Velocity Wanted: Reasons for Money Hoarding 02

 

Nothing good comes for free: We must sacrifice all the other opportunities for the purpose of getting a certain utility as benefit. We do conduct cost-benefit analysis to make the most beneficial choice at each and every step forward, the “marginal” step as called in economics. In general, we choose the single best at the opportunity cost of second best.

             Gregory Mankiw among other macroeconomists proposes that the opportunity cost of “liquidity preference” is the fed fund rate (e.g. Macroeconomics of any edition). In effect, he and they regard “the opportunity to make a deposit at the Fed” as the single best opportunity forgone of all. Believe it or not!

             We the lay people have instead indefinitely many opportunities open to us which depend upon the situation at the time of choice: the first best followed by the second best followed by the third best followed by all the way to the fed funds rate, the second last. No one on Earth but for Cambridge macroeconomists would name “the fed rate” as the opportunity cost of money at any time of the day.

             We need abstraction before building a theory. Let’s name the opportunity in general of money “the purchasing force” with which we can attract quite any benefit including human virtue. The next question: In what form are we carrying such purchasing force? Will it be the “liquidity of no return” or “an asset bearing some returns”?

             The first answer: Ceteris paribus, we always and everywhere choose the asset over the liquidity. Alas, in the economy as organism usually in mutates mutandis, we have to pay various costs in transforming the asset aka “illiquidity” into the GAME aka “liquidity.” Such costs are sometimes called “financial transaction costs,” in that we pay those costs in transforming an interest-bearing financial asset into the infertile financial asset, i.e. the GAME (for generally accepted medium of exchange).

             “People Face Tradeoffs” on one hand, while “Rational People Think at the Margin” (Gregory Mankiw, Principles of Economic).  

             Question #1: What is the marginal cost of hoarding the first dollar? The second dollar? The millionth dollar? The answer: The marginal cost of holding money from the first to the last is the greatest interest obtainable of all the financial markets. There is no place in the sun for “the fed funds rate” as a candidate. Incidentally, the marginal cost of “liquidity preference” is horizontal: The demand curve for money is horizontal if exogenous to Cambridge or Eternity.

             Question #2: What is the marginal benefit of preferring liquidity from the first to the last dollar under our control? The answer: All the relevant financial transaction cost shall be taken into account in the equation of savable costs; by definition “saving a cost” is a benefit. 

          First of all we have to pay the so-called “bid-ask” spread and other fixed brokerage fees in trading the asset for the GAME. Second, we have to pay premiums for all the uncertainties, including delinquencies of our party and unexpected costs, in association with fertile investment. Third, some people hate, ordinarily or extraordinarily, all the hassles, inconveniences and annoyances in association with the financial transaction from asset to money or the reverse. 

The Money Stock Preferred. According to the equation of William Baumol (1952) from Princeton based upon the aggregate cost-benefit analysis;

M^d= (b∙T/ 2i)^1/2, subject to matching M^d to M^s, with TINA.

Application 1: Switching T with the nominal GDP P∙Y, we know that the relationship between money and GDP is not in the first order as in the Cambridge Quantity equation but in the second order. That’s a difference in kind, or “in the order of magnitude” more specifically. How instead of (M^d)²= k∙P∙Y can “liquidity preference be” M^d= k∙P∙Y?

Application 2: Times being difficult and uncertain after a stock-market crash, we tend to hoard more money due to the heightened risk premiums. If you will, it’s “speculative.”

 

The Closing Questions. Can on Earth the aggregate demand for liquidity be ever different from the aggregate supply of money? Can there in Earthly economics be anything like “the money market”? Clue: “Demand” in economics is a different species from “preference” in macroeconomics. After all, a mule is infertile.

             Can, times being good or bad, the k be “constant”? Clue: When times are bad, the so-called “speculative motive” pushes the k up, pulling V down.

             Velocity Wanted!