Regulation and Differences in Financial Institutions

Abstract

Some regulation of financial markets is accepted even in these dirigiste times and even by those neoclassical economists who find it a struggle to explain why the market for money is different from the market for peanuts. Monetary regulation as defined in this paper has three parts: the legal framework, monetary policy, and the supervision of banking and financial markets. Historically, these roles have developed alongside the systems they regulated, new measures being created by the monetary authorities-or even by large private banksas specific problems presented themselves. Within this evolutionary framework, policies were tailored to the institutions as they existed at the time. Thus, when banks provided only a minor proportion of monetary instruments, prudential regulation was left to the banks themselves and caveat depositor. When bank-issued notes began to create what we would now describe as macroeconomic instability, the government/monetary authority took over the issue of notes. When bank credit and deposits became a force to reckon with, the authorities devised such instruments as reserve or liquid asset requirements and, where the development of securities markets allowed it, open market operations to keep the banks on a short lead. Each of these episodes marks a shift in the power to provide money, first away from the state to the private sector, then back again as the state regains control. The current situation, almost everywhere in the developed world, is that the power to create money lies almost entirely with the private sector. The current situation in the European Union (EU) bears some similarities to the situation at the time of the institution of the Federal Reserve System, which, of