Financial Markets, Money and the Real World

Financial Markets, Money and the Real World

Paul Davidson

Paul Davidson investigates why the 1990s was a decade of financial crises that almost precipitated a global market crash. He explores the reasons why the global economy still struggles with the aftermath of these crises and discusses the possibility that volatile financial markets in the future will have real impacts on whole industries and national economic systems.

Chapter 5: Why Liquidity Preference?

Paul Davidson

Subjects: economics and finance, money and banking, post-keynesian economics

Extract

The fundamental question for any monetary analysis applicable to a money-using, market-oriented economy is: ‘Why do people prefer to hold money which is barren or even interest bearing or dividend yielding securities as a store of value rather than real “productive” physical goods?’ Our response involves explaining that the use of money contracts to organize production and exchange processes is the way an entrepreneur system deals with an uncertain (nonergodic) economic future. This use of money contracts requires economic decision makers to maintain a liquid cash position in order to avoid the malady of illiquidity or the gallows of bankruptcy. Money is the liquid asset par excellence in that tendering it will always legally discharge a contractual obligation. The demand for liquidity involves either the demand for money directly or the demand for any other financial asset with low carrying costs that can be readily converted into money rapidly and without significant transaction costs. 5.1 THE FOUR MOTIVES FOR HOLDING MONEY Without money [as a liquid store of wealth], we cannot put off deciding what to buy with the thing we are in the act of selling. If we do not know precisely what use a thing will be to us, we are compelled nevertheless, by an absence of money, to override and ignore this ignorance. It is money which enables decisions to be deferred.1 In The General Theory, Keynes distinguishes three motives for holding money: (i) the transactions-motive, i.e., the need for cash for the current transaction...

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