Response to “A note on ‘Rethinking liquidity creation: Banks, shadow banks and the elasticity of finance’”

Abstract

In an article published in vol. 40, issue 3 of the Journal of Post Keynesian Economics, we challenged the post Keynesian view that nonbank financial institutions (NBFIs) are intermediaries between savers and borrowers. We argued that the “intermediary” framework is not an appropriate description of what financial institutions do. Instead, we proposed to broaden the endogenous money theory by incorporating nonbank financial institutions into it using the hierarchy of money. Our article generated a response by Bouguelli in which they argue that the traditional post Keynesian framework, with its clear-cut distinction between banks and NBFIs is better suited for understanding the different roles of these institutions and their “symbiotic relationship.” In this rejoinder, we respond to the critique of Bouguelli and clarify our position. We demonstrate that banks and nonbanks are similar in how they issue liabilities to finance positions in assets and settle on a netted basis using the liabilities of another entity higher up in the hierarchy. Moreover, we argue that NBFIs’ reliance on banks is better captured by the framework of leveraging rather than that of intermediation.

Keywords:

• Liquidity creation
• fictitious liquidity
• nonbank financial institutions
• endogenous money theory

Notes

1 Interestingly, this narrow definition of money that some post Keynesians adhere to is even “stricter” than the mainstream definitions. For instance, various official monetary aggregates measured by central banks include a much broader set of financial liabilities, including those issued by NBFIs.

2 Even smaller banks settle on the books of larger banks. Hence the deposits of one bank may act as “money” for another.

3 Different assets are subject to different settlement rules. For instance, stocks, bonds, municipal securities, exchange-traded funds are settled on a T + 2 basis, that is, they are settled on the second day after the trade has been “locked,” by the end of the day (this used to be T + 3 before 2017; SEC 2017). U.S. Treasury securities, on the other hand, are subject to a T + 1 settlement rule (Morris and Goldstein 2009, 13–15).

4 Because of their special position in the economy of making and receiving payments day in and day out, financial institutions, and not just banks, usually only have small negative clearing balances each day.