Liquidity Preference Theory of Interest (Rate Determination) of JM Keynes. The demand for money as an asset was theorized to depend on the interest â¦ According to Keynes people divide their income into two parts, saving and expenditure. M V = P Y. where: (2020). According to Keynes, the interest rate is not given for the saving i.e. LIQUIDITY PREFERENCE AND THE THEORY OF INTEREST AND MONEY By FRANCO MODIGLIANI PART I 1. 42, No. Refer to Figure 33-4. SFC modeling and the liquidity preference theory of interest. Journal of Post Keynesian Economics: Vol. According to him, the rate of interest is determined by the demand for and supply of money. Thus the theory explains that the rate of interest is determined at a point where the liquidity preference curve equals the supply of money curve. Keynes states in his Liquidity Preference theory that there are three motives that drive peopleâs desire for liquidity. âLiquidity preference is the preference to have an equal amount j ^ of cash rather than claims against others.â -Prof. Mayers Determination of Interest: According to liquidity preference theory, interest is determined by the demand for and supply of money. (2) Abstinence or Waiting Theory of Interest. The demand for money. 1, pp. First, to point out the limits of the liquidity preference theory. Short-term investments are more liquid than long-term investments. hoarding. Downloadable! (1) Productivity Theory of Interest. Mr. Keynes's liquidity-preference theory of interest is that the interest rate is determined It is the money held for transactions motive which is a function of income. The very late and very great John Maynard Keynes (to distinguish him from his father, economist John Neville Keynes) developed the liquidity preference theory in response to the rather primitive pre-Friedman quantity theory of money, which was simply an assumption-laden identity called the equation of exchange:. We present a simple stock-ow consistent (SFC) model to discuss some recent claims made by Angel Asensio in the Journal of Post Keynesian Economics regarding the relationship between endogenous money theory and the liquidity preference theory of the rate of interest. The reason is that the interest rate is the opportunity cost of Liquidity preference is his theory about the reasons people hold cash; economists call this a demand-for-money theory. LIQUIDITY PREFERENCE THEORY The cash money is called liquidity and the liking of the people for cash money is called liquidity preference. As originally employed by John Maynard Keynes, liquidity preference referred to the relationship between the quantity of money the public wishes to hold and the interest rate.. The Liquidity Preference Theory has a goal of remaining liquid and in order to remain most liquid people should not borrow money, so the interest rate is the cost for having to borrow money and not remaining liquid. We have already discussed the classical theory of interest rate. Journal of Post Keynesian Economics: Vol. Corpus ID: 156322853. The liquidity premium theory of interest rates is a key concept in bond investing. Theories of interest rate determination are very important in economics. we can also call this theory as Liquidity Preference theory. Liquidity-preference is a potentiality or functional tendency, which fixes the quantity of money which the public will hold when the rate of interest is given; so that if r is the rate of interest, M the quantity of money and L the function of liquidity-preference, we have M = L(r). At the equilibrium interest rate, the quantity of real money balances demanded equals the quantity supplied. According to Keynes people demand liquidity or prefer liquidity because they have three different motives for holding cash rather than bonds etc. 4, pp. keynesâ interest is the reward for parting with liquidity â¦ Liquidity Preference refers to the additional premium which holders of wealth or investors will require in order to trade off cash and cash equivalents in exchange for those assets that are not so liquid.