The Importance of "Money"
Abstract
What types of financial instruments get treated as “money”? What are the implications for financial regulation? These two questions animate The Money Problem: Rethinking Financial Regulation by Morgan Ricks and my review of his thought-provoking new book.
The backbone of The Money Problem is a reform agenda that aims to give the government complete control over the creation of money equivalents. According to Ricks, the government should insure all bank deposits, no matter how large, and prohibit any other entity from issuing short-term debt. I question the efficacy, benefits, and costs of the proposed reforms. Both theory and history suggest that so expanding the government’s formal safety would engender massive moral hazard while likely failing to achieve the purported aim of “panic-proofing” the financial system. I also worry about the foregone credit creation and other costs of eliminating money market mutual funds, sale and repurchase agreements (repos), commercial paper, and other arrangements that are pervasive today and would be outlawed under the proposed reforms.
Nonetheless, The Money Problem could – and should – transform the ongoing debate about how best to promote financial stability. Ricks’s core insight is that financial crises routinely emanate from changes in the types of instruments that market participants are willing to treat like money. The range of instruments accorded that status expands during periods of financial stability and contracts rapidly when the boom turns to bust, magnifying the adverse consequences of that change. His claim that government guarantees are the most effective way to staunch runs in the face of such a change is also persuasive. Combining these insights with a heightened appreciation of the inevitable dynamism of financial markets lays the groundwork for a different set of reforms. I argue that the government should be prepared to act as an “insurer-of-last-resort” to stem the spread of a budding financial crisis. This type of support, however, should be reserved for periods of systemic distress. More broadly, history suggests that the rise of private money, as embodied in the growth of shadow banking before the recent crisis, is endemic to finance. Rather than fooling ourselves into believing that a broad ex ante regime can eliminate private money creation, we should recognize its development as inevitable and devise a regime that is capable of responding as markets evolve.