Abstract
WITH THE INCREASED USE OF NOW accounts and the attempts by the S&Ls to make passbook accounts checkable, it is simply a matter of time until the prohibition against interest payments on demand deposits will be removed. Once explicit interest is allowed, the current devices to circumvent ie prohibition, such as free checks and activity charges at below marginal cost, should disappear. The effect of these changes in the institutional structure of the monetary system on the money supply process is the subject of this paper. In an earlier work [6] I developed a money supply model in which I incorporated the banking industry as profit-maximizing firms. I assumed iat the prohibition against interest payments was completely circumvented by the banks in a way that resulted in zero activity charges plus a positive deposit rate. This approach is inappropriate here, since the interest payments will now be explicit so that the device of reducing activity charges is neither necessary nor optimal . In spite of my previous assertions to the contrary [6, p. 293, fn. 10] neglecting ie market determination of deposit rates does significantly affect the results of a market-determined supply process. In fact, allowing for the market determination of both deposit rates and activit charges removes the ambiguity concerning ie effect of interest rate changes and introduces ambiguity in ie effect of income and weali changes. In the usual portfolio approach to money supply determination [1, 3, 4, 5], increases in market interest rates increase ie money supply because of reductions in desired reserve holdings. In this work increases in interest rates increase ie money
Published Version
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