Tobin's Portfolio demand for money
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TOBIN’S THEORY OF PORTFOLIO DM
Prof. Prabha Panth,Osmania University,
Hyderabad
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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.03/05/2023 Prabha Panth 2
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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.
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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
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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
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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.
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Tobin’s liquidity preference curveR
ate
of in
tere
st
Asset D for Money
0
DM
Asset D for Money
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Tobin’s Model
rs = expected real return on stocksrb = expected real return on bondsp e = expected inflation rateW = real wealth
( / ) = ( , , , ),d es bM P L r r W
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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.
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