Taking the Money Market Seriously

Pure money ... is nothing else but the most perfect type of security. Bills of short maturity form the next grade, being not quite perfect money, but still very close substitutes for it. ... The rate of interest on these securities is a measure of their imperfection — of their imperfect "moneyness." — John Hicks, 1946

Are the instruments of the money market — the short-term debt instruments we have been calling cash equivalents — really money? The question seems to invite a semantic debate. It obviously depends on how one defines "money." Still, semantic debates can sometimes be useful; they can help to sharpen concepts. This is one of those cases.

Start with the textbook definition of money. That definition can be rehearsed by any student of introductory economics. Money is conventionally defined as the set of assets that can be readily used in transactions. In this regard the medium of exchange function of money is commonly said to be paramount. But cash equivalent instruments, unlike checkable bank deposits, generally do not function as a medium of exchange. Rather, they must be converted into the medium of exchange — by selling them or waiting for them to mature — before they can be used in transactions. In this respect, cash equivalents resemble other (nonmonetary) financial assets like stocks and longer-term bonds.

So, under the textbook definition, cash equivalents are not money. And some experts — perhaps many — favor sticking to this usage. Consider the following observations from a prominent macroeconomist regarding the Federal Reserve's (now discontinued) M3 monetary aggregate, which consisted of several important classes of cash equivalents: "Economists define 'money' as an asset that is used to pay for transactions. ... I have to confess that in a quarter century of teaching and research, I never had any occasion to make use of M3. It always seemed to me that this unambiguously failed the definition of an asset that is used to pay for transactions. If you're going to include such assets in your concept of 'money,' why stop there?"

Along the same lines, another well-known monetary economist recently had this to say about "money market": "I know that finance people and business people frequently use the words 'money market' to mean the market for short term bonds/loans. But when you are talking about models of monetary exchange, it is a really bad idea to use the words 'money market' in that way. What you really mean is 'bond market.'" This same economist has also said that "money market" is "just a weird slang name for the market in short-term bonds." And two other influential economists recently