Why Do People Hold onto Money - Essay Example

Demand for money Analysis for the results for the mode: R squared (R2) R squared refers to the coefficient of determination and it indicates the extent to which a given data set fits the econometric model. The measure helps in achievement of accuracy in predictions of some phenomenon. Additionally, the coefficient of determination is used during hypothetical analysis. The value also represents the total number of variations of the model used. For instance, the coefficient of determination for the econometric model in quest is 0.958026537. This shows that there is 95.8% of variation of outcome of the econometric model. The measure is denoted by: Adjusted R2: The adjusted R squared is used to compare the explanatory power of regression model, which has different numbers of prediction variables. The variable is usually an adjusted version of R squared. The R squared is adjusted subject to the predictor of the mode of concern like econometric models. The adjusted value for R2 for the current model is 0.957985165. This implies that the predictors of the model are reliable. It is denoted by: F-test F-test is usually made up of two chi-square variables, which are independent. The variables are divided by the appropriate degrees of freedom. The F-test is characterized by negative F values and a non-symmetric distribution of values. Additionally, the mean of the F-test is 1. The major purpose of the F-test is to ascertain whether the variances of two populations are equal. In this regard, the ration is one when the population variances are equal. In the above case, the population variances were equal because the F significance is 0. F-test applies when the null hypothesis is true. The F-test is denoted by: F =  T-statistic This is a standardized value, which is obtained from sample data. The t-test is used in conjunction with the F-test to determine the reliability of the null hypothesis. In this regard, the t-test helps a researcher to compare the results of the null hypothesis and the researcher’s data successfully. The value also helps in the computation of p-value when the null hypothesis ought to be rejected. The t-test for the above model is 4.788. The t-test indicates that the null hypothesis should be upheld. It is denoted by: SSE The explained sum of squares represents the total sum of squares of deviation from mean value, of various predicted values. In this regard, high values of the sum of squares indicate reliability of the model used for statistical analysis. It is denoted by: Null hypothesis, F = 0; Null hypothesis indicates the equality of variances of two population sets. In this case, the F-test supports the null hypothesis. The values are all accepted subject to the null hypothesis. The Demand for Money: The Classical and the Keynesian Approach towards Money Introduction The demand for money is based on the function of money, which include medium of exchange and store of value. This implies that people hold money with an intention of acquiring goods and services in exchange for money while some people purchase assets to preserve the value of the money. Summary The demand for money changes subject to disposable income of people. The demand for money is also subject to the substitution effect. When there are assets available for substitution with money, the demand for money reduces. The substitution view considers money equivalents like bonds and stock as determinant of the demand for money. Chand (2009) posits that when the bond interest rates increase many investors are compelled to keep their money in cash instead of incurring foreseeable losses. In this case, the demand for money increases. However, when bond interest rates fall, investors opt to purchase bonds hence reduction of money demand. The substitution view derives precautionary and speculative demand for money. Classical approach The approach is based on the quantity theory of money. The transaction demand for money is essential in the exploration of the classical approach to money demand. The velocity of circulation of money is subject to the transaction demand for money. The fact that money serves as a medium for exchange implies that the quantity theory of money is indispensable in the subject. The velocity of circulation of money is subject to the equation of exchange. MV=PT; M represent money while V represents the velocity of money flow in the economy. P is the general price level while T represents the commodities exchanged for money. Therefore, PT is the demand for money while MV represents the supply of money in the economy. The transaction demand for money is based on employment income. The relationship between the demand for money and national income shows that scale view on money demand is valid. The volume of trade is also a determinant of money demand because some people keep money in order to purchase goods when market conditions are favorable. This means that money is also used for speculative purpose. According to Chand (2009), investors invest money to earn interest and use money to avert risks especially in the case of forward contracts and futures. Time deposits are also considered money because of accrual and prudence concepts of financial management. The Cambridge theory of money demand is also helpful in the determination of the value of money. Other convertible funds are also considered money during transactions. The demand for money is also subject uncertainty. However, the theory has flaws including the ignorance of many as a store of value. The classical theory does emphasize on only one function of money, medium of exchange. Moreover, money serves as a facilitator in buying and selling of commodities. This notwithstanding, money does not create wealth when it is stored. Therefore, the classical theory ignored the function of money, store of value. Conversely, money acts as an asset because vital assets can be bought and resold later when the market has improved. Money value can be stored in the form of debentures, equities and real assets. In this regard, the classical theory falls short of reality when it ignored the vital function of money. Keynesian approach Keynes approach underscores liquidity preference. According to Keynes, money demand is subject to speculative demand, precautionary demand and transaction demand. The transaction demand for money is derived from the function of money, medium of exchange. The regular payment of debts and purchase of commodities involves the Keynesian approach. The approach established the need for money to settle current transactions in business. The business covered in this scenario includes personal and corporate businesses. Additionally, the approach covers income motives. The demand for money is also subject to business motives. Business motives are crucial because capital is needed to seal business deals. According to Chand (2009), business motive is indispensable in money demand because investors are usually focused on marginal returns from business. Business motive is vital for an investor because it usually reduces the time lag