Which of the following is a feature of the 'Baumol-Tobin Model' of money demand?
A. Only the speculative motive matters
B. Money demand is proportional only to wealth
C. Money demand is independent of the interest rate
D. Money demand arises from the transactions motive and depends on income and the interest rate
Answer: Option D
Solution (By JKSSB Mock Tests)
The Baumol-Tobin inventory-theoretic model derives transactions demand for money as a function of income (or expenditure), the interest rate and the fixed cost of transferring funds between money and interest-bearing assets.
Explanation:
The Diamond-Dybvig model shows that banks transform illiquid assets into liquid liabilities, providing liquidity insurance to depositors, but that this arrangement is vulnerable to self-fulfilling runs.
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