Liquidity preference facts for kids

In Macroeconomics, liquidity preference is a big idea about why people like to keep their money as cash or in easy-to-reach bank accounts. It means they prefer having money ready to spend or use, rather than having it tied up in investments that are harder to turn into cash quickly.

This idea is also called Cash preference. A famous economist named John Maynard Keynes first explained it in his book, The General Theory of Employment, Interest and Money, which he wrote in 1936.

What is Liquidity Preference?

Liquidity preference explains why people choose to hold onto cash instead of investing it. Cash is "liquid" because you can use it right away. Other things, like houses or stocks, are less liquid because it takes time to sell them and get cash.

Why People Hold Cash

Keynes said there are three main reasons why people prefer to hold cash:

Transaction Motive

This is the most common reason. People need cash for everyday spending. Think about buying snacks, paying for bus tickets, or getting groceries. You need money readily available for these regular transactions.

Precautionary Motive

People also keep cash for unexpected events. What if your bike breaks down? Or you suddenly need to buy a new school book? Having some cash saved for emergencies makes people feel safer and more prepared. It's like having a safety net.

Speculative Motive

This reason is a bit more complex. Sometimes, people hold cash because they expect interest rates to change. If they think interest rates will go up soon, they might hold onto their cash. They wait for a better time to invest, hoping to earn more money later. If interest rates are low, they might prefer to keep cash rather than invest it for a small return.

Interest Rates and Cash

The amount of interest you can earn on investments affects how much cash people want to hold.

• When interest rates are high, people might want to hold less cash. They would rather put their money into investments to earn more interest.
• When interest rates are low, people might want to hold more cash. There isn't much to gain from investing, so they prefer the safety and ease of having cash.

Who Was John Maynard Keynes?

John Maynard Keynes (1883–1946) was a very important British economist. His ideas changed how many governments and economists thought about the economy. He believed that governments could help fix economic problems like unemployment and recessions. His work, especially "The General Theory," is still studied today.

Importance of Liquidity Preference

Understanding liquidity preference helps us see how people's choices about holding cash can affect the economy. It helps economists and governments understand:

• How interest rates are set.
• Why people save or spend.
• How money supply policies can work.

For example, if everyone suddenly decides to hold a lot of cash and not spend or invest, it can slow down the economy. This is because less money is flowing around to businesses and workers.