How to Think of the Range of Assets Subject to Liquidity Preference

To follow up on Philip Pilkington’s posts on liquidity preference.

I propose the following table as a preliminary way of conceptualising the range of assets subject to liquidity preference.

At the top, we start from the least liquid assets and move down the list to the most liquid asset (physical currency or high-powered money held as reserves at a central bank).

One can quibble about the order of some of the assets at the top and middle (such as stocks and shares), but a rise in liquidity preference involves investors selling off or shunning purchases of assets at the top of the list and moving into assets at the bottom.

For Keynes, a rising liquidity preference lowers demand for less liquid/illiquid assets and lowers their price (raising their yields), while it raises the prices of liquid assets (lowering yields).

It is also important to note that in the terminology of financial markets and financial market theory, the word “cash” is often taken to mean:

(1) physical currency (notes and coins) or reserves, or

(2) demand deposits, checking accounts, transactions accounts, or savings accounts, or

(3) short-term, liquid government bills/bonds, or

(4) short-term, liquid money market funds.

Further Reading
Philip Pilkington, “Keynes’ Liquidity Preference Trumps Debt Deflation in 1931 and 2008?,” Fixing the Economists, February 24, 2014.

Philip Pilkington, “What is a Liquidity Trap?,” Fixing the Economists, July 4, 2013.

Philip Pilkington, “Financial Markets in Keynesian Macroeconomic Theory 101,” Fixing the Economists, July 24, 2014.

Philip Pilkington, “Paul Krugman Does Not Understand the Liquidity Trap,’” Fixing the Economists, July 23, 2014.

BIBLIOGRAPHY
Kelton, S. 2012. “Liquidity Preference,” in J. E. King (ed.), The Elgar Companion to Post Keynesian Economics (2nd edn.). Edward Elgar, Cheltenham. 372–378.