Following the Global Financial Crisis, some scholars have conceptualized the credit instruments that lay at its center as “shadow money”. As this perspective seems to contradict most established monetary theories, we situate the “shadow money” concept in the history of monetary thought and clarify the underlying assumptions which make it meaningful. First, the shadow money concept stems from a market-based credit theory of money which rejects the notions that money is primarily chosen by the state and that credit is logically subordinate to money. Second, it assumes an inherent hierarchy of monetary systems which gives rise to a spectrum of monetary forms at the edge of which definitions of moneyness get blurry; hence, conceptually ambiguous shadow money forms have existed across multiple historical eras. Third, the shadow money concept transcends the orthodox three-functions-theory of money because it prioritizes the unit of account function over others as the basis to operate payment systems. Finally, we emphasize that a useful empirical benchmark for whether an instrument can be classified as “shadow money” is if it is created via a swap of IOUs, trades at par to hierarchically higher money forms, and is treated as a substitute for hierarchically higher forms of money.
Tobias Pforr, European University Institute