The classical school of economics always argued that wages would adjust to clear gluts of unemployed workers over a reasonably short period of time and that cash would not be hoarded but used to purchase bonds or otherwise spent on either investment or consumption. In this way markets would clear and involuntary unemployment would not be a problem. But today throughout the leading capitalist countries of Europe and in North America we have many examples of hoarded cash, principally in the treasuries of companies but also in certain banks and financial institutions and at the same time not surprisingly elevated unemployment. How did this happen and why is hoarded cash a barrier to lower unemployment. Once again it is Keynes that provides us with the answer.
Keynes developed three motivations for holding cash: transactions, precautionary reasons , and finally speculative reasons. The first two reasons are straight forward enough .One can actually combine them under the rubric of transactions One needs a certain amount of cash to acquire the things people want to buy. Also there can be unexpected needs for cash during the day, hence precautionary motivations. But it is the third that is the most important in understanding how hoarding can cause unemployment. Bond prices and interest rates on bonds move in the opposite direction. If bond prices rise interest rates fall and if bond prices fall interest rates rise. This aspect of bond market behaviour became the central explanati0n that Keynes relied upon to explain the possibility of unemployment in the real world economy. Unlike the classical model in which there appeared no advantage in hoarding cash once we introduce the speculative motive it becomes clear there will be times when expectations about the limits to lower interest rates have been reached and bond buyers expect interest rates to rise and bond prices to fall they will hang onto cash to avoid the losses associated with falling bond prices when rates rise.
So the classical school postulated a demand for money that was transactions dominated M= lPy derived from the classical quantity theory. But Keynes critically expanded the demand for money to include a speculative demand M=lPy+L(r) since
M=Mt + Ms
Mt=lPy and Ms=L(r)
hence M= lPy + L(r) ( see Gardiner Ackley Macroeconomic Theory, p402 & pp.201 ff Macmillan, N.Y.:1961)
Once we introduce the possibility of hoarding as Keynes called it or quasi-hoarding as I prefer to call it, prolonged unemployment gluts become possible.This is because the hoarded cash is not being invested and the economy needs to shrink to bring swollen intended savings into equality with diminished intended investment.Total aggregate demand can only support a smaller level of ouput so long as the hoarded cash does not circulate. So long as the cash hoards are not spent they contribute nothing to job creation. An equilibrium at much below full employment is created. This unfortunately is the position of the global economy today. This is why we continue to need major economic stimulus to break out of the liquidity trap.