The financialization of modern economies in monetary ... - SSRN papers

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then argue that the macroeconomic consequences of financialization can be better ... Intuitively, financialization may refer to the growing dominance of finance in ...


Marc Pilkington, University of Nice Sophia Antipolis, France

ABSTRACT In this paper, we aim at conceptualizing anew the shadow financial system, with the introduction of an institutional sector composed of all the unregulated non-banking financial institutions (NBFIs) that fall outside the regulatory scope of central banks. This new sector is first defined as a broad accounting category in a macroeconomic stock-flow consistent accounting framework, inspired by the works of Lavoie and Godley. We then argue that the macroeconomic consequences of financialization can be better explained with such an accounting framework that captures how the economic system functions as an organic whole, wherein the shadow financial system is constantly interacting with the traditional sectors of the economy (households, firms, traditional deposit-taking financial institutions and the government sector). I. INTRODUCTION The turmoil observed in financial markets throughout the world since August 2007 has bewildered policymakers, financial analysts, institutional and individual investors alike. The events of the last year have highlighted the sheer interconnectedness of markets throughout the world in an era characterized by financial deregulation, sophisticated innovation, and fast-pace technological change. The financialization of modern economies has now caught all the attention of regulators, due to its far-reaching implications on the real sphere (Fahrer, 2007, p.21). What are the consequences of this complex and multifaceted phenomenon for the traditional institutional sectors of the economic system? The sheer complexity of this question poses a serious challenge to macroeconomists and therefore calls for a renewed reflection on the interactions between the various institutional sectors of the economy, including the modern financial one that has moved away from the functions traditionnally performed by banks. In this paper, I aim at distinguishing between the so-called shadow financial system and the traditional banking sector within a post-Keynesian macroeconomic stock-flow consistent framework, drawing on the seminal works published by Lavoie and Godley (2001-2002, 2004, 2007, L-G from now on). In such a stock-flow consistent (hereafter SFC) accounting framework, all flows come from somewhere and go somewhere, so that there is no black hole in the economy (Godley, 1996, p7). This approach has an advantage over other macroeconomic tools, in so far as it captures the logical constraints that apply to the economy considered as an organic whole (Lavoie & Godley, 2007). In order to conceptualize financialization anew, I equate the shadow financial system to a transnational institutional sector constantly interacting with the traditional sectors of the domestic economy (households, firms, traditional banks, the Government).

II. FINANCIALIZATION IN A FEW QUESTIONS Of course, I do not claim to be exhaustive in this introductory section. I shall very briefly address the definitional aspects, the role of securitization, the rise of US household debt, financial disintermediation, and finally the rise of the shadow financial system. A) What is the meaning of financialization? Intuitively, financialization may refer to the growing dominance of finance in the total of economic activity, financial objectives in the management of corporations and financial assets among total assets. In the recent literature, financialization plays the role of an umbrella term used to describe an emerging, multifaceted and complex reality (Epstein, 2005, p.3) that implies a redefinition of corporate governance priorities in favor of shareholder value maximization, a decreasing share of bank credit in all financing operations, the increasing political and economic influence of the owners of financial assets, the exponential rise of innovative financial products and finally, a general pattern of accumulation in which profit-making occurs increasingly through a

For useful constructive comments and suggestions, I am grateful to the anonymous reviewers and B&ESI Conference Participants in 2008; all errors remain mine.

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financial channels (Krippner, 2004, p.14). Epstein (ibid) has put forward a comprehensive definition of financialization encompassing all the previously mentioned aspects: „financialization means the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies.‟ Financialization has considerably impacted on the distribution of power between States, monetary institutions, corporate banks and other giant private operators acting as powerful insitutional investors (Dombrowski, 1998, p.1). As a consequence, the latter hybrid and complex institutions have arguably become the major players in modern financial markets. B)

What is the role of securitization?

