Islamic Capital Markets: Theory and Practice

Chapter 16

The Demand for Money

The purpose of this chapter is to study a pillar of capital markets, which is money. Studying capital markets without studying the money market would not permit an understanding of powerful monetary forces that drive capital markets. The demand for money plays a key role in the economy and has a direct impact on real output, employment, price level, interest rates, capital markets, and foreign exchange markets. A study of the demand and supply of money would provide a better understanding of the economic activity and capital and foreign exchange markets, and would enable to explore the link between money and bond markets and the link between goods and assets markets. Developments in capital markets and changes in key variables such as the price level and interest rates cannot be understood without a study of the demand for money. The demand for money is the amount of cash balances an individual desires to hold over a given period of time such as a week, a month, or a year for transactions purposes, savings (store of value), or precautionary and speculative purposes.

The private nonbanking sector demands money. A trader who sells a commodity such as oil or wheat is exchanging that commodity for money; a worker who offers his service is demanding a money wage; and a company that sells a bond or a stock is demanding a money capital. If a worker instantly spends all his income upon receipt, then his demand for money is zero. It is important to define ...