The Adjustment Process

The structure of financial relations in an economy is based on asset—liability relations between economic units. In some instances, these are direct relations (an individual member of a household holds (as an asset) the equity of a corporation (its liability), or a household has a liability in the form of a hire purchase contract that is a company’s asset). More frequently, the relations between the primary sectors are indirect. For most economic units, the major part of their financial assets (money, quasi-money, life insurance and pension protection, obligations of unit trusts, and similar assets) are claims on financial intermediaries; and similarly most liabilities are held by financial intermediaries (bank loans, mortgages granted by financial institutions, institutional holdings of securities etc.). In large part, these indirect relations reflect the inconsistent asset and liability desires of individual economic units. Asset holders wish to concentrate a large part of their holdings in liquid deposit type assets, claims on life insurance and pension funds and other readily disposable assets (such as unit trust units); liability acceptors wish to obtain security by accepting revolving bank loans, commitments with predetermined repayment schedules over a period (extending up to 20 years or more on house mortgages etc.) and long-term debt. Financial intermediaries intervene to reconcile these inconsistent desires. The major theme of Chapter 7 is a discussion of this reconciliation.