Securitization is the process of creating a new financial instrument by combining other financial assets, and then marketing them to investors; it has gone hand in hand with credit risk extraction from banks‟ balance sheets, and its subsequent transfer towards the financial portfolios of investors seeking high returns on potentially risky securities. In 2007, an estimated $4.01 trillion of securitized assets were issued in the USA (Securities Industry and Financial Markets Association, 2008, p.1). A fundamental characteristic of securitization is to enable the allocation of credit risk between traditional banks and non-banking financial institutions (Knight, 2007). In fact, securitization is not such a recent phenomenon; since the 1970s banks had been pooling individual mortgage loans, using the cash flow provided by these loans to generate residential mortgage-backed securities (Ashcraft & Schuermann, 2008). These securitized loans were themselves repackaged in the form of CMOs (“Collateralized Mortgage Obligations”) that were comprised of tranches that is, groupings of income streams from mortgages, divided so as to pay off the principal of each tranche‟s debt in sequence. In the 1990s, and especially at the end of the decade, banks began to construct CDOs (“Collateralized Debt Obligations”), which mixed together various risk-profiles (low, medium and high) with subprime mortgages, along with other types of debt instruments (see Graph 1). Despite the unprecedented bailout of ailing financial institutions recently decided by the U.S government, policy makers and analysts still fear that the meltdown in the housing market could precipitate both a sharp economic downturn and further financial turmoil (IMF, 2008). Interest rates are thus a key issue to determine the macroeconomic impact of falling home values and rising consumer debt service ratios, possibly leading to a larger number of personal bankruptcies. Moreover, U.S. consumption remains a powerful determinant of the health of the world economy, and its potential decline raises the spectrum of an amplification of this global crisis. Unfunded 175


150 125 100 75 50

Oct 2006


Nov 2007

Source: Federal Reserve, Independent Strategy Graph 1

Global Issuance of Collateralised Debt Obligations (October 2006 – November 2007)

Securitization now entails substantial monetary flows in the financial system. For instance, the US subprime market alone was extremely active in 2006 with 650 securitization deals worth $539 billion (Tett & Davies, 2007). Moreover, securitized mortgages now account for roughly 70 to 75 percent of outstanding, first-lien U.S. residential mortgages (Crédit Suisse, 2007).

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C) Did US household debt get out of control along the way? Until the outbreak of the subprime crisis in the summer 2007, the housing bubble sustained by unprecedented levels of household debt (see Table 1 and Graph 2) had been crucial to ensure the prosperity of U.S. households, in spite of the two major macroeconomic shocks caused by the dotcom crisis and the 9/11 terrorist attacks. The outstanding amount of household financial liabilities increased from 89% of personal disposable income in 1993 to 139% in 2006 (OECD, 2007). As the boom turned into a self-feeding bubble, from late 2004 to early 2006, banks accelerated innovation to target subprime borrowers although the application of sound creditworthiness criteria should have excluded them from the market under normal conditions. Of course, at the root of the crisis were the so-called subprime mortgages, granted precisely to households with unfavorable credit histories. In 2006, those risky mortgages accounted for nearly 40% of all new mortgages (Tilton, 2007). Year

1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Table 1


Home Mortgage

Consumer Credit




Graph 2 Evolution of US Household debt per capita (1957-2007)

360.4 231.9 103.4 Data: Federal Reserve 380.7 245.1 108.6 412.3 262.2 119.3 444.6 280.5 129.2 $45,000 460.2 289.0 133.7 503.0 313.0 149.2 555.4 343.5 168.8 $40,000 624.9 383.3 193.0 680.3 419.3 201.9 734.3 459.0 207.0 818.9 517.0 229.0 $35,000 946.7 603.0 264.9 1,105. 4 708.6 311.3 1,276.1 826.7 354.6 1,396.0 926.5 358.0 $30,000 1,507.2 998.2 377.9 1,576.4 1,031.1 396.7 1,732.0 1,116.2 444.9 1,943.3 1,242.8 526.6 2,276.5 1,448.3 610.6 $25,000 2,535.6 1,647.0 666.4 2,753.8 1,826.6 698.6 3,042.2 2,052.8 745.2 3,335.5 2,276.0 809.3 $20,000 3,595.9 2,503.7 824.4 3,784.1 2,681.4 815.6 3,983.1 2,852.7 824.8 4,221.1 3,011.9 886.2 $15,000 4,541.2 3,178.9 1,021.0 4,862.9 3,332.7 1,168.4 5,190.4 3,538.2 1,273.8 5,493.5 3,754.3 1,344.9 $10,000 5,919.9 4,055.9 1,442.1 6,416.8 4,432.9 1,556.6 7,008.3 4,810.5 1,748.6 $5000 7,659.4 5,296.4 1,899.6 8,470.7 5,978.6 2,012.2 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 9,463.4 6,837.3 2,116.1 10,580.5 7,824.5 2,231.6 11,795.5 8,876.3 2,326.0 12,817.2 9,704.7 2,430.8 Evolution of US household debt (1966-2006) / Source: Federal Reserve

