The Psychological and Business Incentives To Liquidity

What are the motives for liquidity-preference or the love for cash?

The love for cash is also closely connected with the “income-velocity of money”.

They say that:

• the income-velocity of money is the proportion of the income of the people that they choose to have as cash.
• an increased income-velocity of money may be a symptom of a decreased love for cash.

But this is misleading because:

• the individual can choose between cash and illiquidity when it comes to his savings.
  • He cannot have the same choice for his income.
• it makes us think that the demand for money is related to income.

• In reality, this presumption should apply only to a portion of the public’s cash holdings because it overlooks the part played by interest rates.

My Treatise on Money Chapter 3 studies the total demand for money under:

• income-deposits
• business-deposits, and
• savings-deposits.

Money held for each of the 3 purposes forms, nevertheless, a single pool.

• Its holder is not obliged to segregate this into 3 water-tight compartments, for they need not be sharply divided even in his own mind.

The same sum can be held primarily for one purpose and secondarily for another.

• Thus an individual’s aggregate demand for money is a single decision, even if it is the composite result of different motives.

We can classify these motives under certain headings:

1. Transactions-motive

2. Income-motive

This bridges the timespan between:

• the receipt of income and
• its disbursement.

The strength of this motive is in deciding to hold cash depending on:

• the amount of income and
• time between its receipt and its disbursement.

The concept of the income-velocity of money is appropriate here.

3. Business-motive

This includes cash held by dealers to bridge the timespan between purchase and re-sale.

Cash is held to bridge the interval between the time of:

• business costs and
• the sale of goods.

The strength of this demand will chiefly depend on:

• the value of current output (and hence on current income), and
• the number of hands through which output passes.

4. Precautionary-motive

This provides for contingencies requiring sudden expenditure or future liability.

5. Speculative-motive

This is:

• less well-understood and
• is important in transmitting the effects of a change in the quantity of money.

Normally, the amount of money needed to satisfy the need for cash and the need for security is a result:

• of the general activity of the economic system and
• of the level of money-income.

But it is by playing on the speculative-motive that monetary management is brought to bear on the economic system.

The strength of these 3 types of motives will partly depend on the cheapness and the reliability of ways to get cash when needed through some form of temporary borrowing.

• An example is by overdraft.

There is no necessity to hold idle cash to bridge over intervals if it can be obtained without difficulty at the moment when it is actually required.

• Their strength will also depend on what we may term the relative cost of holding cash.
• If the cash can only be retained by forgoing the purchase of a profitable asset, this increases the cost and thus weakens the motive towards holding a given amount of cash.
• If deposit interest is earned or if bank charges are avoided by holding cash, this decreases the cost and strengthens the motive.
• It may be, however, that this is likely to be a minor factor except where large changes in the cost of holding cash are in question.