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The Precautionary Motive in Money Demand: Holding Money for a Rainy Day
The precautionary motive is one of the three main reasons why people hold money. It refers to the desire to have money on hand to cover unexpected expenses or emergencies. This could include anything from a medical bill to a car repair.
People hold money for precautionary reasons because they want to avoid having to borrow money at high interest rates or sell assets at a loss in an emergency. They also want to avoid the stress and anxiety that comes with not having enough money to cover unexpected expenses.
The amount of money that people hold for precautionary purposes will vary depending on their individual circumstances. Factors that can influence the precautionary demand for money include:
- Income: People with higher incomes are more likely to have a larger precautionary demand for money, as they have more money to set aside.
- Debt: People with a lot of debt are more likely to hold a larger precautionary demand for money, as they are more vulnerable to financial shocks.
- Age: Younger people are more likely to have a larger precautionary demand for money, as they are more likely to face unexpected expenses, such as medical bills or car repairs.
- Risk aversion: People who are more risk-averse are more likely to hold a larger precautionary demand for money, as they are more willing to sacrifice returns in order to avoid risk.
The precautionary demand for money is an important factor in the overall demand for money. It helps to explain why people hold money even when they are not planning to spend it in the near future.
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