D) What do we mean by financial disintermediation? Today, traditional bank loans account for a smaller share of all financing operations in the world economy. Hence, firms and households now often invest in securities instead of saving their income in the form of liquid bank deposits, while borrowers fund themselves directly on capital markets. Financial disintermediation entails the transfer of credit risk from commercial banks to NBFIs: „[b]anks have designed ingenious but dangerous ways of shifting trillions of dollars of credit risk off their balance sheets and into the hands of unsophisticated foreign investors, hedge and pension fund managers who gorged on high-yield debt instruments they didn't understand and financial engineers who built towers of "securitized" debt with math models that were fundamentally flawed (Markman, 2007)‟. Paradoxically, financial disintermediation has not undermined the extent of securities investments by commercial banks that continue to be involved in risky asset-management activities (Knight, 2007); the distinction between traditional banks and NBFIs is therefore increasingly blurred: „there has been an important trend for dissolution of functional boundaries, particularly between banking and securities activities. This has led to the creation of increasingly complex institutions, which integrate both types of activities (Griffith Jones, 1998, p.23)‟. E) What is the shadow financial system? Institutional checks and balances carried out by a wide range of regulators, assessors, credit rating agencies, intra-firm auditors, and institutional shareholders were not sufficient to prevent the outbreak of the subprime crisis. What happened then that was beyond the regulatory and analytical scope of all those financial actors? Economists and practitioneers alike have recently endorsed the idea of a powerful transnational shadow financial system, with a huge potential destabilizing impact on the domestic and the international economy. It is well known that regulated banks in the United States fund themselves with insured deposits, backstopped by access to the discount window of the Fed acting as a lender of last resort. Contrariwise, so-called shadow financial institutions are far less regulated and fund themselves with the help of uninsured commercial paper. The shadow financial system is largely formed by NBFIs with short-term liquid liabilities and long-term illiquid assets, subject to higher levels of liquidity risk. Of course, in conditions of market illiquidity, the inability to meet shortterm obligations can lead to bankruptcy. Therefore, the shadow financial system is vulnerable to massive runs such as the one that occured in August 2007 with a near $200 billion drop in asset-backed commercial paper within a few weeks (see Graph 3). Run on the Shadow Financial System during the Subprime Crisis US$Billion 1250 1200 1150 1100 1050 1000 950 900 850 800 11/ 06 12/06 1/07 2/07 3/07 4/07 5/07 6/07 7/07 8/07 9/07

Source: Federal Reserve Graph 3 US Asset-backed Commercial Paper Outstanding (November 2006 – September 2007)

