The precautionary demand for money is the stock of money that people hold to Que

Question

The precautionary demand for money is the stock of money that people hold to

Question 1 options:

A) pay their predictable, everyday expenses.

B) pay for any unexpected expenses that may occur.

C) buy stocks, bonds, and other nonmoney financial assets.

D) buy the foreign currencies needed to purchase imports.

If the Fed wants to lower interest rates, then it can use its open market operations to

Question 4 options:

A) increase the money supply.

B) decrease the money supply.

C) increase money demand.

D) decrease the money demand.

Keynesian economists argue that monetary policy works through its effects on

Question 5 options:

A) interest rates and investment.

B) price and wage flexibilty.

C) budget deficits and trade deficits.

D) the spending and money multipliers

Explanation / Answer

According to Keyne's demand for money theory, people demand money for three reasons -

1) Transactionary motive :To provide for daily, predictable expenses that one might need to bear to carry out their day-to-day operations.

2) Precautionary motive: To provide for contingencies that may arise because of unpredictable circumstances. So, some stock of money is kept aside so that if these unforeseen situation emerges they will be at least prepared to some extent, if not completely.

3) Speculative motive : People demand money for putting them in shares or bonds based upon bulls or bears trend.

Given this background, let's understand the answer.

Ques 1 comes straight from Precautionary treatment of demand for money. So, answer is-

part (B)

Ques 4. Part A)

When money supply increases, people will have lots of cash in their hands. This will induce a lower pressure on interest rates. Note that, federal reserve has command over only supply of money and it cannot altercate demand, which is governed by reactions of households, firms and individuals.

Question 5. Part A)

According to Keynes, monetary policy doesn't necessarily have an affect on spending, because it can well happen that with increase in money supply people increase their reserve of idle balance and thus produce no effect on spending - this rules out the possibility of part D)

Budget deficits and trade deficits do get affected by inflations but not directly by monetary policy.

Keynes assume that there is wage - price rigidity in the economy and thus monetary policy cannot work through it.

Monetary policy with its effects on demand for money changes the interest rates which will in turn affect the goods market through investment. Thus, monetary policy works through networks of interest rates and investments.

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