ECONOMICS

Economics of Money and Banking

Economics of Money and Banking

Introduction

Tobin's portfolio demand for money

This approach of Tobin for demand of money is also called the “Inventory Theoretic Approach”, that is a major progress over the Keynesian theory for the transaction demand for money. There are two major points that score the improvement above the “Keynesian theory” of transaction demand for money are as follows: where Keynes had preferred precautionary, speculative, transaction demand for money individually.

The Risk Curve

In this figure it shows the diversifiers and risk-lovers that is the optimum portfolio at expected returns and maximum risk where at ray OC the opportunity of locus is present, and the expected highest return can be viewed on point C accessible by the investor that is the expected risk and return from holding the complete balance in consol. Maximum utility can occur at C either for risk lover or averter. This indifference curve also represents opportunity linked with the complete balance.

Figure 1 representing Plungers, the possible portfolio at maximum or minimum Risk & expected return

The corner shows the origin of the maximum where the complete balance is represented in cash. Possibly this could also happen for the diversifier.

Optimisation Approach

Tobin's Theory can be known in the type of two propositions that are: that Keynes suggested the individual have the capability of holding wealth in two ways that is in the form of bonds or money that is neither empirically true nor rational. He claims instead that the individuals tend to hold a combination of both bonds and cash within their portfolios of assets, that is not limited to bonds or cash. Tobin also states that this assumption is both empirically verifiable and more rational too. He also demonstrated that where the individuals hold a combination of both bond and cash, they also show their efforts towards holding both that will result in increasing the returns and risk on the bonds. His theory is also known to be the simplest forms and that the individuals have a choice on creating their asset portfolios and that Tobin also prefers increased wealth to lesser wealth. But at the same he opts for lesser risk because his return and risk indifference curve are clearly known and also the trade offs between return and risk (Dwivedi, 2010, pp 254).

Tobin has constructed his theory by claiming the interest that is gained from the bonds and the advantages of liquidity that are not of major significance in the individuals choice of asset portfolio. What matters in his theory and has greater significance are the choices that an individual has for the asset portfolio and the possibilities are of capital loss and capital and gain when the money is put in the bonds. The bonds gain capital with help of declining interest rate and the loss of the capital arises with the higher rates on the interest. And with the decreased rates in interest, the prices of the bonds tend to rise and then the bond holders are capable of ...