Following the outbreak of the subprime crisis, The Financial Times also devoted its attention to the shadow banking system: „[a] plethora of opaque institutions and vehicles have sprung up in American and European markets this decade, and they have come to play an important role in providing credit across the financial system. Until the summer, structured investment vehicles (SIVs) and collateralised debt obligations (CDOs) attracted little attention outside specialist financial circles. Though often affiliated to major banks, they were not always fully recognised on balance sheets (Tett & Davies, FT, December 16 2007)‟. Moreover, until the advent of the subprime crisis, these NBFIs that form the bedrock of the shadow financial system had no access to emergency liquidity facilities provided by the central bank in times of crisis: „[t]hese institutions, moreover, have never been part of the “official” banking system: they are unable, for example, to participate in Monday‟s Fed auction (ibid)‟. However, the severity of the subprime crisis prompted the Fed to extend its lender of last resort support. In the aftermath of the major liquidity crisis in August 2007, the Fed accepted to lend enormous amounts of short-term liquidities to these highly leveraged NBFIs outside its regulatory scope thereby exacerbating moral hazard distortions in the credit market. For Paul Mc Culley (2007, Internet), who arguably coined the term, the shadow financial system denotes „the whole alphabet soup of levered up non-bank investment conduits, vehicles, and structures‟. By and large, the shadow financial system has now gained centre stage in the world economy, as it interacts with the other macroeconomic institutional sectors in a manner that arguably needs to be conceptualized anew in modern macroeconomics. This brief overview of some of the issues raised by financialization is far from complete. Nonetheless, I have tried to cast light on a few selected issues that I deemed relevant such as securitization, rising household debt, financial disintermediation, and the rise of the shadow financial system. I pursue hereafter my conceptual attempt to integrate this global evolution in a macroeconomic framework by pointing out the existence of a complex nexus of accounting operations, linking the main institutional sectors of the economic system. III. A NEW MACROECONOMIC STOCK-FLOW CONSISTENT ACCOUNTING FRAMEWORK A) Banks, firms and households as a macroeconomic nexus of accounting operations One way to analyze the function of banks is to look at the fundamental accounting principles involved in banking activity. From a historical perspective, one salient characteristic has always been the prevalent role of double-entry bookkeeping: „debts and credits are perpetually trying to get in touch with one another, and it is the business of the banker to bring them together (...). There is thus a constant circulation of debts and credits through the medium of the banker who brings them together and clears them as the debts fall due. This is the whole business of banking as it was three thousand years before Christ, and as it is today (Innes, 1913, pp.402403)‟. The importance of double-entry bookkeeping as a primary accounting principle should not be underestimated. Without such an accounting rule, the great wheel of circulation outlined by Adam Smith (1776) would remain motionless, and would not give rise to the effective circulation of goods, services and debts within the economic system. Lavoie (1984, p.774) has thoroughly analyzed the role of double-entry bookkeeping in the process of income formation: „[t]hese flows of credit then reappear as deposits on the liability side of the balance sheet of banks when firms use these loans to remunerate their factors of production‟. Double-entry bookkeeping relations define a nexus of accounting operations linking banks, firms and households on a macroeconomic scale (Cencini, 1997, pp. 273-4.), which is logically independent of microeconomic theory (Cencini, 2003). A misconception of banking activity is precisely to assume that banks are independent of firms in the shaping of macroeconomic magnitudes. Lavoie (1984, p.774) has argued that „[a]ny production in a modern or in an “entrepreneur” economy is of a monetary nature‟. If a bank generates flows of credit by granting loans to firms and households, the resulting outcomes will appear in the balance sheets of the other institutional sectors belonging to the real sphere of the economy: „[t]he additional debts of banks are issued and used to accept and pay for additional offer contracts of producers and workers‟ (Davidson 1988, p.164). In The Meaning of Money, Withers (1909) reversed the direction of causation between deposits and loans as stated in previous banking theory. According to Withers, it is bank loans that make deposits. Furthermore, the bank deposits created as a result of bank loans „must be held somewhere in the economy, willingly or unwillingly, and the increased holdings count as saving, voluntary or involuntary‟ (Chick, 1986, pp 13-14, emphasis added). Interestingly, this logical observation seems to discard the idea of an unidentifiable leakage of financial funds in the process of financial disintermediation. As Keynes (1930, p.243) had foreseen in the Treatise on Money when he distinguished between financial and industrial circulation, the monetary flows between the financial and the industrial sectors might result in a „speculative boom‟ wherein the financial sector ends up „stealing resources from the industrial sector (ibid., p254)‟. Prior to the overwhelming emergence of current financialization trends, Post-Keynesians had argued that commercial banks were the main actors in the process of financial

intermediation, wherein deficit-spending units are able to borrow from saving units the resources they need to finance their net flow of expenditures (Ball 1964, p.168). As Moore (1988, p.373) argued, „banks, after all, are essentially in the business of selling credit‟. However, in the light of the recent events that have shaken the financial world, we argue that equating the financial sector to the mere traditional banking sector entails a major analytical omission that can be source of confusion, when describing the interactions between the real and the financial sphere. The exponential role of NBFIs cannot be overlooked in the process of financialization. Therefore, the complex nexus of macroeconomic operations involving firms, households and banks should also include the shadow financial system that comprise some of today‟s largest world financial conglomerates. B)

