The difference between the interest rate on nonmonetary assets and the interest rate on money assets is

• A. The opportunity cost of holding money.
• B. Long-term interest rates.
• C. Short-term interest rates.
• D. The rate of return of holding money.

Answer: (A)

The main idea here is the opportunity cost of holding money. When you hold money, you’re forgoing the return you could earn by investing in nonmonetary assets like bonds or other interest-bearing instruments. The difference between the return on those assets and the return on holding money captures that foregone interest, i.e., the opportunity cost of liquidity.

For example, if a bond yields 3% but holding money yields 0% return, the gap is 3%—the amount you’re giving up by keeping money instead of investing. This concept is why the desire to hold money decreases as the opportunity cost rises: people prefer to put funds into assets that earn more, and it helps explain how monetary policy and interest rates influence how much money people want to hold.