Financial Intermediaries and Monetary Policy

Abstract

The Radcliffe Report2 has touched off a lively debate on the theoretical conceptions underlying monetary policy, and in particular on the significance of the operations of non-bank financial intermediaries. Comment on this, as on other aspects of the Report, has been copious, but fragmentary. The object of this article is to bring together, from several sources, some of the more controversial opinions that have been expressed on this problem; and to attempt a critical assessment. Over-simplifying for clarity's sake, we may take as our startingpoint the basic Radcliffe theory and an opposing view which I shall label traditionalist . Thus we have the traditionalist approach emphasizing, so to speak, the medium of exchange function of money, a function in which money (defined as coin, notes and bank deposits) has virtually no effective substitute. It is therefore reasonable to expect, so the argument runs, that control of the stock of money will have significant influences on the flow of expenditure. These influences may work through the direct route, because, say, a reduction in the money supply makes people feel illiquid, so that to restore liquidity they are induced to restrict spending. Or they may work through the indirect route, because a reduction in money supply and the liquidity of the public causes an unwillingness to part with money evidencing itself in rising interest rates; the demand for credit then tends to contract and loan-financed expenditure to fall. Against this there is the Radcliffe approach, which from one standpoint may be regarded as emphasizing the store of value function of money, a function in which money has a number of close substitutes capable of neutralizing any potential effect of a reduction in the money supply on spending. The argument is that a relatively small rise in the rate of return on such substitutes will induce some holders of money balances to transfer part of their balances to intermediaries, who will re-lend them for the finance of various classes of expenditure.3 This summary of the opposing viewpoints is brief to the point of caricature, but it highlights the aspects most relevant to the subsequent