Although financial circulation is an important part of banks' balance sheets in the form of savings deposits, this is hardly discussed in monetary circuit theory. In this paper, we argue that monetary circuit theory would be more coherent if it were expanded to incorporate some aspects of Keynes's view on financial circulation. As a matter of fact, it is financial circulation which contributed significantly to the inflated asset bubble in the first place and to the credit crunch in the second round. Hence, bank lending, which creates means of payment, should be regulated and monitored closely. In particular, banks should be divided into two categories: industrial or business banks, where deposits are used as means of payment (and covered by a State guarantee), and financial banks, where deposits carry an interest, but are not guaranteed by legal arrangement. This regulation would limit the amount of means of payment to what is required for production and trade, and would still make it possible for the central bank to pursue a flexible monetary policy. This insight can be obtained by combining monetary circuit theory and Keynes's analysis of industrial and financial circulation, as put forward in his Treatise on Money.
European Journal of Economic and Social Systems, 2010, Vol 23, Issue 1, p. 119-134
Bank Regulation; Financial Crisis; Keynes's Monetary Theory; Monetary Circuit Theory