We know the creation of money rest with the power of the commercial banks to increase money supply by lending loans, A matter which can be tracked by money multiplier, broad money supply divided by monetary base. Now my question is, what happen to money multiplier and money supply, if due to evolving of financial sector, companies and households go for other means to finance their needs instead of taking loans from commercial banks? Does it cause money multiplier to decrease? And if it is the case, what is its implication in terms of inflation or central bank power to control money supply? What about financial innovation like securitization? Is their impact on money multiplier the same or not?
Dear Soroush,
Your question is a very debatable and (sorry) sound a little bit confused . Equity funding (by stocks) is not a part of system of lending activities. In essentially, money multiplier deals with the amount of money generated by banking sector with each unit ($, euro, yen etc...) of reserves but no with equity funding...
First of all substitution of bank lending with equity in a nation's capital market is not lending since the buyer of equity is exchanging money for ownership of the firm issuing the equity. The only thing bank lending and purchasing of equity and debt have in common is that they act as source of fund for corporate entities. Increased capital market activities may decrease money creation ability of the banks in the short run but in the long run, the capital market activity drives the economy growth. Evidently savings may reduce but investments will increase and with it the GDP and a strong capital market attracts foreign investors. So bank lending substitution may affect household savings positively since the banks will reduce lending rates to attract funds from the various components of the business cycle. With the growth in the economy comes some level of inflation and as long as the capital gains in the securities out pace inflation in the long run, all is good and fine. Emerging economies that are yet to attain their market capacity would prefer monetary policy options that would open their markets globally
Dear MR. Mehmed Ganic,
Thank you very much for your answer. I think I should make my question clearer. I know the equity funding is not a part of the system of lending activities. I mean when companies and households get a gradual tendency to finance their activities by stock or bond issuance or any other means available in the lending system except taking loans from commercial banks, it can indirectly reduce the amount of loans the banking sector make. Take the extreme case in which nobody goes to commercial banking sector for taking loans. In that case, no loan is granted and the money multiplier should drops to one, a matter I guess may have implications for the economy. Is not it true?
I got it your point. Hypothetically, it is a possible but be aware that all payment transactions must go through banking sector and one part of money in circulation will be held at banking sector. Another point is that many financial systems across the word are bank oriented but no financial oriented (U.S, Canada) . But theoretically it is possible to conduct any research related with previous topic
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