The Effects of Financial Innovation on the Instruments of Monetary Policy

Proper understanding of the effects on the instruments of monetary policy of changes in the technology of making and receiving payments has been marred by failure to observe three distinctions. One is the distinction between changes in technology that overcome regulatory and legal restrictions and changes that would occur in the absence of these restrictions. A second distinction is between money and credit, or more properly the distinction between technical changes or innovations that increase borrowing and lending and innovations that change the demand for and supply of money. A third distinction is between the immediate or impact effect on a particular type of institution and the full equilibrium effect on the economy. In this section, I discuss the first of these issues. The following sections distinguish between money and credit and analyze the impact and final effect of innovation on both money and credit.