Question

1. Why do people hold money?

2. What are the tools of monetary policy and how can the Federal Reserve apply these in a recessionary environment?

Answer 1

1) People hold money for various reasons and keep it in the form of cash in hand or cash at bank.

Firsty,people hold moeny instead of investing it as they are precautionary in nature regarding the future.People will hold more money with them if they are unsure about the investment and if the market is not performing well and is unstable. Also,if they think that future is uncertain and may bring some unforeseen liabilities then they will have to arrange for a huge amount of money which will be difficult to arrange in future so,its better to hold and deposit the money.

Secondly, people hold money when they speculate regarding the future change in prices of assets. In this case people will hold more moeny and will be able to purchase the assets at low prices. For example if you want to buy a home and specualte fall in prices in future due to some law going to be passed or due to change in market forces,then one will hold more money in various forms to be able to buy it at low price. These assets come in various forms such as bonds,securities whose prices are speculated a lot in the market. The interest rates, these assets hold changes often with changes in the market and if, one knows and studies the market well then one is able to speculate the prices and prepare accordingly.

Thirdly,people hold money to pay for their day to day expenses such as food and cloth.There is always a gap between two time periods when people earn income and during this period,people have various consumption and budget constraints which requires money and holding money makes it possible to pay for such goods and services. This income is only a small part of income and one usually holds and spends more when their income increases and decreases when their income decreases.