The term coined by John Maynard Keynes initially to explain the great depression of 1930s.
Liquidity preference literally mean what the term itself suggests, the desire to keep the money liquid. The theory states that interest is a price for the money. The higher the interest rate for a long term with higher risk, the more people would be willing to part with their immediate liquidity, i.e. cash. People do not wish to part with the cash at a lower rate of interest. They would take the risk only if high interest rates are offered. People prefer liquidity in cash for the following reasons: 1. Transactional 2. Precautionary 3. Speculative
Transactional is to meet the day to day requirements like buying groceries, paying rent etc.
Precautionary is used in case if extraordinary event like medical emergency.
Speculative is because it is being perceived that the interest rates might go higher in the future and therefore it would be beneficial to invest then.
Ideally, an interest rate on let’s say a treasury bill for 10 years would be higher than the treasury bill for 2 years. Therefore people would prefer investing in the bond for 10 years.
It is worthwhile to note that the recession is being speculated because the returns on a 2 year government bond was seen higher than the 10 year bond in the United States. Therefore, the liquidity preference would be higher.
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