Liquidity Preference Theory

The liquidity preference theory is a monetary theory that explains the relationship between interest rates and the demand for money. It was developed by John Maynard Keynes in his book, The General Theory of Employment, Interest, and Money.

The liquidity preference theory states that the demand for money is a function of the interest rate. The higher the interest rate, the lower the demand for money. This is because when interest rates are high, people are more likely to save their money rather than spend it.

The liquidity preference theory also states that the demand for money is a function of the level of income. The higher the level of income, the greater the demand for money. This is because when people have more money, they are more likely to spend it.

The liquidity preference theory is used to explain why interest rates change. When the demand for money increases, interest rates rise. This is because when people want to hold more money, they are willing to pay a higher interest rate to do so. Conversely, when the demand for money decreases, interest rates fall. This is because when people want to hold less money, they are willing to accept a lower interest rate.

The liquidity preference theory is an important part of Keynesian economics. It helps to explain how interest rates are determined and how they affect the economy.