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Liquidity preference as rational behaviour under uncertainty

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  • Mierzejewski, Fernando

Abstract

An important concern of macroeconomic analysis is how interest rates affect the cash balance demanded at a certain level of nominal income. In fact, the interest-rate- elasticity of the liquidity demand determines the effectiveness of monetary policy, which is useless under absolute liquidity preference, i.e. when the money demand is perfectly elastic. An actuarial approach is developed in this paper for dealing with random income. Assuming investors face liquidity constraints, a level of surplus exists which maximises expected value. Moreover, the optimal liquidity demand is expressed as a Value at Risk and the comonotonic dependence structure determines the amount of money demanded by the economy. As a consequence, the interest-rate-elasticity depends on the kind of risks and expectations. The more unstable the economy, the greater the interest-rate-elasticity of the money demand. Moreover, part of the adjustment to reestablish the short-run monetary equilibrium may be performed through volatility shocks.

Suggested Citation

  • Mierzejewski, Fernando, 2006. "Liquidity preference as rational behaviour under uncertainty," MPRA Paper 2771, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:2771
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    References listed on IDEAS

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    Cited by:

    1. Mierzejewski, Fernando, 2008. "The optimal liquidity principle with restricted borrowing," MPRA Paper 12549, University Library of Munich, Germany.

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    More about this item

    Keywords

    Money demand; Monetary policy; Economic capital; Distorted risk principle; Value-at-Risk;
    All these keywords.

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E0 - Macroeconomics and Monetary Economics - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory

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