Stock-flow consistent frameworks

We now consider the macroeconomic interaction of institutional sectors (Silva, Dos Santos, 2008). In order to study the impact of financialization in a stock-flow accounting framework that does not leave financial phenomena in the dark (Denizet, 1969), and ensures there is no black hole (Godley, 1996, p7) in the economy, we adopt hereafter the stock-flow consistent (SFC) approach that bases „[its] models on detailed accounting frameworks that consistently integrate financial flows of funds with a full set of balance sheets (Zezza & Dos Santos, 2004, p.184)‟. We therefore draw on the seminal work published by Lavoie and Godley (2001-2002), who have presented a fully consistent stock-flow consistent accounting framework describing how „an industrial capitalist economy works as an organic whole (Lavoie & Godley, 2007)‟. The accounting framework presented here pursues the same objective; it must nevertheless be distinguished from a standard theoretical model. The latter necessarily includes behavioral hypotheses about the variables stated in the former. A clear specification of the target country/region under scrutiny, as well as a relevant sample period, is needed in order to assess the influence of the variables in the model on economic outcomes. However, these specifications are not needed at this stage as we are primarily concerned with the preliminary design of a holistic macro-accounting framework. Moreover, the systematic and uncritical use of behavioral hypotheses in economic models is sometimes even criticized by SFC economists. Hence, as Godley and Cripps (1983, p.44) suggest, „[w]e do not ask the reader to believe the way economies work can be discovered by deductive reasoning. We take the contrary view. The evolution of whole economies, like their political systems, is a highly contingent historical process. We do not believe that it is possible to establish precise behavioral relationships comparable with the natural laws of physical sciences by techniques of statistical inference. Few laws of economics will hold good across decades or between countries. On the other hand, we must exploit logic so far as we possibly can. Every purchase implies a sale, every money flow comes from somewhere and goes somewhere; only certain configurations of transactions are mutually compatible. The aim here is to show how logic can help to organize information in a way that enables us to learn as much from it as possible. This is what we mean by macroeconomic theory […]‟. SFC models have in common the following features: 1) Economic agents are defined by the characteristics and net worth of their stocks of wealth. 2) Balance sheets are constantly influenced by economic transactions that generate money flows between agents and institutional sectors. 3) There are extensive chains of interrelations between agents‟ assets and liabilities. 4) Variations in the value of stocks that come from capital gains/ losses impact on agents‟ future decisions, and therefore for the dynamics of the system. 5) SFC models do not assume a pure market-clearing mechanism as the accumulation of assets and liabilities when the economy grows - is far from balanced. Agents‟ and sectors‟ portfolios tend to evolve in asymmetric ways, with varying degrees of leverage, risk, and liquidity. Fundamentally, the portfolio choices of the agents are crucial determinants of the equilibrium in each period (Dos Santos, 2007, p.5) so the linking of short periods must stress their balance sheet implications. In fact, SFC models aim to model balance sheet dynamics rigorously so as to capture the dynamic trajectories generated by the individual institutional sectors without neglecting the interrelations between these sectors. The goal of SFC models is the definition of the relevant economic agents (or social categories/institutional sectors), and all their respective (and interdependent) assets and liabilities as well as the condition of their reproduction over time (Graziani, 2003, p.19).

