VARYING THE MONEY SUPPLY OF COMMERCIAL BANKS By

We consider the problem of financing two productive sectors in an economy through bank loans, when the sectors may experience independent demands for money but when it is desirable for each to maintain an independently determined sequence of prices. An idealized central bank is compared with a collection of commercial banks that generate profits from interest rate spreads and flow those through to a collection of consumer/owners who are also one group of borrowers and lenders in the private economy. We model the private economy as one in which both production functions and consumption preferences for the two goods are independent, and in which one production process expereinces a shock in the demand for money arising from an opportunity for risky innovation of its production function. An idealized, profitless central bank can decouple the sectors, but for-profit e-mail: [email protected] e-mail: [email protected]