between the purchase of commodities and the earning of sale proceeds from the same goods. This motive helps in the reduction f stockholding costs incurred in the course of holding goods before reselling. Moreover, when the time lag is small people because of the turnover of stock hold low amounts of money. In this regard, the business motive is a critical aspect of determination of money demand. The expectation of businesspersons and their counterparts, prospective consumers is vital. The Keynesian approach is based on the interest rate, business turn-over and income. Interest rate is a direct determinant of the transaction demand for money because high interest rates discourage investors leading to high levels of money among the investors. However, when the interest rates are low there is low amount of money among the investors. The precautionary demand for money is directly related to the desire to cover the contingencies. The contingent aspect compels many people to keep money for speculative purpose. For instance, people never foresee accidents. Conclusion Both classical and Keynesian approaches to demand for money underscore the precautionary motive, which is vital because the people are able to earn profits from unforeseen eventualities. Speculative demand for money serves to secure profits from business deals. Hoarding is the most common practice in this scenario. The interest bearing bonds are the most common form of speculative tools used to earn profits. Recent developments in demand for money issues: survey of theory & evidence with reference to Arab countries Introduction Demand for money is a critical function of economic stability. Moreover, the demand for money plays a critical role in the drafting of policies. The authorities must be able to adjust both the supply and demand of money in order to regulate an economy properly. For instance, the implementation of a monetary policy helps in the maintenance of equilibrium state in a money market. Summary Modification of the monetary structure is essential in meeting the demands of money in an economy. The interaction between theory and reality in the money market leads to the establishment of sustainable monetary policies (Tahir, 2010). Monetary disturbances are avoided through the regulation of money supply and money demand. Money demand depends on money supply, which is subject to price, income level and balance of payment. The recent development realized in money demand is the transition from quantity theory of money to modernist theories of money like Cambridge theory f money demand. Money demand is influenced by various variables. The level of transaction determines the demand for money. Income is also an essential component of the demand for money. The aspect of wealth and permanent income counts in determination of the demand for money. This notwithstanding, the perception of people also influences the relationship between money demand and permanent income. Wealth is subject to time while income is subject to speculation. For instance, wealth creation is a continuous process of re-investing back profit made from business deals. In this regard, the demand for money depends on the priorities of a businessperson. Money can be considered a medium of exchange subject to the intention of an investor. For instance, an investor can decide whether to bas his priorities on the current or permanent income depending on transitory income. Interest rate is a variable of the demand for money. The demand for money demand is inversely related to the yield of assets (Tahir, 2010). Interest rate represents the opportunity cost of holding money. The economic aspect of interest rates is logical and determines the demand for money. People prefer to hold financial assets including treasury bills when interest rates are high. The expected rate of inflation is also a development in the demand for money. Inflation disrupts the demand for money. During inflation, the public holds high amounts of money. This leads to economic underdevelopment because price level increases to an extent people do not afford some products. Commodities also become scarce because the cost of raw materials for production of commodities also shoots high. The situation is worsened because such a situation provides an opportunity for cartels to exploit the public. Contraband products are supplies at low prices hence compromising the quality of original products. Moreover, the underdevelopment of money and capital market makes the maintenance of equilibrium difficult. Moreover, the demand for money is never established when the markets are weak. The markets are usually weak because of lack of interest rate data. This leaves investors guessing as to the trend of interest rates. The confusion creates leads to increase in speculation. The increase in speculation leads to high retention of cash among investors. In the long-run high amounts of cash is wasted because of cash redundancy. Inflation also disrupts business prospects leading to losses. The exchange rate is another form of developments in determination of demand for money. External financial pressures also indirectly influence the demand for money. According to Tahir (2010), an increase in foreign interest rates encourages the locals to hold more foreign assets in order to avoid risks. The foreign rates increase almost negatively affects the local interest rates because the foreign rates reflect the true global state of economic development. Therefore, the reduction of the foreign interest rates leads to low foreign asset holding among the local investors. Holding of foreign assets negatively affects local economy because the locals use domestic money reserves to purchase the foreign assets. Therefore, the domestic money reserves are exhausted hence money demand increases. However, it is difficult to regulate the variable given that it is determined by external factors. The stability of the demand function for money depends on the economic development and the macro-policies established by a particular economy. However, monetary policies serve to maintain a sustainable demand for money. The expansionary measures are used balance the supply and demand of money to avoid crippling an economy. Conclusion There are various developments, which have been made in the determination of demand of money. The analysis of foreign interest rate and inflation rates serve as critical factors of determining te demand for money. The domestic interest rate is also vital in determination of money demand. Stabilization of monetary policy structures is a priority for many governments. However, stabilization of the structures requires appropriate adjustments on various internal and external factors. Stability of monetary policies will indicate sustainable money demand. References Chand, S. (2009).  The Demand for Money: The Classical and the Keynesian Approach Towards Money, p.1-14. Tahir, J. (2010). Recent developments in demand for money issues: survey of theory & evidence with reference to Arab countries. Survey of Recent Developments in Economic Theory, p.1-29. Read More