Answer to Question #310417 in Finance for Ana

Question

Why is Keynes's analysis speculative demand for money important to his view that velocity will undergo substantial fluctuations and thus cannot be treated as constant?

Answer 1

In Keynes' analysis on speculative demand for money, he argued that demand for money is a choice between holding cash and buying bonds. If interest rates are low, there will be anticipation of rising interest rates in the near future, leading to fall in bond price. If interest rate is high, people anticipate interest rate to fall and thus bond price will rise. Thus, money demand, and hence velocity of money, is affected by interest rates. Interest rates are not constant and fluctuate a lot, and hence velocity will fluctuate as well.