same thing. I defined “Bearishness” as the functional-relationship between:

• the collective price of assets and debts and
• the quantity of cash

It is not a relationship between:

• the interest rate (or price of debts) and
• the quantity of cash

This treatment, however, involved a confusion between results due to a change in the rate of interest and those due to a change in the schedule of the marginal efficiency of capital, which I hope I have here avoided.

Hoarding

Hoarding is a first approximation to the concept of the love of cash.

If we substituted “propensity to hoard” for “hoarding”, it would be the same thing. But if we mean by “hoarding” an actual increase in cash-holding, it is an incomplete idea — and seriously misleading if it causes us to think of “hoarding” and “not-hoarding” as simple alternatives.

The decision to hoard is not taken absolutely or without regard to the advantages offered for parting with cash.

It results from a balancing of advantages. We should know what lies in the other scale.

It is impossible for the actual amount of hoarding to change as a result of decisions on the part of the public, so long as we mean by “hoarding” the actual holding of cash.

The amount of hoarding must be equal to the quantity of cash (or — on some definitions — to the quantity of money minus what is required to satisfy the transactions-motive).

The quantity of cash is not determined by the public.

All that the propensity of the public towards hoarding can achieve is to determine the interest rate at which the aggregate desire to hoard becomes equal to the available cash.

The habit of overlooking the relation of the interest rate to hoarding may explain why interest has been usually regarded as the reward of not-spending. In reality, it is the reward of not-hoarding.

Author’s Footnotes

1. Without disturbance to this definition, we can draw the line between “money” and “debts” at whatever point is most convenient for handling a particular problem. For example, we can treat as money any command over general purchasing power which the owner has not parted with for a period in excess of three months, and as debt what cannot be recovered for a longer period than this; or we can substitute for “three months” one month or three days or three hours or any other period; or we can exclude from money whatever is not legal tender on the spot.

It is often convenient in practice to include in money time-deposits with banks and, occasionally, even such instruments as (e.g.) treasury bills. As a rule, I shall, as in my Treatise on Money, assume that money is coextensive with bank deposits.

2. In general discussion, as distinct from specific problems where the period of the debt is expressly specified, it is convenient to mean by the rate of interest the complex of the various rates of interest current for different periods of time, i.e. for debts of different maturities.

3. This is the same point as I discussed in my Treatise on Money under the designation of the two views and the “bull-bear” position.

4. It might be thought that, in the same way, an individual, who believed that the prospective yield of investments will be below what the market is expecting, will have a sufficient reason for holding liquid cash. But this is not the case. He has a sufficient reason for holding cash or debts in preference to equities; but the purchase of debts will be a preferable alternative to holding cash, unless he also believes that the future rate of interest will prove to be higher than the market is supposing.