Monetary Economics, Demand for money, portfolio of assets

1. TOBIN’S THEORY OF
PORTFOLIO DM
Prof. Prabha Panth,
Osmania University,
Hyderabad

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.
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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.
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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
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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
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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.
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7. Tobin’s liquidity preference curveRateofinterest
Asset D for Money
0
DM
Asset D for Money
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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
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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.
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