bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

154 MONETARY ECONOMICS
they do. Institutional change is, in effect, assumed exogenous. In practice,
it is much more likely that anything that shifts the function will change the
elasticities (the slope of the demand curve will change as well as the curve
shifting). Consider, for example, the impact of monetary policy. A period
of high interest rates may encourage the development of financial innovations,
allowing money balances held for transactions purposes to be
reduced. This introduces the possibility of a ratchet effect — when interest
rates are high, it pays to spend time and effort on the development of financial
innovations. In the 1970s and 1980s, for instance, we saw the introduction
of concentration accounts (in which funds deposited in other
accounts are automatically transferred at the end of each working day), zero
balance accounts (that allow firms to do without transactions balances at
banks, yet give them the opportunity to write cheques) and automated teller
machines. Having been introduced, such innovations are not reversed when
interest rates fall again because the costs involved are mainly set-up costs
such as computing hardware and software. In this case, it was, therefore,
likely that financial innovation increased the interest-elasticity of the
demand for narrow money (as movements between demand deposits and
high interest-bearing deposits became much easier) as well as causing a
downward shift in the function. Thus, monetary policy measures may affect
the demand for money indirectly through inducing financial innovations.
Pause for thought 6.9
Do you think the introduction of internet banking has been an important financial
innovation? What effect, if any, do you think it will have on the velocity of money?
Since the principal aim of explanations of the apparent demand for
money instability has been to retain belief in a stable long run function, it is
not surprising that most explicit attempts to include the effects of institutional
change on the demand for money, has focused on long-run changes.
While Friedman and Schwartz (1982) employed dummy variables to allow
for selected institutional changes, the major studies to include institutionally-related
variables have been by Bordo and Jonung (1981, 1987, 1990),
Siklos (1993), Klovland (1983) and Akhtar (1983). The variables have
included bank offices per head of population, the proportion of the labour
force employed outside of agriculture, and the ratio of currency to total
money stock and of non-bank to bank financial assets. Other efforts have
involved the inclusion of past peak levels of interest rates on the grounds
that the incentive to innovation comes from changes in costs of which interest
rates are an important part (Judd and Scadding, 1982; Goldfeld, 1992).