C) The shadow financial system defined as a new institutional sector Surprisingly, there is no non-bank financial institution sector in existing SFC models. This striking difference with previously published works in post-Keynesian literature is the main justification for the present article. In fact, the term NBFI is relatively recent and first appeared in 1992 in the USA with „The AnnunzioWylie Anti-Money Laundering Act‟, which expanded the regulatory definition of financial institutions beyond the scope of traditional deposit-taking institutions (Gup, 1995). We introduce hereafter a new institutional sector, in order to address these shortcomings. The shadow financial system is viewed in our analysis as a conceptual entity, defined as a transnational macroeconomic sector constantly interacting with the other domestic macroeconomic sectors (households, banks, firms and the government sector) in an SFC framework. The shadow financial system consists of conduits, SIVs, investment banks/broker dealers, money market funds, hedge funds and other NBFIs (regardless of their nationality) such as insurance and finance companies, securitization firms, mutual funds, private pension funds and public sovereign funds. In fact, the distinction between traditional banks and the shadow financial sector is increasingly complex. All these institutions are highly leveraged; their liabilities are quite liquid as they tend to borrow short, but their assets are illiquid as they invest and/or lend long. The shadow financial system is subject to the same risk as banks (credit, market, rollover, operational or liquidity risk). However, the main difference is that the shadow financial system does not have access to emergency liquidity provided through the lender of last resort function; shadow financial institutions therefore fall outside the regulatory scope of central banks. We therefore argue that the latter regulatory criterion is the decisive factor that should enable us to distinguish between the traditional banks and the shadow financial system. In the following tables, I present my renewed SFC accounting framework that includes the shadow financial system (SFS). 

Table 2

Aggregate balance sheet of the macroeconomic sectors Households

1) Bank deposits 2) Bank loans

Banks -D


- Lfb



+D - Lhb





3) SFS loans







4) SFS securities





- Ssfs








5) Gov’t bills 6) Capital goods 7) Equities

+Pk +pe.Eh

- pe.E

+Pk +pe.Eb




Notes: 1) pe stands for the unit price of equity 2) Positive figures denote assets, while negative ones denote liabilities 3) All sectors buy equities, government bills and the securities of the shadow financial system. 4) Banks grant loans to firms and households but we assume that only the latter save a significant share of their income in the form of bank deposits. 5) Pk is the net creation of capital goods produced by firms over one period. 6) I amalgamate the Treasury and the Central Bank for present purposes. Table 2 is organized so that we get a clear picture of the structure of the balance sheet of the various macroeconomic institutional sectors of the economy. Table 1 presents the aggregate stocks of wealth and debt of each of these macroeconomic sectors that are explicitly identified with their interdependent assets and liabilities.

Table 3

The current transactions matrix Households

Firms (current)



Consumption Gov’t expenditure

Firms (capital)



∑ 0



+ p.∆K

Investment in fixed capital



- p.∆K








- Tb

Interests on bank loans


-iLf (t-1)


Interests on SFS securities







Interests on SFS loans





+ iSt-1


Interests on gov’t bills







Interests on bank deposits






- Fd





0 0


+Fd +Fb+ Fsfs








Note: Positive figures denote sources of funds, while negative ones denote uses of funds The current flows are described in Table 3. All sectors receive interest on securities and government bills, and they pay interest on their lagged stock of loans. All sectors pay taxes to the government. Only households receive interest on bank deposits, income in the form of wages, distributed profits of banks, firms and shadow financial institutions, and use it to consume goods and services, pay taxes and interest on their loans and buy securities. The government, in turn, receives money from taxes and uses it to buy goods from firms and pay interest on its lagged stock of debt, while firms use sales receipts to pay wages, taxes, interest on their lagged stock of loans, and dividends, retaining the rest to finance investment. Finally, banks receive interests on loans granted to firms and households that they use to pay interest on households‟ deposits, taxes and dividends. As in previous LG models, every monetary flow has to „come from somewhere and go somewhere’ (Godley, 1999), and this is why all row and column totals are zero. 

