Market mechanism and Maturity transformation: Difference between pages

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imported>Doug Williamson
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The interaction of [[demand]] and [[supply]], resulting in an equilibrium quantity and price being set by the market.
Borrowers and depositors generally have differing preferences about the maturity of their obligations and investments.


Borrowers normally prefer to borrow longer-term, for example to fund long-term investment in productive assets.


When demand exceeds supply, market prices are likely to rise.
Investors generally prefer shorter-term, more liquid assets.


When supply exceeds demand, market prices are likely to fall.


When demand and supply are equal, market prices are likely to remain stable.
Maturity transformation is the essential economic function of banks and other intermediaries, which enables both borrowers and investors to meet their differing needs for maturities.


 
For this to work, there needs to be a very high degree of market confidence in the bank, especially on the part of its depositors.
The mechanism described above is a result of the interaction of the [[demand curve]] and the [[supply curve]] in a given market.
 
 
<span style="color:#4B0082">'''Example 1: Demand exceeds supply'''</span>
 
When demand exceeds supply, sellers will run out of stock and realise that they can sell the goods at a higher price.
 
Sellers will increase their prices accordingly.
 
This will cause demand to fall.
 
It will also cause supply to increase.
 
Demand will continue to fall, and supply will continue to increase, until demand and supply are equal.
 
At this point the market is said to clear, and prices will in theory be stable.
 
 
 
<span style="color:#4B0082">'''Example 2: Supply exceeds demand'''</span>
 
When supply exceeds demand, sellers will be unable to sell all their stock.
 
Sellers will have to cut their prices to reduce stock.
 
This will cause demand to rise.
 
It will also cause supply to decrease.
 
Demand will continue to rise, and supply will continue to fall, until demand and supply are equal.
 
At this point the market is again said to clear, and prices will again in theory be stable.




== See also ==
== See also ==
* [[Equilibrium]]
* [[Bank]]
* [[Free market]]
* [[Interest rate transformation]]
* [[Demand]]
* [[Leverage]]
* [[Demand curve]]
* [[Liquidity preference]]
* [[Supply]]
* [[Maturity]]
* [[Supply curve]]
* [[Maturity mismatch]]
* [[Prudential Regulation Authority]]
* [[Riding the yield curve]]
* [[Run]]
* [[Shadow banking]]

Revision as of 19:40, 10 August 2016

Borrowers and depositors generally have differing preferences about the maturity of their obligations and investments.

Borrowers normally prefer to borrow longer-term, for example to fund long-term investment in productive assets.

Investors generally prefer shorter-term, more liquid assets.


Maturity transformation is the essential economic function of banks and other intermediaries, which enables both borrowers and investors to meet their differing needs for maturities.

For this to work, there needs to be a very high degree of market confidence in the bank, especially on the part of its depositors.


See also