Making Money Work

Foreword by Jacques de Larosiere iii
Introduction v

Part One: How Money Works. Institutions of the Monetary Economy 1

Chapter 1 Rethinking Monetary Economics 3
Macroeconomics Without Money 3
Broad Money and the Banking System 4
From Interest-rate Policy to Quantity-based Policy 6
Neutral Monetary Policy 7
Productive Capital Markets 7

Chapter 2 Fiat Money Systems 9
Specifying Money So That Money Matters 9
Money is essentially an abstract measure of value 10
Money consists in a claim or credit 11
The state, or an authority, is an essential basis for money 12
Money is not neutral in the economic process 13
Fiat Monetary Standards 15
Metallic standards 15
Standards after metallic standards 17
Foreign exchange and the quest for an international monetary standard 17
Revisiting the Foundations of Monetary Economics 20

Chapter 3 The Institutional Structure of the Monetary Economy 21
The Government Sector 21
The fiscal authority 22
The monetary authority 23
The consolidated government 24
The Commercial Banking System 26
Deposit creation by individual banks 27
Fallacious accounts of bank funding and deposit creation 28
Financial Intermediaries 31
Asset managers 31
Money market funds 32
Asset-backed securities 33
Consolidated financial intermediation sector 34
The Nonbank Public: Nonfinancial Firms and Households 35
Nonfinancial business 36
Households 37
The Rest of the World 37
The Money Supply and its Connections to the Nonbank Public 38
The System of Claims as a Foundation for Monetary Theory 40

Chapter 4 Financial Intermediation in the Capital Markets 42
Savings and Investment: The Standard Macroeconomic Story 43
Savings and Investment: The Microeconomic Foundations 44
The NPV criterion 45
Information asymmetry 46
Equity rationing 46
Revising the growth model 47
Financial Intermediation and Project Stratification 48

Chapter 5 Credit Creation by the Commercial Banking System 50
Savings and Investment: Expanding the Standard Story 50
The Set of Bankable Projects 53
Maturity Transformation and Bank Risk Management 55
Credit risk management 55
Interest rate risk management 57
Liquidity risk management 58
Economic Growth with Credit and Capital Markets 61

Chapter 6 Universal Banks and the Banking–Capital Markets Boundary 63
Complementarities and Competition in Banking and Capital Markets Business 65
Risk Transformation in Securitization Markets 67
Risk Transfer Contracts 68
Bank Lending to Nonbank Financial Institutions 71
Risk Management in Universal Banks 72

Part Two: A Broader View of Monetary Policy 75

Chapter 7 Analytical Frameworks and Basic Monetary Facts 82
The Equation of Exchange and the Demand for Money 83
The Cambridge equation 84
The equation of exchange in economic theory 84
Divisia Broad Money 86
Constructing Divisia indices 87
Comparing Divisia and simple sum aggregates 88
Sources of Divisia money 92
Divisia money by sectors and strata 93
Evolution of Bank Balance Sheets from 1945 to 2023 97
Broad trends 99
Finer details 101
Bank lending versus capital market finance 103
Three Big Questions 109

Chapter 8 The Regulation of Universal Banks 112
Bank Capital Regulation 114
Defining bank capital 114
Capital adequacy before the Basel era 116
Capital adequacy after the First Basel Accord 117
The 1996 market risk amendment 118
The monetary policy impact of the Basel I era 119
The Problem of the Trading Book 120
Regulatory Capital Under Basel III 122
Bank Liquidity Regulation 123
The Liquidity Coverage Ratio 124
The Net Stable Funding Ratio 127
Summing Up 128

Chapter 9 Monetary Aspects of the Government Budget 129
Stable Government Debt Dynamics and the Monetary Standard 130
Stability conditions 130
Deposit insurance 132
Fiscal Influences on Aggregate Conditions 133
Central bank transactions in government obligations 133
Government-sponsored Enterprises and financial agencies 134
Monetary consequences of GSE guarantees 136
The Federal Home Loan Bank system 137
Crowding-out in capital markets 138
The Disaggregated Budget Arithmetic 139
Some examples of sector-level fiscal influence 140
Sectoral impact of the fiscal impulse from quantitative easing 141
Appendix 9.A Propagation of a Fiscal Impulse 143

Chapter 10 Central Bank Policy 146
Central Bank Policy Implementation Before and After the GFC 147
Interest Rate Policy Transmission and Asset Prices 156
An Unintended Period of Steady Broad Money Growth 158
Prospects for Future Interest Rate Policy 161

Part Three: Rewriting the Rules of Our Financial System 163

Chapter 11 Defining Neutral Monetary Policy 165
Neutral Monetary Policy 165
Efficient Use of Global Savings 169

Chapter 12 Universal Banks in the Monetary System 172
Competition in Commercial Banking 173
Governance 178
Regulation 180

Chapter 13 The Base of Investable and Bankable Projects 181

Chapter 14 Rewriting the Rules 192

Bibliography 213
Endnotes 232
About the Authors
Index