Abstract

Financial Innovations and the LM Curve

This contribution discusses implications of product innovations for the money market: in the case of innovative financing options representing in alternative to money, the demand for money becomes more interest-elastic and the LM curve thus flatter. On the other hand, the interest-rate elasticity increases with innovative products that take the form of money with interest paid, which makes the LM curve steeper. The implications for the supply-side of the money market depend on how portfolios are restructured after the product innovation has been launched. In the event that the financial innovation results in a restructuring of portfolios with a shift from money to innovative instruments, the money-creation multiplier would decrease with an option that represents an alternative to money, whilst this multiplier would remain constant with an instrument that takes the form of money with interest paid. Where the innovative product is financed within the framework of restructuring portfolios using forms of investment alternative to money, it is not possible to say with any degree of reliability in the case of financial innovations alternative to money what the changes in the money-creation multiplier would be; in the case of innovative financing instruments taking the form of money with interest paid the money-creation multiplier would increase.