By Dow, J. C. R.; Saville, I. D.
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Additional info for A Critique of Monetary Policy
How much a firm can raise on the money or capital markets at any time is thus fairly narrowly circumscribed. The implication is that, although interest rates in money and capital markets are flexible and market-determined, and although these are markets where the price mechanism appears to operate, the prices established are not market-clearing prices. Borrowers' power to borrow in them is subject to limits similar to those restricting their access to bank finance. The ability of the banks to maintain rationing of credit is thus not undermined.
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. To this basic question we revert in our two final chapters (and there give reasons why we do not discuss many propositions stemming from the postulate of rational expectations that have figured in recent discussion).
Such confidence is potentially fragile, for Macro-behaviour of the Banking System 19 depositors have little to go on but the reputation of a bank. 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.