B) as the interest rate rises, the demand for real balances will rise. The Liquidity Preference Theory says that the demand for money is not to borrow money but the desire to remain liquid. B. Liquidity preference is his theory about the reasons people hold cash; economists call this a demand-for-money theory. The Liquidity Preference Theory was first described in his book, "The General Theory of Employment, Interest, and Money," published in 1936. Speculative Motive A. The central bank in this economy is called the Fed. 4. Liquidity Management: Theory # 2. According to Keynes people demand liquidity or prefer liquidity because they have three different motives for holding cash rather than bonds etc. The Keynesian Monetary Theory and the LM Curve 2. 1. Precaution Motive 3. Skip to content. As interest rates rise, people will reduce their money holdings and therefore velocity will rise. Suppose the price level decreases from 90 to 75. Online Driver Ed. The theory asserts that people prefer cash over other assets for three specific reasons. Liquidity Preference Theory Definition. The Liquidity Preference theory proposes higher premiums on medium- and long-term securities. Explain why aggregate demand might increase by more or less than $3 billion. Use the theory of liquidity preference to explain how a decrease in the money supply affects the aggregatedemand curve. Solution for According to liquidity preference theory, if the price level increases, then the equilibrium interest rate Answer rises and the aggregate quantity… The government spends $3 billion to buy police cars. Assume that the Fed faces the quantity of money supplied. 4. The term liquidity preference was introduced by English economist John Maynard Keynes in his 1936 book, “The General Theory of Employment, Interest, and Money.” Keynes called the aggregate demand for money in the economy liquidity preference. Home; Services. As interest rates rise, people will increase their money holdings and therefore velocity will decrease. 2. The Shift-Ability Theory : The shift-ability theory of bank liquidity was propounded by H.G. The theory of liquidity preference and the downward-slopingaggregate demand curve The following graph shows the money market in a hypothetical economy. What does Keynes's liquidity preference theory predict about the relationship between interest rates and the velocity of money? There are several other factors which influence the rate of interest by affecting the demand for and supply of investible funds. C) the interest rate will have no effect on the demand for real balances. In other words, the interest rate is the ‘price’ for money. 3. A. The theory of liquidity preference implies that: A) as the interest rate rises, the demand for real balances will fall. C. D) as the interest rate rises, income will rise. Liquidity preference is not the only factor governing the rate of interest. 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