bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

THE MEANING OF MONEY 11
authorities as being completely in control of the money supply (the money
supply is exogenous). Then, if they choose to keep the supply of money
unchanged in the face of an increased demand for it, market forces cause
interest rates to rise. The alternative is to see the monetary authorities as
having little or no direct control over the money supply (the money supply
is endogenous) but as having control over interest rates. In this case, the
monetary authorities respond to what they see as inflationary pressure
caused by the initial increase in demand for goods and services by increasing
the rate of interest. If this does persuade people to borrow and spend
less, the supply of money (or its rate of growth) will fall but, in this case,
the influence of the authorities on the stock of money is only, at best, indirect,
taking place through the rate of interest and then through the demand
for credit.
Expressed in this way, the difference between these channels of influence
of the authorities does not seem very important. It remains that the
debate over which helps us better understand how the system works has
been long and heated and we shall need to consider the issue.
Secondly, as demand for goods and services and the desire to borrow
increases, banks might respond by not granting additional loans but by
tightening the conditions on which they are willing to lend. Then, some
people who previously could borrow would be unable to do so and others
would be able to borrow less than previously. That is, people’s ability to
borrow and hence their spending resources would be restricted — they
would be credit-constrained. Again, the money supply would not grow but
this would occur without an increase in interest rate being necessary. This
might happen because, in an uncertain situation and with asymmetric information
(discussed in Section 3.5), banks might choose to act in this way.
Alternatively, banks might tighten their lending criteria because they are put
under pressure to do so by the monetary authorities. That is, the monetary
authorities might attempt to influence the ability of people to borrow not by
increasing interest rates but by trying to control directly the quantity and/or
types of loans made by banks. Examples of this in the UK in the 1950s and
1970s are discussed in Section 11.2.
The question arises here of why banks might not meet an increased
demand for loans since these are the source of their profits. The view that
the authorities have direct control over the supply of money sees this as
occurring through control over the size of the monetary base (high-powered
money), 3 on the assumption that there is a reliable and predictable relationship
between the size of the monetary base and the quantity of deposits
banks can create. If this were the case, banks would not meet the increased