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IAI Actuarial Core Principles · Business Economics · Role of money and interest rates in the economy

According to the Keynesian speculative demand for money, what happens when market interest rates are very high relative to what investors regard as normal?

Speculative money demand falls. High interest rates mean bond prices are low, and investors expect rates to fall and prices to rise, so they switch from idle cash into bonds to gain capital appreciation.

  1. ABond prices are expected to rise, so speculative money demand fallsCorrect
  2. BBond prices are expected to fall, so speculative money demand rises
  3. CMoney demand becomes perfectly elastic at that rate
  4. DTransactions demand rises sharply because of higher income
  5. Speculative demand is unaffected because it depends only on income

Explanation

Bond prices move inversely to interest rates. When rates are high versus normal, investors expect rates to fall and bond prices to rise, so they move out of money into bonds. Speculative demand for money therefore falls. The opposite holds when rates are low.

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