Money Creation and the Shadow Banking System

Abstract

It is widely argued that shadow banking grew rapidly before the recent financial crisis because of rising demand for “money-like” claims. This paper assesses a key premise of this argument: that investors actually treated short-term debt issued by shadow banks as a money-like claim. I present a model where the financial sector and the central bank jointly respond to demand for money-like claims. The model generates predictions about the prices and quantities of Treasury bills, central bank reserves, and shadow bank debt. These predictions are borne out in the data, suggesting investors did treat shadow bank debt as money-like.

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