45
is a compromise, in that it exceeds the 100% of GDP reported for 2006 by the Federal
Financial Institutions Examination Council (2007), while it is well below the almost 350%
of GDP reported for safe or information-insensitive financial assets by Gorton et al.
(2012). Federal Financial Institutions Examination Council (2007) includes U.S.
commercial banks, U.S. branches and agencies of foreign banks, thrift institutions, and
credit unions, but it excludes the shadow banking system, while Gorton et al. (2012)
include shadow banks. Similar numbers to Gorton et al. (2012) are provided by Pozsar et
al. (2010), who use the Flow of Funds database to show that, just prior to the onset of the
2007 crisis, total liabilities of the U.S. commercial banking sector equalled around 100% of
GDP, while the size of the shadow banking sector was around 150% of GDP, and despite a
large subsequent contraction it still exceeded the size of the commercial banking sector in
2010. Gorton (2010) emphasizes that a key component of the shadow banking system is
the repo market, but that its size is very hard to estimate reliably due to a lack of
comprehensive data coverage. Nevertheless, available estimates for the most recent period
range between U.S.$ 10 trillion (gross) according to Hördahl and King (2008) and U.S.$
12 trillion according to Gorton (2010). Our reason for including at least a conservative
estimate of the liabilities of the shadow banking system is that these liabilities perform
money-like functions that must not be omitted from a model of the modern U.S. financial
system. This is also emphasized by Gorton et al. (2012), who describe the functions of safe
or information-insensitive financial sector liabilities as follows: “To the extent that debt is
information-insensitive, it can be used efficiently as collateral in financial transactions, a
role in finance that is analogous to the role of money in commerce.” A large share, and
perhaps by now the majority, of financial system debt can therefore command an interest
rate discount below the policy rate by yielding these financial, rather than purely goods
market, transactions services. Because, in terms of our model, the full menu of safe assets
considered by Gorton et al. (2012)
35
, and also by Pozsar et al. (2010), includes items not
always intermediated by the financial system (e.g. treasuries) and items that would
represent double-counting in a model with a single aggregated banking system (e.g.
interbank loans), we adopt the compromise calibration of approximately 185% of GDP.
36
This figure also turns out to be approximately consistent with Flow of Funds information
on the size of borrowing exposures of the U.S. corporate and household sectors. Just
before the onset of the recent crisis, the total amount of credit market debt outstanding
for non-financial businesses reached 80% of GDP, according to the Survey of Consumer
Finance (SCF). Ueda and Brooks (2011) show that around 20%-25% of this was
short-term debt with a maturity of up to one year. We therefore set the steady state
values of short-term or working capital loans
ˇ
ℓ
m
t
equal to 20% of GDP.
37
We allocate the
remaining 60% of GDP to long-term or investment loans
ˇ
ℓ
k
t
. Similarly, just prior to the
crisis the ratio of residential mortgages to GDP reached around 80% of GDP. Our model
does not feature housing investment, but rather a fixed factor referred to as land. A
35
The asset categories included in safe assets by Gorton et al. (2012), who use the Federal Reserve’s Flow of
Funds database, include bank deposits, money market mutual fund shares, commercial paper, federal funds,
repurchase agreements, short-term interbank loans, treasuries, agency debt, municipal bonds, securitized
debt and high-grade financial sector corporate debt.
36
Primarily due to the inclusion of the shadow banking system, this figure is much larger than traditional
measures of the money supply such as M2, MZM or M3 (discontinued in 2006), with even M3 only reaching
around 80 percent of GDP in 2006.
37
Bates et al. (2008) show that, as in our model, nonfinancial firms simultaneously borrow and hold large
amounts of cash, reaching a cash-to-assets ratio of 23.2% in 2006.