Is there a substitution effect between deposits and money market funds?
One school of thought most prominent among economists is that there is a substantial substitution effect between money market funds and deposits. In essence MMFs represent a competing liquidity product. And, that is why the U.S. Federal Reserve includes MMF into the money supply measures M2 and M3. Another school of thought suggests there is no substitution effect between deposits and MMFs. When a depositor withdraws $100 to invest it into a MMF, the manager of the MMF in turn buys $100 in commercial paper. And, the commercial paper issuers deposit the $100 from their commercial paper issuance. In summary, the MMF caused a $100 deposit to move from one depositor to other depositors (CP issuers or investors) without decreasing overall bank deposit balances within the economy. Following this rational, it suggests that both M2 and M3 measures are flawed because counting MMFs within the money supply is a form of double counting since substitution did not occur. What do you believe is corre
