Wednesday, July 22, 2009

the shift ability theory

the shift ability theory recognized that liquidity could be provided if a certain portion of deposits were used to acquire such assets as loan and securities for which a secondary market exists. Thus, if a bank requirements, these highly liquid assets could be sold. Such securities are called secondary reserve, and they include U.S. Treasury bills, commercial paper,and bankerُ s acceptances. By adhering to the shift ability theory, bank managers justified the making of longer-term loans,which extended the average maturity of the loan portfolio.
This shifting of assets from less liquid loans to more liquid money market instruments is effective only if all banks are not at the same time selling liquid money market instruments to obtain cash. Everyone cannot be a seller of T-bills simultaneously. someone must be a buyer. An attempt to increase the total liquidity of the banking system through this process is doomed to failure unless an institution such as centeral bank will purchase T-bills when all banks are attempting to increase their liquidity.
the shift ability theory, theory, then, contains the same defect that plagues the commercial loan theory. Both must early on third party, such as the fed, to increase the supply of total liquidity when necessary.For, without the fed, what will provide instant liquidity for one or a few banks at most cannot provide a source of increased liquidity for the banking system as q whole.The fed must be a ready buyer of securities from any and all banks for total liquidity to increase.

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