In order to understand how the American economy works, one must broaden the definition of money to include treasuries, commercial paper, repos and mortgage-backed securities. During the financial crisis, mortgage-backed securities were used to collateralize every kind of transaction and eventually, individuals lost faith in them.
By: John Carney
Published: Friday, 24 Feb 2012
Once you start thinking about money as a medium of exchange, it becomes clear that we need to broaden our definition of money if we really want to understand our economy.
The standard government monetary measures, for example, missed out on the monetary functions of mortgage-backed securities. Inside of the financial system, MBSs were used to collateralize every kind of transaction imaginable. They were a form of financial system currency.
David Beckworth points out that this is very important for understanding the financial crisis:
This crisis has taught us that institutional money assets--those assets like treasuries, commercial paper, and repos that facilitate transactions in the financial system--matter too. The bank run on the shadow banking system was a bank run using institutional money assets.
If we really want to understand money and its implications for the economy we need to be thinking about these money assets too.
What happened during the financial crisis can be looked at as a form of hyperinflation. The relevant market participants lost faith in the MBS currency, so its purchasing (collateralizing) power nearly vanished.