What is money? Why do people prefer to hold money?

Answer Details

Money is anything that is generally acceptable as a means of payment for goods and services and in the settlement of debts. To perform this role well it acts as a medium of exchange, a measure of value, a store of value and a standard for deferred payments.

Why people prefer to hold money (liquidity preference). According to Keynes, people demand to hold money in cash rather than in other assets for three main motives:

1. Transactions motive: money is held to meet day-to-day spending on goods and services (food, transport, bills) between the times income is received.
2. Precautionary motive: money is held as a reserve against unforeseen or emergency needs such as sickness, accident or sudden opportunities to buy.
3. Speculative motive: money is held to take advantage of future changes in the price of assets such as bonds; people keep cash to buy bonds when their prices are expected to fall (interest rates to rise), and hold fewer bonds when prices are high.

In addition, money is preferred because it is the most liquid of all assets: it can be used immediately without loss of value or delay in converting it into other things.