3. 4. As interest rates rise, people will reduce their money holdings and therefore velocity will rise. C. The government spends $3 billion to buy police cars. Assume that the Fed faces the quantity of money supplied. In other words, the interest rate is the ‘price’ for money. 3. Liquidity Preference Theory Definition. 1. Liquidity preference is not the only factor governing the rate of interest. The liquidity preference theory does not explain the existence of different rates of interest prevailing in the market at the same time. Online Driver Ed. Skip to content. A. The theory of liquidity preference implies that: A) as the interest rate rises, the demand for real balances will fall. Suppose the price level decreases from 90 to 75. Speculative Motive 2. The theory asserts that people prefer cash over other assets for three specific reasons. What does Keynes's liquidity preference theory predict about the relationship between interest rates and the velocity of money? Transaction Motive 2. The central bank in this economy is called the Fed. Home; Services. 4. Liquidity preference is his theory about the reasons people hold cash; economists call this a demand-for-money theory. New Student Enrollment; Existing Student’s Login LIQUIDITY PREFERENCE THEORY The cash money is called liquidity and the liking of the people for cash money is called liquidity preference. D) as the interest rate rises, income will rise. The theory of liquidity preference and the downward-slopingaggregate demand curve The following graph shows the money market in a hypothetical economy. C) the interest rate will have no effect on the demand for real balances. Solution for According to liquidity preference theory, if the price level increases, then the equilibrium interest rate Answer rises and the aggregate quantity… A. According to John Keynes, there are three motives of liquidity theory: 1. The term liquidity preference was introduced by English economist John Maynard Keynes in his 1936 book, “The General Theory of Employment, Interest, and Money.” Keynes called the aggregate demand for money in the economy liquidity preference. B. 2. The Liquidity Preference Theory was first described in his book, "The General Theory of Employment, Interest, and Money," published in 1936. As interest rates rise, people will increase their money holdings and therefore velocity will decrease. The Liquidity Preference Theory says that the demand for money is not to borrow money but the desire to remain liquid. Liquidity Management: Theory # 2. B) as the interest rate rises, the demand for real balances will rise. The Keynesian Monetary Theory and the LM Curve The Liquidity Preference theory proposes higher premiums on medium- and long-term securities. B. The Shift-Ability Theory : The shift-ability theory of bank liquidity was propounded by H.G. Precaution Motive 3. 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