Liquidity and Credit Creation

  • Y. C. Jao


In countries where a central bank exists, the traditional theory of money and credit is that it is a quantity uniquely controlled by the monetary authorities. Given the banks’ reserve ratio and the public’s cash ratio (b and p in the previous chapter), the central bank is said to be able to control the total quantity of money and credit by manipulating the reserve base (vault cash plus balances with the central bank).


Central Bank Banking System Balance Sheet Money Supply Banking Sector 
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Notes and References

  1. 1.
    Don Patinkin, ‘Financial Intermediaries and the Logical Structure of Monetary Theory’, American Economic Review (Mar 1961) pp. 111–12.Google Scholar
  2. 2.
    H. G. Johnson, Essays in Monetary Economics (London, 1967) p. 97.Google Scholar
  3. 3.
    A. J. Meigs, Free Reserves and the Money Supply, (Chicago, 1962) Ch. 2 and 4Google Scholar
  4. L. C. Anderson and A. E. Burger, ‘Asset Management and Commercial Bank Portfolio Behaviour’, Journal of Finance(May 1969) pp. 207–22.Google Scholar
  5. 4.
    Cf. W. F. Crick, ‘The Genesis of Bank Deposits’, reprinted in Readings in Monetary Theory (London, 1956) pp. 41–53Google Scholar
  6. G. W. Woodworth, The Money Market and Monetary Management(New York, 1965) pp. 457–88.Google Scholar
  7. 5.
    H. D. Crosse, Management Policies for Commercial Banks (Englewood Cliffs, N. J. 1962) p. 79.Google Scholar
  8. 6.
    J. M. Keynes, Reatise on Money (London, 1930)Google Scholar
  9. 8.
    See W. T. Newlyn, Theory of Money (London, 1971) pp. 128–9Google Scholar
  10. R. F. G. Alford and J. M. Parkin, G. Clayton, J. C. Gilbert and R. Sedgwick (eds), Monetary Theory and MonetaryPolicy in the 1970s (London, 1971) pp. 218–27.Google Scholar
  11. 9.
    In Britain an 8 per cent cash ratio used to be generally observed, though ‘cash’ here means the sum of till money and balances at the Bank of England, so that the vault cash ratio is actually lower. In U.S. the vault cash ratio is also very low and this is especially true of the central reserve city banks. However, such a low ratio is justifiable owing to the existence of a central bank. For a discussion of the significance in the British setting, see J. E. Wadsworth, ‘Banking Ratios Past and Present’, in C. R. Whittlesey and J. S. G. Wilson (eds), Essays in Money and Banking in Honour of R. S. Sayers(London, 1968) pp. 229–52Google Scholar
  12. J. E. Wadsworth (ed), The Banks and the Monetary System in U.K. 1959–1971(London, 1973) Chapter 5.Google Scholar
  13. 10.
    F. Y. Edgeworth, ‘The Mathematical Theory of Banking’, Journal of the Royal Statistical Society Vol 51 (1888) pp. 113–27.Google Scholar
  14. 11.
    W. J. Baumol, ‘The Transactions Demand for Cash: An Inventory Theoretic Approach’, Quarterly Journal of Economics (Nov 1952) pp. 545–56Google Scholar
  15. James Tobin, ‘The Interest Elasticity of Transactions Demand for Cash’, Review of Economics & Statistics (August 1956) pp. 241–37Google Scholar
  16. C. M. Sprenkle, ‘Large Economic Units, Banks, and the Transactions Demand for Money’, Quarterly Journal of Economics (Aug 1966) pp. 436–42.Google Scholar
  17. 13.
    R. I. Robinson, The Management of Bank Funds, 2nd ed. (New York, 1952) p. 2Google Scholar
  18. S. M. Goldfeld, Commercial Bank Behaviour and Economic Activity (Amsterdam, 1966) pp. 14–19. The emphasis on loan-deposit ratio is also justified by the time-honoured tradition that granting loans is the primary function of a bank, while investment is subsidiary in that it provides an outlet for residual funds after all loan demand has been accommodated.Google Scholar
  19. 17.
    In the text we have neglected the role of non-bank financial intermediaries in credit creation. In advanced economies where there are a variety of such intermediaries, the public is likely to hold deposits with them in addition to bank deposits, the relative proportions of which will depend on the relative attractiveness of yields. Thus there may be net leakages from the banks to other intermediaries which affect the bank credit multiplier. See D. K. Sheppard and C. R. Barrett, ‘Financial Credit Multipliers and the Availability of Funds’, Economica (May 1965) pp. 198–214. However, as described in Chapter 4, the non-bank intermediaries are still at a rudimentary stage of development in Hong Kong, and there are sufficient reasons to suppose that the marginal intermediary deposits/bank deposits ratio is likely to be very negligible. It thus can be ignored without affecting the substance of our analysis.Google Scholar
  20. 18.
    D. J. Coppock and N. J. Gibson, ‘The Volume of Deposits and the Cash and Liquid Asset Ratios’, Manchester School, (Sept 1963) pp. 203–22.Google Scholar
  21. 21.
    It is well known that before 1971 British banks generally maintained stable cash and liquidity ratios which were conventional rather than statutory. See Wadsworth, loc. cit., and E. Nevin and E. W. Davies, The London Clearing Banks (London, 1970) Chapter 7.Google Scholar
  22. 22.
    In 1959 ten native banks maintained on average a loan ratio of 53.8 per cent and a liquidity ratio of 50.8 per cent. See Ng Kwok Leung, ‘The Native Banks’, Far Eastern Economic Review (11 February 1960) pp. 307–19. The author then included Hang Seng, Wing Lung, Kwong On, Dao Heng, Hang Lung, Tai Sang, and Po Sang as native banks All of them have now been reorganised as modern banks.Google Scholar
  23. 23.
    Of course, what has been said about the bankers’ behaviour merely denotes their attitudes to the conventional canons of sound banking, and does not imply that they are conscious of the real-bills doctrine as such. The doctrine has long been exposed by economists as being based on a fallacy of composition. See L. W. Mints, A History of Banking Theory (Chicago, 1945) passim.Google Scholar

Copyright information

© Y. C. Jao 1974

Authors and Affiliations

  • Y. C. Jao
    • 1
  1. 1.University of Hong kongChina

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