Central Banking and Money Market Changes

The ability of a central bank to achieve its object ives depends upon how its oper a tions affect the various elements that make up the money market. Hence, the effic acy of any partic u lar tech nique of monet ary policy depends upon the finan cial insti tu tions and usages that exist. If finan cial insti tu tions do not change signi fic antly, then, once the effic acy of the various central bank oper a tions is estab lished, finan cial insti tu tions can be ignored in discus­ sions of monet ary policy. However, if a period of rapid changes in the struc­ ture or in the mode of func tion ing of finan cial markets occurs, then the effic acy of central bank actions has to be re­examined. Changes in finan cial insti tu tions and money­market usages are the result

of either legis la tion or evol u tion. Legislated changes typic ally are the result of some real or imagined malfunc tion ing of the monetary­financial system

and hence they usually are accom pan ied by discus sions of their impact. Evolutionary changes occur typic ally in response to some profit possib il it ies which exist in the money market. As the evolved changes often center around some tech nical detail of money­market beha vior and as they usually start on a small scale, their signi fic ance for monet ary policy is gener ally ignored at the time they first occur. Only if, at a later date, some malfunc tion ing of the finan cial system is imputed to such an evolved money­market insti tu tion will it be discussed, and then the discus sion usually occurs as a prelude to “correct ive” legis la tion. Awareness of the condi tions which induce insti­ tu tional changes in the money market and know ledge of the typical effects of such insti tu tional changes should enable the Federal Reserve or the legis lat ing author it ies either to take prevent ive meas ures or to be ready to minim ize the effects of a “crisis” when one occurs. As evol u tion ary changes in finan cial insti tu tions and usages are the result

of profit­seeking activ it ies, the expect a tion is that such finan cial changes will occur most frequently during periods of high or rising interest rates. Such rates are evid ence of a vigor ous demand for finan cing relat ive to the avail able supply. They act as a signal to money­market profes sion als to seek ways of using the avail able lending ability more effi ciently.1