Question

in what ways do non bank financial intermediaries (NBFIs) constitutes clog on the effectiveness of monetary policy?

Answer 1

NBFI perform the role of intermediary for purchasing primary securities, common or preferred stocks, and other short term debts. On the other hand they also issue and sell indirect securities such as common fund stocks, time deposits, insurance polices to the ultimate lenders.

By buying and selling such securities, the intermediaries influence the availability of credit and the structure and level of interest rates. They tend to influence the supply of money by creating credit different from the commercial banks, and thus hinder the operations of an effective monetary policies.

The saving deposit held by NBFIs are known as near-monies. Since the demand deposits are controlled by the central bank,it follows that savings deposits held by NBFIs will hinder the successful operations of a successful monetary policy.

Thus when money supply is reduced by a restrictive monetary policies, the NBFIs are able to increase velocity of money and total spending by turning primary securities into indirect securities for the portfolio of ultimate lenders.

Similarly, NBFIs can make an expansionary monetary policy ineffective by reducing the velocity of money.

Hence , it is not possible for the interest rates to settle back at their old levels even by the operations of NBFI. Rather, interest rates would tend to rise further. The money supply will remains tight and its influence on spending would be restrictive.