By Dow, J. C. R.; Saville, I. D.

ISBN-10: 0198283199

ISBN-13: 9780198283195

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Elucidation of the effects of a relaxation of banks' lending criteria requires an analysis of the financial counterparts of the stage-by-stage multiplier expansion of incomes and expenditure which will be set in train by the increased spending made possible by the increased bank lending. For simplicity, assume a closed economy, without a government sector, in which productivity is not increasing, and with stable prices; and suppose that an increase in investment to a higher steady rate is made possible by an increase in the rate of bank lending.

As with other decisions that have to be made in face of great uncertainty, banks, for want of anything better, are driven to apply rules of thumb in making such decisions. This feature of banks' behaviour is a matter of direct observation, and is the starting point for our subsequent analysis. Even if the reasons for it suggested above were not accepted, it would appear a reasonably firm starting point. Our account of banks' behaviour over time rests on the argument that many of the criteria by which banks determine the scale of their lending are related to their customers' past and prospective income, and thus are likely to rise as aggregate nominal incomes rise.

Thus though banks have some freedom to vary lending and hence the stock of money, this is true only within a certain range. In much macroeconomic theory, the twin assumptions of exogenous money 'supply' and stable money demand mean that money 'supply' controls the price level — either continuously except for temporary divergencies (as in monetarist models); or in the equilibrium long term (as in other macroeconomic models). If, as on our view, the money stock is largely or wholly endogenous, it cannot provide a nominal 'anchor' that controls the price level.

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A Critique of Monetary Policy by Dow, J. C. R.; Saville, I. D.


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