Liquidity Preference Theory (Keynesian Demand for Money)

📈 Economics By CampusDown Wiki Editorial Team Last updated October 15, 2026

Quick answer: Keynes's liquidity preference theory says people hold money for transactions, precaution and speculation, so money demand rises with income and falls with interest rates.

Contents

1. Three motives
2. Interest rates and the liquidity trap
3. Contrast and successors
4. References

Three motives

Transactions: money for everyday spending, rising with income.
Precautionary: a buffer for unexpected needs, also rising with income.
Speculative: holding money instead of bonds when bond prices are expected to fall, which grows as interest rates fall.

Interest rates and the liquidity trap

Keynes held that the interest rate is set by the demand for and supply of money, not by saving and investment. At very low rates everyone prefers cash, so extra money supply cannot push rates lower - the liquidity trap - and fiscal policy is needed.

Contrast and successors

The quantity theory (MV = PY) treats money only as a medium of exchange with stable velocity; Keynes treated money as an asset, so velocity varies with interest rates. Baumol (1952) and Tobin (1956) showed transactions demand is interest-sensitive, and Tobin (1958) recast speculative demand as risk aversion.

References

Keynes, J. M. (1936). The General Theory of Employment, Interest and Money. Macmillan, ch. 13-15.
Baumol, W. J. (1952). The transactions demand for cash: An inventory theoretic approach. Quarterly Journal of Economics, 66(4), 545-556.
Tobin, J. (1958). Liquidity preference as behavior towards risk. Review of Economic Studies, 25(2), 65-86.

Reports and materials that use this theory (Korean)

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This article was last updated on October 15, 2026. It is based on widely recognized original works and textbooks; when citing it in a paper, please check the original sources listed in the references.