The opportunity cost of holding money is determined by

• A. The interest rate on nonmonetary assets
• B. The price level
• C. The rate of inflation
• D. The growth rate of GDP

Answer: (A)

Holding money has no interest earned, so its opportunity cost is the return you give up by not putting that money into an interest-bearing asset. In other words, the cost of holding money is the interest rate on nonmonetary assets like bonds or savings accounts. When those rates are higher, the foregone interest is larger, so people are incentivized to hold less cash; when rates are lower, holding money becomes cheaper.

The price level and inflation influence how much money people need for transactions or how the value of money changes over time, but they don’t set the rate of return you sacrifice by holding money. Growth in GDP affects incomes and spending patterns but not the direct trade-off between holding cash and investing it. For example, if you could earn 5% elsewhere, the opportunity cost of $1,000 held as cash is $50 per year; if the rate rises to 8%, the cost rises to $80.