Liquidity preference theory of interest

Liquidity preference theory (i.e., Keynesian theory) of interest:

Usually people prefer to hold a portion of their assets in the form of cash. Cash is a liquid benefit. According to Keynes, interest is the prize for parting with liquidity for a particular period of time. In another words, it is the prize for not hoarding.

According to Keynes, people encompass liquidity preference for three motives. They are:

1. Transaction motive;
2. Precautionary motive; and
3. Speculative motive.

The transaction motive refers to the wealth held to finance day to day spending. Defensive money is held to meet an unexpected expenditure.

Keynes states speculative motive as “the object of securing profit from knowing better than the market what the future will fetch forth.”

Out of the three motives, speculative motive is more significant in determining the rate of interest. Keynes supposed that the amount of money held for speculative motive would differ inversely with the rate of interest.

Keynes view was that the rate of interest was determined by liquidity preference on one hand and the supply of money on the other.

2268_liquidity interest.jpg

 Figure: Diagrammatic example of Liquidity preference Theory of interest

In figure above Liquidity preference is illustrated by L and the supply of money is symbolized by M and the rate of interest is indicated by r. Rate of interest is determined by the intersection of L& M curves. There will be raise in the rate of interest to r1, when there is an augment in demand for money to L1 or by a reduction in the supply of money to M1.


Keynesian theory is a common theory of interest and it is far superior to the earlier theories of interest. However critics say that Keynes has over-emphasized liquidity preference factor in the theory of interest. Furthermore, only whenever a person has savings, the question of parting with liquidity occurs. In terms of Jacob Viner, “without saving, there can be no liquidity to surrender. Rate of interest is the return for “saving without liquidity”.

Latest technology based Economics Online Tutoring Assistance

Tutors, at the, take pledge to provide full satisfaction and assurance in Marginal Productivity help via online tutoring. Students are getting 100% satisfaction by online tutors across the globe. Here you can get homework help for Marginal Productivity, project ideas and tutorials. We provide email based Marginal Productivity help. You can join us to ask queries 24x7 with live, experienced and qualified online tutors specialized in Marginal Productivity. Through Online Tutoring, you would be able to complete your homework or assignments at your home. Tutors at the TutorsGlobe are committed to provide the best quality online tutoring assistance for Economics Homework help and assignment help services. They use their experience, as they have solved thousands of Economics assignments, which may help you to solve your complex issues of Marginal Productivity. TutorsGlobe assure for the best quality compliance to your homework. Compromise with quality is not in our dictionary. If we feel that we are not able to provide the homework help as per the deadline or given instruction by the student, we refund the money of the student without any delay.

2015 ┬ęTutorsGlobe All rights reserved. TutorsGlobe Rated 4.8/5 based on 34139 reviews.