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Tobin's Portfolio demand for money

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Tobin's Portfolio demand for money

  1. 1. TOBIN’S THEORY OF PORTFOLIO DM Prof. Prabha Panth, Osmania University, Hyderabad
  2. 2. KEYNES DEMAND FOR MONEY • Keynes assumed that public holds its assets either as bonds or cash. • Tobin has criticised this assumption. • People hold their assets or wealth in many forms – or in various “Portfolios” • This includes: a) Money, b) Bonds, c) Property, etc. • Transaction DM may also be affected by rate of interest. 01/05/2016 Prabha Panth 2
  3. 3. Tobin’s Portfolio DM • According to Tobin, people hold a Portfolio of Assets – some cash, and some bonds. – Idle cash is safe (no risk), but earns zero income or interest. – Bonds earn interest, but they are risky. Therefore people hold a balanced combination of both safe and risky portfolio of assets. Depends on the individual’s attitude to Risk. 01/05/2016 Prabha Panth 3
  4. 4. Tobin’s Portfolio DM • According to Tobin, individuals show “Risk Aversion”. • They prefer less risk to more risk at a given rate of interest. • Also, they are uncertain about the future rate of interest 01/05/2016 Prabha Panth 4
  5. 5. Tobin’s Portfolio DM • But holding cash is unproductive, as it earns no income. • So they have to choose a combination or portfolio of assets – some less risky (safe) but less productive -- some more risky but more productive. The portfolio of assets depends on the nature of the individual 01/05/2016 Prabha Panth 5
  6. 6. Tobin’s liquidity preference curve • Like Keynes, Tobin shows the LP is inversely related to rate of interest. • When i is high, people change their portfolio to bonds, and hold less cash • When i is low, they prefer to hold cash, and reduce the number of bonds. • Thus the Asset DM is inversely related to the rate of interest. 01/05/2016 Prabha Panth 6
  7. 7. Tobin’s liquidity preference curveRateofinterest Asset D for Money 0 DM Asset D for Money 01/05/2016 Prabha Panth 7
  8. 8. Tobin’s Model rs = expected real return on stocks rb = expected real return on bonds  e = expected inflation rate W = real wealth     ( / ) = ( , , , ),d e s bM P L r r W 01/05/2016 Prabha Panth 8
  9. 9. Tobin’s Model • Stocks and bonds are alternatives to money. • An increase in i makes money less attractive, reduces desired money holdings. • The real return to holding money is -e. • An increase in e is decrease in real return to holding money, and cause a decrease in desired money balances. • And finally, an increase in wealth causes an increase in the demand for all assets. 01/05/2016 Prabha Panth 9

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