Explain the speculative motive for the demand for money and consider its significance in relation to monetary policy.

Mark scheme

Marking points from the official mark scheme (Oct/Nov 2019). The mark or mark type is shown in brackets.

1. The speculative demand for money is determined by an individual's view of what will happen to future rates of return on long-term government securities. There is an inverse relationship between the price of bonds and the rate of return on these bonds. Investors will hold cash if they think interest rates are likely to rise in the future and hold bonds if they think interest rates will fall in the future. At very low rates of interest the speculative demand for money might become perfectly elastic. This creates a liquidity trap and makes it very difficult for monetary policy to have a significant impact on real variables.
2. L4 (9-12 marks): For an answer that attempts to evaluate the significance of the speculative demand for money by drawing a diagram, identifying the liquidity trap and then linking this to monetary policy. A conclusion might consider the extent of this significance and why it might vary depending upon the state of the economy. For example, the speculative demand for money is likely to be more significant in a time of recession.
3. L3 (7-8 marks): For an answer that provides a clear analysis of the relationship between expectations of changes in the future rate of interest and the speculative demand for money. A diagram might be provided which helps to analyse this relationship.
4. L2 (5-6 marks): For a limited explanation of the speculative demand for money but does not explain clearly why interest rates will affect the speculative demand for money.
5. L1 (1-4 marks): For an answer that has some basic correct facts but includes irrelevancies and errors of theory.
6. Monetary policy might use changes in the money supply, changes in interest rates and changes in exchange rates. Changes in all three of these variables might have an impact on demand-pull inflation. For example, a decrease in interest rates might stimulate consumption spending or cause a fall in exchange rates which should increase aggregate monetary demand.
7. Alternatively, a fall in exchange rates would increase the price of imported raw materials which could cause cost-push inflation. Diagrams could be used to illustrate these effects.
8. L4 (9-13 marks): For an answer which attempts to address the view contained in the question. Responses should focus upon evaluating the extent of monetary policy on demand-pull inflation and whether/why monetary policy can cause cost-push inflation. A conclusion should be provided which makes a judgement regarding the view under consideration and this should be based on preceding evidence.
9. L3 (7-8 marks): For an answer which analyses the effects of different monetary policy options which have different impacts on aggregate demand and costs, and why these changes can cause inflation. Supporting diagrams might be used to illustrate these effects.
10. L2 (5-6 marks): For an answer which identifies different types of monetary policy and which describes some of the causes of demand-pull and cost-push inflation.
11. L1 (1-4 marks): For an answer that has some basic correct facts but includes irrelevancies and errors of theory.