Table 4

Flows of Fund Households

∆ Bank deposits








0 0

∆ Bank loans




∆ SFS loans







∆SFS securities



















∆ Gov’t bills ∆ Equities

Table 4 depicts the dynamic nature of the model with the flows of fund for each institutional sector. It satisfies the condition that each unit of money spent by one sector necessarily originates somewhere and goes somewhere, which ensures that there is no black hole in the economic system (Godley, 1996, p7). This approach is in fact an extended version of the Lavoie and Godley (2001-2002) framework but it is not yet a fully operational model. Therefore, the next challenge will be to add some carefully examined behavioral hypotheses that translate into a dynamic system of equations calibrated to real-world data, with a set of relevant exogenous variables, in order to account for complex macroeconomic phenomena such as the changes in the reserve ratio and the capital requirements of lending institutions, the variations in firms‟ inventories and stocks of capital goods, households‟ target of wealth relative to income, the reactions to fiscal shocks and interest-rate policy decisions, firms‟ expectations of sales, and households‟ expectations of inflation (Godley, 2004). IV. CONCLUSION In the light of the exponential rise of transnational financial institutions that are often outside the regulatory scope of central banks, I have attempted to conceptualize a new macroeconomic sector, namely the shadow financial system that was integrated into a stock-flow consistent framework. The SFC methodology is a powerful macroeconomic approach based on accounting principles that enables analysts to clarify the macroeconomic functioning of the economic system, viewed as an organic whole whose components are constantly interacting. I believe that such a macro-accounting framework will help us understand the way unregulated shadow financial institutions interact with traditional banks and other categories of economic agents (households, non-financial corporations, the central bank and the Government sector). Further theoretical developments on the shadow financial system, and its integration into a macro-accounting framework will need to overcome the immense conceptual difficulty posed by its postulated transnational nature, which will require the disaggregation of data on NBFIs that shall be retrieved from national accounts and subsequently excluded from our revisited definition of the domestic banking sector, before being re-aggregated within our newly defined transnational shadow financial sector. Other challenges probably await the developers of SFC frameworks, such as a more adequate treatment of the behavior of economic agents, and the specification of the relevant sample periods and countries/regions under study. However, such a macro-accounting framework is a promising starting point, and will undoubtedly constitute a major step towards the clarification of the increasingly complex web of macroeconomic interactions within our financialized economies. APPENDIX According to Dos Santos (2007, p. 5), „the size and the desired composition of the balance sheets of the various institutional sectors [...] determine (short period) equilibrium asset prices which, in turn, crucially affect real [macroeconomic] variables‟. Drawing on this idea, we consider the simplified balance sheet of households, firms and traditional deposit-taking banks hereafter. We omit the other institutional sectors for present purposes. Table 5 Balance sheet of households ASSETS Securities owned by households purchased from firms (ex: equities, corporate bonds...) Securities owned by households purchased from banks (deposit certificates) Securities owned by households purchased from the Shadow Financial System (ex: share in mutual funds) Cash reserves supplied by the Shadow Financial System (ex: contractual payments made by NBFIs) Funds lent by the Shadow Financial System (ex: loans granted by NBFIs) Securities owned by households purchased from the government (ex: treasury bonds) Bank deposits owned by households (if positive) Real assets owned by households LIABILITIES Outstanding debt (bank loans and loans granted by the Shadow Financial System)

Table 6 Balance sheet of firms

ASSETS Securities owned by firms purchased from other firms (equities, corporate bonds...) Securities owned by firms purchased from the Shadow Financial System (ex: mortgage-backed securities) Cash reserves supplied by the Shadow Financial System (contractual payments made by NBFIs) Funds lent by the Shadow Financial System (ex: venture capital funds) Securities owned by firms purchased to banks (ex: certificate of deposits) Securities owned by households purchased from the government (ex: treasury bonds) Bank deposits owned by firms (if positive) Cash reserves as a result of internal liquidity management and retained profits Real assets owned by firms LIABILITIES Own equity funds and capital reserves Outstanding debt (bank loans, Shadow Financial System loans, inter-firm liability and tax liability)

Table 7 Balance sheet of traditional deposit-taking banks


Securities owned by banks purchased from other banks (ex: certificates of deposit) Securities owned by banks purchased from firms (equities, corporate bonds...) Securities owned by banks purchased from the Shadow Financial System (ex: mortgage-backed securities) Financial services purchased from the Shadow Financial System (ex: credit risk transfer instruments) Cash reserves supplied by the Shadow Financial System (ex: contractual payments made by NBFIs) Funds lent by the Shadow Financial System (ex: loans granted by NBFIs) Securities owned by banks purchased from other banks Securities owned by banks purchased from the government (ex: treasury bonds) Loans granted to firms, households and other banks Cash reserves as a result of internal liquidity management and retained profits Real assets owned by banks LIABILITIES

Own equity funds and capital reserves Outstanding debt (deposits, interbank liability and tax liability)

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