CH. 15 INCENTIVES TO LIQUIDITY 199

new situation. Thus the new equilibrium rate ofinterest will be associated with a redistribution ofmoney-holdings. Nevertheless it is the change in therate of interest, rather than the redistribution of cash,which deserves our main attention. The latter isincidental to individual differences, whereas theessential phenomenon is that which occurs in thesimplest case. Moreover, even in the general case,the shift in the rate of interest is usually the mostprominent part of the reaction to a change in thenews. The movement in bond-prices is, as the news-papers are accustomed to say, “out of all proportionto the activity of dealing”;—which is as it should be,in view of individuals being much more similar thanthey are dissimilar in their reaction to news.

II

Whilst the amount of cash which an individualdecides to hold to satisfy the transactions-motive andthe precautionary-motive is not entirely independentof what he is holding to satisfy the speculative-motive,it is a safe first approximation to regard the amounts ofthese two sets of cash-holdings as being largely inde-pendent of one another. Let us, therefore, for thepurposes of our further analysis, break up our problemin this way.

Let the amount of cash held to satisfy the transac-tions- and precautionary-motives be and the amount

held to satisfy the speculative-motive be M2. Corres-ponding to these two compartments of cash, we thenhave two liquidity functions L1 and L2 . L1 mainlydepends on the level of income, whilst L2 mainlydepends on the relation between the current rate ofinterest and the state of expectation. Thus

M = M1 + M2 = L1 (Y) +L2(r),where L1 is the liquidity function corresponding to