Different Credit Expansion Channels Do Not Affect the Basic Mechanism of the Business Cycle But Cause Differences in the Secondary Features of the Cycle

These different credit expansion channels do not affect the basic mechanism of the business cycle (characterized by erroneous investments as a result of the artificially lowered interest rate) but are responsible for the differences in the so-called secondary features of business cycles that make them nonidentical despite obvious similarities.

Finally, it is worth noting that the course of the business cycle and the implementation of the Cantillon effect are influenced not only by the investment policy of commercial banks, but also by other factors. I mention a few of them here. First of all, central banks may conduct monetary policy in various ways and create a monetary base, which has varied effects on credit expansion and, consequently, on the course of the business cycle. For example, quantitative easing is a different mechanism of introducing new money into the economy, relative to traditional open market operations, generating a slightly different first-round effect. While in the open market operations the most frequently purchased debt instruments are short-term Treasury bonds, quantitative easing may take place through also buying long-term bonds, including non-treasury bonds (e.g. corporate bonds or bonds secured by mortgages). This entails different redistributive effects, also affecting the yield curve and the risk premium in different ways.

Second, the type of entity that creates new money through the credit market and the way it is created is also important for the course of the business cycle and the implementation of the accompanying Cantillon effect. At present, a significant portion of loans are granted for the purpose of converting them into securities or, in general, by entities other than commercial banks. Indeed, banking activity has changed significantly in recent years and banks have largely abandoned traditional commercial banking based on taking deposits and lending, and instead adopted a business model based on loan securitization and their distribution to the so-called shadow banks. The effects of increasing the money supply (in the form of credit) vary, therefore, depending on what type of bank (rural or urban, small or large) or institution provides the loan. Loans can be created not only by commercial banks. Other depository institutions (such as savings banks or credit unions) and the so-called shadow banking system also participate in this. The creation of money by shadow banks seems particularly important in the modern economy, because securitization enables traditional commercial banks to increase lending (including through transfer of credit risk outside the bank balance sheets to investors purchasing securities), and intermediation of liabilities allows the so-called shadow banks to create loans by themselves. The creation of a loan through a shadow banking system implies a different implementation of the Cantillon effect, because the shadow banks’ asset structure differs from the structure of traditional banks’ assets, and certain types of loans are more readily used in the securitization process.

—Arkadiusz Sieroń, Money, Inflation and Business Cycles: The Cantillon Effect and the Economy, trans. Martin Turnau, Routledge International Studies in Money and Banking (Milton Park, UK: Routledge, 2019), 91-92.