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19. Explain the liquidity preference theory of interest. What are its criticisms?

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GinnyAnswer

Final answer:

The liquidity preference theory by Keynes explains the preference for holding cash over other assets, while criticisms of the theory mainly focus on its simplicity compared to Friedman's modern quantity theory and its impact on interest rates.


Explanation:

Liquidity preference theory: Developed by John Maynard Keynes, this theory explains that individuals prefer to hold cash because of its high liquidity and low risk compared to other assets like bonds or equities. Criticisms:

  • Complexity: Friedman's modern quantity theory is criticized for being more complex and accounting for multiple assets compared to Keynes's theory that focuses mainly on money and bonds.
  • Interest rate impact: Critics argue that Friedman's theory is less affected by interest rate changes compared to liquidity preference theory, which predicts a clearer impact on interest rates.
  • Asset demand: The two theories differ in their assumptions about asset demand, with Friedman's theory being more comprehensive and realistic in including various assets beyond money and bonds.

Learn more about liquidity preference theory here:

https://brainly.com/question/46084340


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