"Thus we would expect a downturn caused by a shortage of liquid cash money to be accompanied by very high interest rates on, say, government bonds--which share the safety characteristics of money and serve also as savings vehicles to carry purchasing power forward into the future, but which are not liquid cash media of exchange."
The problem is that government bonds serve both as savings vehicles and as medium of exchange. As Gary Gorton said, "it seems that U.S. Treasuries are extensively rehypothecated and should be viewed as money". You purchase groceries with cash, and you purchase other financial assets with U.S. Treasuries, but in both cases we are dealing with media of exchange.
It is very hard to disentangle these two facets of U.S Treasuries, but we have a great natural experiment. After the collapse of Lehman, TIPS were a perfectly safe savings vehicle, but they were much less liquid than cash or other Treasuries. Lehman has mainly used TIPS as repo collateral, and after liquidation the pattern has shifted, the marginal holder of TIPS was more likely to use it as savings vehicle rather than for transactional purposes. The result was what FT Alphaville has called "The largest arbitrage ever documented", as the price of TIPS fell by as much as 20 cents on the dollar as compared to much more liquid Treasuries. This gives us a clear indication that post-Lehman panic was a flight to liquidity, and not a flight to safety. This means the best policy response was the expansion of the quantity of liquid, rather than safe assets. After March 2009 QE announcement, the Fed has greatly enhanced liquidity properties of TIPS.
While the root cause of the crisis might have changed since the Lehman panic, the low prices of Treasury securities give us no indication what it is. We might have the lack of safe assets, or we might have the lack of liquid assets. Policy responses that expand both are to be preferred at this point. One good option is credit easing - expansion of central bank lending collateralized by a diversified mix of medium quality private sector assets. Replacing 3-month T-Bills with reserves achieves nothing, as 3-month T-Bills have greater utility as medium of exchange than reserves, we know this because 3-month bills often yield less than the effective fund rate.
When the Minsky moment arrived in September 2008, we had a flight to liquidity that was not fully accommodated by the Fed. Investors who thought that we had a flight to safety underperformed after Lehman as they purchased safe but less liquid assets such as TIPS, off-the-run Treasuries and gold mining stocks.