Financial–real-side interactions in an extended monetary circuit with shadow banking: Loving or dangerous hugs?

Monetary circuit (MC) theory is one of the most interesting attempts to formally describe the functioning of a monetary production economy as centered on the concept of the flux–reflux of money. Endogenous money creation by commercial banks allows the circuit to open and firms to implement production processes. Financial markets “passively” close the circuit by intermediating savings via bond and equity issuance. Despite its natural focus on financial-real side links, the monetary circuit literature has paid relatively little attention to “financialization” and the way it has modified real-financial dynamics. In this article, we analyze whether the flux–reflux perspective of the circuit may be fruitfully applied to the description of the linkages between the real economy and finance in a financialized economy. We propose two interconnected circuits, one for the real economy and one for the financial one. In this context, finance can still ensure a consistent closure of the whole system, thus directly allowing the functioning of the real economy. Newly developed inside-finance interactions, however, may indirectly influence real world dynamics, by easing/ restricting access to credit/financial markets, and give rise to boom-and-bust cycles. Our aim is twofold: modeling modern financial worlds within an MC framework and understanding how financialization could have changed real-financial interactions.