Money Transactions Essay Example | Topics and Well Written Essays - 2500 words

Money Transactions - Essay Example While focusing specifically on the transactions demand of money, this paper is aimed at examining the relationship between the interest rate and money demand in the context of a general assumption held by the financial experts that the transactions demand for money may be interest elastic. In this regard the issues related with the interest elasticity of transactions demand for money are discussed to have deep understanding of the issue. In order to find out the evidences about the interest elasticity of the transactions demand for money it is imperative to have deep understanding of the concept of transactions demand for money and its relationship with interest rate within a market. The transactions demand for money could be denoted by M or Lt that refers to the volume of money that is required to meet the financial expenditures. The equation of exchange is a crucial element for the transactions demand of money. According to the equation of exchange M * v = P * Y. In this equation the Lt or M stands for the transactions demand for money, v is the velocity of the money, P refers to the GDP deflator whereas Y represents the real income. The relationship between the transactions demand fo... ionship between the transactions demand for money and the interest rate possesses great important from the perspective that states that there is a pressure to economize on one's transactional case balance and this pressure is originated from the rate of interest. The holders of the transactions money used to buy bonds and also pay fee and brokerage services and as a result they expect high return on their money due to interest rate. In a market the higher is the interest, the more people get as a final return for their money. Due to this reason most of the households use the transaction money to get benefit from the high rates of interest and for this purpose they make investments in bonds etc. (Nouriel Backus, p6, 1998) The relationship between transaction money demand and interest rates has been a major concern for the economists for a long period of time. The transactions demand is believed to be interest elastic because the interest rate and the transactions demand are closely linked with each other. The holder of the cash strived to take maximum benefit from the money he holds and in such situation the equilibrium balance of money is held. In the transactions demand of money the holder has to deal with the Marginal cost as well as with the Marginal revenues. The marginal cost is the interest that has to be certainly paid by the holder and the marginal revenue is the psychological interest rate that is earned by the holder of money due to overcoming the worries that he might face about non having cash money in hand. It is believed by he economists that the more income a person earns, the more cash he might holds and more he became in a position to afford the loss of interest (Robert, p2, 2007). There are two important implications associated with interest