Business, Legal & Accounting Glossary
The Concept of liquidity preference was introduced by John Maynard Keynes. It was he who argued that interest earned from savings cannot be treated as a reward for holding wealth. Wealth could also be held in the form of cash kept with oneself, and since no interest can be earned from that money, Keynes suggested that savings interest cannot be counted as a reward for saving money. Rather, interest on savings could be more appropriately treated as a reward for sacrificing liquidity.
When interest rates are low, a person is likely to demand more liquidity and hence the demand for money rises. High-interest rates would encourage people to sacrifice their liquidity in order to gain rewards on savings. When interest rates are high, money may be used for investment purposes. Liquidity preference also refers to a specific clause used in the concept of venture capital.
In venture capital, a liquidity preference clause is introduced in order to protect investors in case of an occurrence of liquidity. Liquidity preference clause ensures that investors get back their initial investment amount or a multiple of it.
Demand for money is an alternative term used to refer to liquidity preference. Post-Keynes, many other factors have been identified that affect the demand for money. For instance, income levels could be a factor that affects liquidity preference.
When the demand for money is low, wealth is utilized to create savings deposits. Money can also be exchanged for non-liquid assets like government bonds. Liquidity preference is also a good indicator of return on investment related to a particular economy.
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This glossary post was last updated: 27th March, 2020 | 0 Views.