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More Factors Which Influence the Demand for Money

What is the Demand For Money?


2. Consumer Spending

This is directly related to the fourth factor, "Demand for goods goes up". During periods of higher consumer spending, such as the month before Christmas, people often cash in other forms of wealth like stocks and bonds, and exchange them for money. They want money in order to purchase goods and services, like Christmas presents. So if the demand for consumer spending increases, so will the demand for money.

3. Precautionary Motives

If people think that they will suddenly need to buy things in the immediate future (say it's 1999 and they're worried about Y2K), they will sell bonds and stocks and hold onto money, so the demand for money will go up. If people think that there will be an opportunity to purchase an asset in the immediate future at a very low cost, they will also prefer to hold money.

4. Transaction Costs for Stocks and Bonds

If it becomes difficult or expensive to quickly buy and sell stocks and bonds, they will be less desirable. People will want to hold more of their wealth in the form of money, so the demand for money will rise.

5. Change in the General Level of Prices

If we have inflation, goods become more expensive, so the demand for money rises. Interestingly enough, the level of money holdings tends to rise at the same rate as prices. So while the nominal demand for money rises, the real demand stays precisely the same. (To learn the difference between nominal demand and real demand, see "What's the Difference Between Nominal and Real?")

6. International Factors

Usually when we discuss the demand for money, we're implicitly talking about the demand for a particularly nation's money. Since Canadian money is a substitute for American money, international factors will influence the demand for money. From "A Beginner's Guide to Exchange Rates and the Foreign Exchange Market" we saw that the following factors can cause the demand for a currency to rise:
  1. An increase in the demand of that country's goods abroad.
  2. An increase in the demand for domestic investment by foreigners.
  3. The belief that the value of the currency will rise in the future.
  4. A central banking wanting to increase its holdings of that currency.
To understand these factors in detail, see "Canadian-to-American Exchange Rate Case Study" and "The Canadian Exchange Rate"

Demand for Money Wrap Up

The demand for money is not at all constant. There are quite a few factors which influence the demand for money.

Factors Which Increase the Demand for Money

  1. A reduction in the interest rate.
  2. A rise in the demand for consumer spending.
  3. A rise in uncertainty about the future and future opportunities.
  4. A rise in transaction costs to buy and sell stocks and bonds.
  5. A rise in inflation causes a rise in the nominal money demand but real money demand stays constant.
  6. A rise in the demand for a country's goods abroad.
  7. A rise in the demand for domestic investment by foreigners.
  8. A rise in the belief of the future value of the currency.
  9. A rise in the demand for a currency by central banks (both domestic and foreign).
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