What does liquidity preference refer to?

Liquidity preference refers to the demand for money for various transactional purposes. In macroeconomic theory, it is primarily associated with the desire to hold money as a means to facilitate transactions and to address unforeseen expenses. Individuals and businesses prefer to have a certain amount of liquid assets, such as cash or easily convertible investments, to ensure they can efficiently manage their day-to-day transactions without facing liquidity constraints. This concept often plays a crucial role in the determination of interest rates and the overall functioning of the money supply in an economy.

The focus on transactional purposes highlights how liquidity preference affects consumer behavior and business practices, as people weigh the benefits of holding cash against potential returns from investments. This balance between having cash on hand versus investing in longer-term assets is central to understanding monetary economics.