Opportunity cost of holding money
Topic: Banking, Credit Creation and Monetary Policy · NCERT: Class 12, Ch 3 "Money and Banking"
Meaning
The opportunity cost of holding money is the interest you give up by keeping cash instead of putting it in an asset that earns interest, such as a fixed deposit or a bond. So the interest rate works as the "price" of holding money. When interest rates rise, holding cash costs more, and people hold less of it. Because of this, the demand for money is a trade-off between the convenience of liquidity (being able to spend at once) and the interest you lose.
Example
Suppose you keep ₹1,000 as cash for a year instead of depositing it at 6%. You lose the ₹60 of interest the deposit would have paid. That ₹60 is your opportunity cost of holding money.
Don't confuse with
- Cost of borrowing: this is the interest a borrower pays on a loan. The opportunity cost is the interest a holder of cash fails to earn. Both depend on the same interest rate, but they fall on different people.
Related concepts
- Interest rate
- Liquidity
- Demand for money
- Transaction motive
- Speculative motive
- Velocity of circulation
- Liquidity trap