The effects of interest rates on the transactions demand for money

Question

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The effects of interest rates on the transactions demand for money were explored by William Baumol and James Tobin in their model of cash management. They argued that as interest rates increase, individuals and firms would hold less cash and instead hold more interest-earning assets, such as bonds. This is because the opportunity cost of holding cash increases as interest rates rise, making it more expensive to hold cash. Therefore, as interest rates change, the level of the transactions demand for money is likely to change as well.

The Effects of Interest Rates on the Transactions Demand for Money