Chapter 6 complete

6.5.2 Gurley-Shaw version of the liquidity theory 
Gurley and Shaw have divided the total quantity of money under two heads such as, inside 
money and outside money. Inside money is based on the debt of endogenous economic units. 
It is money created within the private sector against some private debt. It consists of financial 
claims by one class of individuals and firms on others within the economy. Outside money on 
the other hand is money is based on the debt of a unit (the government) exogenous to the 
system. Thus, it is currency issued by government, gold, foreign and government securities. It 
is the liability of the government as a debtor and the claim of the private sector as a creditor. 
When a country progresses economically, changes in financial structure are 
observed. Financial assets or claims are generally divided under the two heads of primary 
(direct) securities ans secondary (indirect) securities. The primary securities are financial 
claims against real sector units, for examples, bills, bond, and equities etc. They are created 
by real sector units as ultimate borrowers for raising funds to finance their deficit spending. 
The secondary securities are financial claims issued by financial institutions or intermediaries 
against themselves to raise funds from the public. The examples are such diverse financial 
assets are the Reserve Bank currency, bank deposits, life insurance policies UTI units and 
bonds etc. Gurley and Shaw have divided the total quantity of money into two parts viz; 
inside money and outside money. As per the Gurley and Shaw, it is in the non-banking 
financial companies (NBFCs) that provide liquidity and safety to financial assets and help in 
transferring funds eventual lenders to decisive borrowers for industrious purpose. As per 
them, the savings deposits of NBFCs are similar to the demand deposits of commercial 
banks; so for NBFCs it is not complex to change their savings into cash.
If the central bank 
wishes to control surplus liquidity in the fiscal system only through the decrease in supply of 
money, it will not get success for the reason that the savings deposits of NBFCs can be 
converted into cash. Hence, Gurley-Shaw version of the liquidity theory emphasise that the 
credit control weapons of central bank should apply not only to the commercial banks, but 
also to the NBFCs/NBFIs. In this context, Gurley-Shaw thesis has advocated the application 
of variable-cash-reserve ratio to the NBFIs in the same manner as it is applicable to the 
commercial banks. 
When NBFCs increases rates of interest on their savings deposits, the public 
decreases its demand for money, which in turn decreases the market rate of interest. Fall in 
market rate of interest leads to increase in public expenditure, which in turn leads to increase 
the price level. Therefore, NBFCs make strict fiscal policy less effective. Likewise, NBFCs 
can make an expansionary fiscal strategy unproductive by decreasing liquidity. Unlike, 
Radcliffe Report, Gurley and Shaw argue that the central bank’s control over NBFCs must be 
comprehensive for an effective fiscal strategy.