Credit Expansion in a Multibank System.

This paper presents a model of the banking system that relates system credit expansion to individual bank borrowing and lending decisions. The results of the computer simulation based on the model demonstrate that expectations in the credit expansion process can influence the speed of system deposit expansion--optimism leading to considerably more rapid credit expansion than pessimism. Consequently, statements and action calculated to shift expectations in the appropriate direction may sharpen the effectiveness of various Federal Reserve policies in controlling the total volume of credit. Also, system deposits increase more rapidly when new reserves are introduced throughout the system; therefore, the effectiveness of monetary policy may be improved significantly by decentralizing the Federal Reserve's open market operation. The model's primary advantage is that it illustrates explicitly the connection between system behavior and individual bank lending and borrowing decisions, so that the effects of such factors as bank expectations and uncertainty on system behavior may be predicted. The model may thus provide a more effective means for evaluating alternative Federal Reserve policies. 21 pp.