Money and the Size of Transactions

Consumers make transactions of different sizes over time. This paper shows that this fact, together with transaction costs of various assets, can help in developing a theory of liquidity. Assets with different cost structures are used to purchase different sizes of transactions. This can explain the demand for money itself, the precautionary demand for money, and the demand for cash and demand deposits. Thus consumers use cash for small transactions, demand deposits for larger transactions, and use savings for the largest transactions. Finally, the paper shows that modeling banks as suppliers of liquidity leads to a better understanding of their success as financial intermediaries.