Monetary Economics Essay Example | Topics and Well Written Essays - 2000 words

Monetary Economics - Essay Example The area of concern in this research paper is to evaluate the transaction demand for money. The transaction demand for money is the money held for purchasing everyday goods from the market. Transaction demand for money for the individuals is initiated by their requirements of paying rent, mortgage payments, monthly bills, and car payments among others (Tata McGraw Hill Companies, 2002). Transaction motive of holding money is initiated also among businesses as the business houses require money in their accounts for meeting their payrolls and paying the bills. Before discussing the reasons as to why it is believed that transaction demand for money is interest elastic, it is essential to discuss the relationship that interest rates have on the demand for money. The demand for money or the quantity of money held decreases with the increase in the interest rates. The substitute or the alternative for holding assets other than the form of money is to hold them as a certain form of paper th at bears interest. Thus, as the interest rate is increased, the attraction towards the assets increases and urges to hold money decreases (Tata McGraw Hill Companies, 2002). After the brief discussion on how the transaction demand for money can possibly become interest elastic, it will be easier to understand the reason behind the belief. 2.0. Transaction Demand for Money According to Keynes, transaction demand for money relates to â€Å"the need of cash for the current transactions of personal and business exchange†. The transaction motive is further divided into income motive and business motive. The motive of income is aimed at bridging the interval between the income receipt and disbursements. In the same manner, business motive is the bridging of interval between the costs incurred in business and the receipts of the proceeds of the sales. In both the cases, if the interval is less, then individuals will strive to hold less cash or the transaction demand for money will b e less and vice-versa. Thus, it is evident that the transaction demand for money has a ‘direct positive relationship’ with the level of income (SVMMBA, 2010). 2.1. Transaction Demand and Interest Rate Keynes did not explain the importance of the interest rates in the analysis of his part of the theory of demand for money. However, in the later years, two of the post Keynesian economists, James Tobin and William J. Baumol have depicted the importance of interest rates as a determinant of the transactions demand for money. These economists have mentioned that there is no linear and proportional relationship between the income and transaction demand for money. According to them, income changes lead to smaller amount of proportional changes in the transaction demand for money (SVMMBA, 2010). Individuals hold transaction balances because income that is received only once in a month is not spent by them in a single day. In fact, this is the common nature of the individuals th at they spread evenly the expenditure over the period of the month. Thus, a part of the money that is meant for the purpose of transaction spending can be invested or spent on short-term securities that yield interests. It is likely to put the funds for the purpose of making them work for a few days, say a week, ten days or even a month. The investment can be on short term interest bearing securities such as short-term money market instruments or commercial papers and