Transaction Demand for Money Theory

Inventory method for trading balance demand: expansion of basic trading demand for currency theory was proposed by Baumol (1952) and further expanded by Tobin (1956). The main support of the inventory approach is that individuals trade off the liquidity provided by the currency balance and the interest provided by bond holdings. Therefore, the determinants of the model are the nominal interest rate, the actual income level related to the expected number of transactions, and the transaction cost to convert money into bonds.

John Maynard Keynes (1936) explained money demand through his framework of liquidity preferences in his book "General Theory of Employment, Interest, and Money". According to this theory, the main reasons for holding money are trading, prevention, and speculative demand. The sum of all three requirements is total demand for money. According to theory, personal currency demand (liquidity priority) is low if interest rates are high and demand for currency holding increases if interest rates are low. In Figure 2, curve L1 is the transaction currency plus preventive demand. By definition, L stands for liquidity priority and liquidity priority is the need to keep assets monetarily. L is the total demand for currency outstanding and is derived from the horizontal addition of curve L1 (transaction and preventive fund demand) and L2 (speculative fund demand).

When people have money for daily transactions, they are indicative of the need for a transaction; it results in demand for money. Keynesians believe that increases in production and income will sacrifice daily transaction size, which leads to a higher level of trading demand. However, he neglected the role of interest rates on trading demand. In fact, this is consistent with the theory of classical amounts. Therefore, the amount of money trading demand depends only on income level rather than interest rate. The transaction demand currency Mt = f (Y). This has a positive correlation with national income (Y).

In 1950, Baumol and To bin proposed Keynes' theory on currency trading demand and currency prevention demand. They show that the demand for money depends not only on current income but also on sensitivities of interest rates. (Handa, 2000, p. 86). In addition, they also introduced opportunity costs. The basic idea of ​​their model is the opportunity cost of those who have cash, which has the advantage of avoiding transaction costs. In daily transactions, they will give up some of the cash on bonds, and vice versa, because the opportunity costs of those with cash are higher than the transaction costs of the bonds they have. It also shows that currency demand is sensitive to interest rates. The model can be mathematically expressed: = (4)