{"id":138,"date":"2016-06-02T11:09:11","date_gmt":"2016-06-02T16:09:11","guid":{"rendered":"https:\/\/sites.bu.edu\/perry\/?p=138"},"modified":"2019-01-17T12:06:25","modified_gmt":"2019-01-17T17:06:25","slug":"learning-to-think-about-shadow-banking","status":"publish","type":"post","link":"https:\/\/sites.bu.edu\/perry\/2016\/06\/02\/learning-to-think-about-shadow-banking\/","title":{"rendered":"Learning to Think About Shadow Banking"},"content":{"rendered":"

In retrospect, it is easy to see why most observers didn\u2019t see the crisis coming.\u00a0 The crisis was a stress test of shadow banking, \u201cmoney market funding of capital market lending\u201d.\u00a0 In most universities, including mine, monetary economics and financial economics are separate fields with their own specialized language and faculty, and the regulatory apparatus is similarly bifurcated.\u00a0 But the world isn\u2019t.<\/p>\n

As a consequence of the crisis, money people now realize that they have to learn some finance, and finance people now realize that they have to learn some money.\u00a0 Division of labor that made sense in an earlier time by bringing into sharp focus the essential elements of the system serves today instead to prevent us from seeing new essential elements, simply because they are in the periphery of our gaze.<\/p>\n

A recent workshop on \u201cImplementing Monetary Policy\u201d<\/a> shows this learning process in action, from the money side.\u00a0 How should we think about the role of the central bank in a world where money markets and capital markets are not separate but rather fully integrated, and not only domestically but also globally?\u00a0 Is the Fed Funds rate still the right target, or should we be focusing on something else, maybe even the Reverse Repo Rate?<\/p>\n

A recent report on \u201cMarket-Based Finance\u201d<\/a> shows this learning process in action, from the finance side.\u00a0 How should we think about role of the securities regulator in a world where money markets and capital markets are not separate but rather fully integrated, and not only domestically but also globally?\u00a0 Clearly traditional regulatory focus on agency problems and asymmetric information is no longer enough, but how exactly is a securities regulator supposed to help stem systemic financial fragility?<\/p>\n

The closing two sentences of the latter report hit the nail right on the head, according to me:\u00a0 \u201cthe greatest risk has been and remains the insufficiently deep understanding of the system in both its conceptual and data dimensions. To close these gaps and move towards a more robust regulatory framework requires continued engagement with the system on national and international levels.\u201d\u00a0 New economic thinking is needed, including thinking about new kinds of data that heretofore have been on the periphery of our vision.<\/p>\n

From this perspective, the biggest challenge is not just for money people and finance people to learn from each other.\u00a0 The way we think about money and the way we think about finance both have to change as well.\u00a0 \u00a0If money people only learn traditional finance, and finance people only learn traditional money, then we get nowhere.\u00a0 Money and finance are both moving targets, and that\u2019s the biggest challenge.<\/p>\n

So what finance and what money should money people and finance people, respectively, be trying to learn?<\/p>\n

A great example, according to me, is provided by the recent BIS paper on \u201cHelicopter Money<\/a>.\u201d\u00a0 The authors draw attention to the institutional fact that short term interest rates are determined in the market for bank reserves.\u00a0 Helicopter money would amount to a massive increase in the supply of bank reserves, but with what consequence for the rate of interest?\u00a0 If the central bank continues present practice of setting the floor on short term interest rates by paying interest on reserves, then the rate of interest stays wherever the central bank sets it.\u00a0 The fact that cash pays no interest does not mean it is a free lunch because excess cash becomes excess bank reserves, which do pay interest.<\/p>\n

\u201cThe \u2018decoupling\u2019 of interest rates from reserves is obviously well known to central banks but, surprisingly, it has not yet found its way into textbooks and economic thinking more generally.\u201d\u00a0 This gem, which the authors bury in the middle of the paper, is the key point for present purposes.\u00a0 New thinking about money is needed, by both money people and finance people. \u00a0But it\u2019s not in the textbooks, or the heavily vetted academic journals, precisely because it is new.\u00a0 So don\u2019t look there.\u00a0 Look instead to the writings of practitioners, whose daily engagement with the workings of the actual system forces development of new thinking, pragmatically.\u00a0 They have jobs to do, and when conventional thinking doesn\u2019t help, they have to find other ways of thinking.<\/p>\n","protected":false},"excerpt":{"rendered":"

In retrospect, it is easy to see why most observers didn\u2019t see the crisis coming.\u00a0 The crisis was a stress test of shadow banking, \u201cmoney market funding of capital market lending\u201d.\u00a0 In most universities, including mine, monetary economics and financial economics are separate fields with their own specialized language and faculty, and the regulatory apparatus […]<\/p>\n","protected":false},"author":15789,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[1],"tags":[5,8],"_links":{"self":[{"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/posts\/138"}],"collection":[{"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/users\/15789"}],"replies":[{"embeddable":true,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/comments?post=138"}],"version-history":[{"count":1,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/posts\/138\/revisions"}],"predecessor-version":[{"id":139,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/posts\/138\/revisions\/139"}],"wp:attachment":[{"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/media?parent=138"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/categories?post=138"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/tags?post=138"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}