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Chapter 20: Q 10. (page 547)

What three motives for holding money did Keynes consider in his liquidity preference theory of the demand for real money balances? On the basis of these motives, what variables did he think determined the demand for money?

Short Answer

Expert verified

Prudent, speculative, and transactional incentives are the three types of incentives.

Step by step solution

01

Step 1. Define demand.

Demand refers to the amount of a product which customers are willing to buy at different prices over a set period of time.

02

Step 2. Three motives for holding money

Prudent, speculative, and transactional incentives are the three types of incentives.

Based on three primary components, Keynes argued that the cash ratio was positively tightly associated but negatively related to the rate of interest.

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Go to the St. Louis Federal Reserve FRED database, and find data on the budget deficit (FYFSD), the amount of federal debt held by the public (FYGFDPUN), and the amount of federal debt held by the Federal Reserve (FDHBFRBN). Convert the two “debt held” series to “Annual” using the frequency setting. Download all three series into a spreadsheet. Make sure that the rows of data align properly to the correct dates. Note that for the deficit series, a negative number indicates a deficit; multiply the series by –1 so that a deficit is indicated by a positive number. Manipulate the three series so that all data are given in terms of the same units (either millions or billions of dollars). To do this, if a series is in millions and you are converting it to billions, divide the series by 1,000. Finally, for each year, convert the two “debt held” series into one “changes in debt holdings by the public and the Federal Reserve” series by calculating, for each year, the difference in bond holdings from the preceding year.

a. Create a scatter plot showing the deficit on the horizontal axis and the change in bond holdings by the public on the vertical axis, using the data from 1980 through the most recent period of data available. Insert a fitted line into the scatter plot, and comment on the relationship between the deficit and the change in public bond holdings.

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c. Now repeat part (b), but create separate scatterplots for the period of 1980 to 2007, and 2008 to the most recent year. Comment on how, if at all, the monetizing of the debt is exhibited in the data. Do you think the relationship between the deficit and the change in bond holdings of the Federal Reserve has changed since 2008? Why or why not?
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