By Dow, J. C. R.; Saville, I. D.
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Additional info for A Critique of Monetary Policy
Various forms of uncertainty have an important place at most stages of our account. Not only is money held as a hedge against uncertainty; its creation, via the granting of new loans, depends on the attitudes of banks towards the credit worthiness of borrowers, which is impossible to assess objectively. Because of uncertainty, both capital markets and exchange Introduction 1 markets are, we argue, in some broad sense imperfect. That produces a range of indeterminacy in both interest rates and the exchange rate, and consequently also gives scope for the authorities to influence them.
The cost of alternative sources of finance may therefore have to fall considerably before borrowers find it worthwhile to reduce bank loans by funding. The disparate attitudes on the part of banks and their customers towards the risk attaching to loans create a kind of discontinuity in the adjustment of the financial structure. Second, the incentive to fund is that the cost of security market finance has fallen relative to the cost of bank loans. The price of securities clearly fluctuates a great deal (and with it the relative cost of finance by new 32 The Behaviour of the Financial System issues) for reasons that have nothing to do with the funding process (see further Chapter 3 below); and such fluctuations may swamp the shifts in relative interest rates which abnormally large holdings of money should in theory produce.
Third, even if there is an effective incentive to fund, the response to it is likely to be gradual. Thus, the shift in relative interest rates of the sort here in question will not occur (for reasons already explained) until some time after the start of the multiplier process set in train by the increased bank lending. Furthermore, even if the funding of indebtedness to the banks then becomes advantageous, firms may take time to decide to fund bank loans; for the preparation of an issue takes time, and the absorptive capacity of the stock exchange for new issues in any period is limited.
A Critique of Monetary Policy by Dow, J. C. R.; Saville, I. D.