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ECPR Virtual General Conference 2020

Managing Shadow Money

Political Economy
Public Policy
Daniela Gabor
University of the West of England
Daniela Gabor
University of the West of England
Jakob Vestergaard
Danish Institute for International Studies

Since the global financial crisis, it has been well established that we need to improve our understanding of shadow banking. Research has so far focused on sources of pro-cyclicality, channels of systemic contagion, and policies to mitigate shadow instability. Recently, however, scholars explored broader questions: What does the rise of shadow banking mean for monetary theory and practice? How should we change our traditional theories of money to capture the complex practices through which money is created in modern financial systems?

Pozsar (2014, 2015) argues that shadow money begins where money created by banks (deposits) ends, bringing together demand for safety from cash-rich institutional investors with demand for risk from leveraged portfolio investors. Conceptually, Pozsar’s contribution draws on a tradition in monetary theory that conceives of money as a balance sheet relationship (Minsky, 1987, Bell 2001, Mehrling 2012), with money hierarchies closely reflecting (cross-border) institutional arrangements: gold as money between central banks, reserves as money between banks, deposits as money between firms and households. Pozsar (2014) however assumes that crises matter only for private shadow ‘moneyness’ and that the US-based shadow banking is analytically representative for the entire (shadow) banking universe. These assumptions downplay important questions of national (and supranational) economic management in an era of financial globalization, overlook connections and potential conflicts between fiscal, monetary and macroprudential policies.

In addressing these issues, we draw upon and contribute to the money view literature (Mehrling 2012, Merhling et al 2013, Pozsar 2014, 2015). Noting that shadow banking (or market-based finance) is distinctive from relationship banking in that debt relationships are typically organized via marketable financial instruments, we define shadow money as repo liabilities supported by tradable collateral. We outline the constraints governing the creation of shadow money and examine the specific mechanisms through which these constraints may (de)stabilize money hierarchies.
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