Why is
speculative demand for money inversely related to the rate of
interest?
Why is speculative demand for money inversely related to the rate of interest?
People have the tendency to hold wealth by means of property, bullion, bonds, etc. A person holding bonds can confront various fluctuations in the market in the form of capital gains or capital losses. The demand for money in order to meet these speculative needs is defined as speculative demand for money. Interest rate represents the opportunity cost of holding the money. The speculative demand for money is inversely related to the interest rate. When interest rate on securities is very high then people expect interest rates to fall in future. This implies that in future bond prices will rise indicating capital gain to the bond holders. To maximise the capital gain, more people will convert their cash balances into bonds, thereby leading to a low speculative demand for money. On the contrary, when interest rates are low, people expect interest rates to rise in future, then bond prices will fall in the future, indicating capital loss to the bondholders. Hence, to minimise the capital loss, people tend to convert bonds into money, resulting in high speculative demand for money. This shows that the speculative demand for money is inversely related to the interest rate.
People have the tendency to hold wealth by means of property, bullion, bonds, etc. A person holding bonds can confront various fluctuations in the market in the form of capital gains or capital losses. The demand for money in order to meet these speculative needs is defined as speculative demand for money. Interest rate represents the opportunity cost of holding the money. The speculative demand for money is inversely related to the interest rate. When interest rate on securities is very high then people expect interest rates to fall in future. This implies that in future bond prices will rise indicating capital gain to the bond holders. To maximise the capital gain, more people will convert their cash balances into bonds, thereby leading to a low speculative demand for money. On the contrary, when interest rates are low, people expect interest rates to rise in future, then bond prices will fall in the future, indicating capital loss to the bondholders. Hence, to minimise the capital loss, people tend to convert bonds into money, resulting in high speculative demand for money. This shows that the speculative demand for money is inversely related to the interest rate.
