A model of household saving and demand for money in the presense of liquidity constraints is considered. The work examines both transactions and speculative demand for money and gives an explanation why there is no interest payments on cash. Without assumption of direct utility of money the ratio between money and savings is obtained. The ratio shows that the demand for money may increase with interest rate increasing.
The demand for money and saving supply functions obtained are then used in a general equilibrium model. It is shown that interest of r per cent per annum paid on cash will give rise to an increase of r per cent per annum in the inflation rate. The dynamic equilibrium in an economy with heterogeneous households is studied.
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