Abstract

The Role of the Banks in Monetary Policy

The trend of the quantity of money corresponds roughly to the growth of the balance-sheet totals of the entire banking system; the central bank must exert influence on this trend in order to achieve goals of monetary policy. The growth of the balance-sheet figures of all the banks can be explained only by the dispositions of the individual banks with regard to their assets. If a bank feels its liquidity is greater than it considers necessary, it tries to redeploy its assets, favouring higher yields and reduced liquidity. In this process other banksthen become more liquidthan they wanttobe and react accordingly; once an impetus has been given, it is propagated in the banking system until the actual liquidity situation does not diverge from the desired situation for anybank. Monetary policy must exert an influence on one of these two magnitudesin order to influence the growth. of balance-sheet figures; as a rule the actual liquidity situation will be chosen. M The issue here is the individual liquidity situation of the banks and not, say, their stock of free liquidity reserves in the sense of assets permitting recourse of the central bank. The one corresponds to the other only to the extent that some banks want to hold a minimum of such assets within the framework of their liquidity precautions. For a long time this was indeed the case, and it enabled the central bank to influence the liquidity situation of the banks by variation of the free liquidity reserves. If this condition is not satisfied, the central bank can influence the liquidity situation of the banks only by regulating the quantity of central bank money. Then there ought to be no more free liquidity reserves in the above-mentioned sense, because otherwise regulation of the quantity of central bank money cannot function. The lack of free liquidity reserves under such circumstances is by no means identical with a stringent restrictive policy. How monetary policy acts depends entirely on the extent to which the central bank makes central bank money available. Even without free liquidity reserves the banks may feel their liquidity is very ample, if the central bank pursues an appropriate policy. The problem of regulating the quantity of central bank money lies essentially in the fact that the central bank must, of course, gain acceptance of its own ideas as to the quantity of central bank money which should be made available, but cannot do so without taking account of seasonal and other fluctuations in the need for central bank money. It cannot make use mechanically, so to speak, of the close relationship between central bank money and the monetary trend. It must utilize its monopoly in creating central bank money to provide conditions under which the banks behave in suchamanner that the monetary trend aspired to by the central bank actually takes place. Here there is a combination of interest-rates and risk elements. If, in consideration of the interest rate, it is almost more attractive to lend out disposable money on the money market with a good degree of liquidity, the urge of the banks to redeploy their assets in favour of less liquid assets - and from the overall standpoint in favour of growing balance-sheet figures - is very greatly diminished. Apart from this, the banks will deem it advisable to preserve liquidity, if they observe how difficult it has become to cover deficiences on the money market. High money market rates therefore have a strong contractive effect, particularly as long as the banks have not adjusted their interest rates for advances to the increased cost of procuring money. Following that adjustment, the restrictive effect must come primarily from the deterrent effect of the attained interest level on demand for credit. In the short run, the banks’ possible means of responditngo a change in their situation caused by monetary policy are limited, in which connection special importance attaches to promises of credit. But the banks themselves should be interested in demonstration of th fact that it is possible for the central bank to pursue an effective monetary policy. Control of the creation of money is a basic requirement for an economic order based on division of labour.