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

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

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Banks therefore attach overriding importance to appearing safe. An additional consideration is that, given the emphasis on risk avoidance, the capital that prudence (or bank supervisors) requires a bank to maintain is small in relation to the deposits it takes. Serious miscalculation and bad debts could well result in inadequate capital to carry on business on the previous scale, and could force a bank to make a multiple contraction of its balance sheet. ) In order profitably to employ money deposited with them, banks are nevertheless bound to take limited risks.

That will initiate a cumulative expansion of output and income which will increase savings, and lead to an increase in total holdings of financial assets (or a faster rate of increase than would otherwise occur). Analysis of the effects must then allow not only for changes in the composition of asset holdings, but also for an increase in the total stock. This makes the process more than a static portfolio adjustment. 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.

The potential equilibrium scale of banking Banks match loans and deposits: there can be no growth in one side of their balance sheet unless the other grows as well. At any point in time there must, in principle, be a limit to how far the banking system can profitably expand its operations, the limit being set by the preferences, on the one hand, of depositors and, on the other, of borrowers. The concept of an equilibrium scale of banking derives from portfolio theory. Taking first the deposits side, deposits are one type among others of financial assets that the public holds.

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