Cambridge International as and a level Economics Ebook

speculative motive
, is interest elastic. 
Households and fi rms will hold what are sometimes 
Milton Friedman
John Maynard Keynes
Precautionary motive: 
a reason for holding money for 
unexpected or unforeseen events.
Active balances: 
the amount of money held by households 
or firms for possible future use.
Speculative motive: 
a reason for holding money with a 
view to make future gains from buying financial assets.
KEY TERMS
256
Cambridge International A Level Economics

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bonds will cause the price of bonds to rise and so the rate 
of interest to fall.
TOP TIP
It is interesting to note that, while the transactions 
and precautionary motives for holding money are 
interest inelastic, the demand for holding money for the 
speculative motive is interest elastic.
The liquidity trap
Although it is expected that an increase in the money 
supply will cause the rate of interest to fall, Keynes 
described a situation where it would not be possible to 
drive down the rate of interest by increasing the money 
supply. He described this situation as the 
liquidity trap.
He thought it could occur when the rate of interest is very 
low and the price of bonds is very high. In this case, he 
thought that speculators would expect the price of bonds 
to fall in the future, so if the money supply was to be 
increased they would hold all the extra money. Th
ey would 
not buy bonds for fear of making a capital loss and because 
the return from holding such securities would be low. 
Figure 9.29
shows that at a rate of interest R, demand for 
money becomes perfectly elastic and the increase in the 
money supply has no eff ect on the rate of interest.