Question

Both the portfolio choice and Keynes’s theories of the demand for money suggest that as the relative expected return on money falls, demand for it will fall. Why does the portfolio choice approach predict that money demand is affected by changes in interest rates? Why did Keynes think that money demand is affected by changes in interest rates?

Short answer

As per the portfolio better overall, a rise in interest rates generates an increase as in implicit accrued interest on checkable deposits, thus the relative payback period on money is only slightly reduced. As a consequence, when interest rates go up, the purchasing power fluctuates little in terms of portfolio selection.

Step-by-step solution

Step 1. Define demand.

Demand refers to the quantity of a product that customers are capable and willing to buy at various prices throughout a particular time period.

Step 2. Explanation 

According to Keynes, an increase in interest rates results in a lower relative possible return on money therefore, as a result, a lower demand for money.

As per the portfolio better overall, a rise in interest rates generates an increase as in implicit accrued interest on checkable deposits, thus the relative payback period on money is only slightly reduced. As a consequence, when interest rates go up, the purchasing power fluctuates little in terms of portfolio selection.