Chapter 6. The Baumol-Tobin Model of Money Demand

When individuals make more trips to the bank in a given period of time then they do not need to hold as much cash since the time between trips is shorter. Leaving more money in the bank will lead to more interest and therefore less foregone interest.

If the wait time at the bank falls, then it is less costly to visit the bank so all else the same households are more likely to visit thus reducing the number of days between visits. An increase in the time it takes to get to the bank increases the cost of getting to the bank. An increase in saving will reduce spending and reduce the need to go to the bank. A reduction in the interest rate will reduce the cost of holding money so there is less incentive to leave money in the bank.

If households decide to spend more then they will save less and this will lead to an increase in lost interest. To compensate, households will decide to visit the bank more often.

Higher interest rates will increase the cost of holding money because the money held does not earn interest. As a result, households have an incentive to leave the money in the bank and visit more often in order to earn more interest.