Transcript Chapter 1 An Introduction to Money and the

ECON 304
Money and Banking
Instructor:
Bernard Malamud
–Office: BEH 502
Phone (702) 895 –3294
Fax:
895 – 1354
»Email: [email protected]
Website: www.unlv.edu/faculty/bmalamud
Office hours: MW 3-4; TR 4 - 5:30 pm; and by
appointment
Money, Banking, and Financial Markets
• The role of money and monetary policy in the
economy
TRUST
• How financial markets such as bond, stock and
foreign exchange markets work
TRUST
• How financial institutions such as banks and
insurance companies work
TRUST
Course Objectives
• Roles played by banks and other intermediaries
• Determination of asset prices in financial markets
• How financial institutions operate
– Asymmetric information
• Adverse selection/Moral hazard/Principal – Agent Problems
– Innovations
– Regulation
• The conduct and impacts of monetary policy.
– How policies can promote macroeconomic stability
• Understand and explain the roots, responses and
consequences of the subprime-triggered financial
crisis.
Text
• Frederic S. Mishkin, The Economics of Money, Banking and Financial
Markets, 9th edition. Earlier editions work
Supplemental Books and Articles:
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Frank Partnoy. Infectious Greed: How Deceit and Risk Corrupted the Financial Market,
Times Books, 2003.
Gillian Tett, Fool’s Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was
Corrupted by Wall Street Greed and Unleashed a Catastrophe, Free Press, 2009.
David Wessel, In Fed We Trust: Ben Bernanke’s War on the Great Panic, Random House,
2009.
Michael Lewis, The Big Short: Inside the Doomsday Machine. W.W. Norton, 2010
Andrew Ross Sorkin, Too Big to Fail. Viking, 2009
Simon Johnson and James Kwak, 13 Bankers : The Wall Street Takeover and the Next
Financial Meltdown. Random House, 2010
Raghuram G. Rajan, Fault Lines: How Hidden Fractures Still Threaten the World Economy.
Princeton, 2010.
Liaquat Ahamed, Lords of Finance: The Bankers Who Broke the World. Penguin, 2009.
Articles in Journal of Economic Perspectives (JEP) and Federal Reserve System publications
cited in this outline and as added as the semester proceeds. These can be accessed from
the JEP and Federal Reserve Bank websites.
• A security (financial instrument) is a claim on the
issuer’s future income or assets
• A bond is a debt security that promises to make
specified payments over time
– An interest rate is the cost of borrowing or the price
paid for the rental of funds
• Common stock represents a share of ownership
in a corporation
– A share of stock is a claim on the earnings and assets
of the corporation
Interest Rates on Selected Bonds, 1950–2008
Sources: Federal Reserve Bulletin; www.federalreserve.gov/releases/H15/data.htm.
Banking and Financial Institutions
• Financial Intermediaries—institutions that borrow funds
from people who have saved and make loans to other
people and businesses
• Banks—accept deposits and make loans
• Other Financial Institutions—insurance companies,
finance companies, pension funds, mutual funds and
investment banks
• Financial Innovation
– The information age and e-finance
– Derivatives … bubbles and crisis
– Securitization … bubbles and crisis
Money and Business Cycles
• Recessions (unemployment) and booms (inflation) affect all of us
• Monetary Theory ties changes in the money supply to changes in
aggregate economic activity and the price level
Money Growth (M2 Annual Rate) and Interest Rates
(Long-Term U.S. Treasury Bonds), 1950–2008
Sources: Federal Reserve Bulletin, p. A4, Table 1.10; www.federalreserve.gov/releases/h6/hist/h6hist1.txt.
Money and Inflation
• The aggregate price level is an average price of
goods and services in an economy
• A continual rise in the price level (inflation) affects
all economic players
Monetary and Fiscal Policies
• Monetary policy is the management of the money supply
and interest rates
– Conducted by the Federal Reserve Bank (Fed)
• Fiscal policy is government spending and taxation
– Any deficit must be financed by borrowing …
government borrowing affects interest rates
Bernanke’s Focus
• PREVENT DEPRESSION
• Inflation Targeting in tranquil times
– Adjust “real” rate of interest with eye on preannounced target rate of inflation
– Wiggle room for other objectives/emergencies
– Transparency and accountability
• Other Governors:
www.federalreserve.gov/bios
– Oppose Deflation
• Great Depression and clogged credit channel
Core Principles of Money and Banking
• Time has Value  Interest rate
• Risk Requires Compensation
• Financial decisions are based on
Information and TRUST
• Markets set prices and allocate resources
• Stability reduces risk and spurs enterprise
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Uncertainty  Fear  Enterprise
Where to Find the Numbers
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http://research.stlouisfed.org/fred2/
www.federalreserve.gov/releases/
www.economist.com
www.ft.com
www.nytimes.com
www.bea.doc.gov
http://www.gpoaccess.gov/eop/
Function of Financial Markets
• Channel funds from economic players that have
saved surplus funds to those that have a shortage
of funds
• Promotes economic efficiency by producing
an efficient allocation of capital
– increases production
• Improves consumer well-being
– allows them to time purchases better
Structure of Financial Markets
• Debt and Equity Markets
• Primary and Secondary Markets
– Investment Banks underwrite securities in primary markets
– Brokers and dealers work in secondary markets
• Exchanges and Over-the-Counter (OTC) Markets
• Money and Capital Markets
– Money markets deal in short-term debt instruments
– Capital markets deal in longer-term debt and
equity instruments
Principal Money Market Instruments
Principal Capital Market Instruments
Internationalization of Financial Markets
• Foreign Bonds—sold in a foreign country and
denominated in that country’s currency
• Eurobond—bond denominated in a currency other than
that of the country in which it is sold
• Eurocurrencies—foreign currencies deposited in banks
outside the home country
– Eurodollars—U.S. dollars deposited in foreign banks outside
the U.S. or in foreign branches of U.S. banks
• World Stock Markets
Function of Financial Intermediaries: Indirect Finance
• Lower transaction costs
– Economies of scale
– Liquidity services
• Reduce Risk
– Risk Sharing (Asset Transformation)
– Diversification
• Asymmetric Information
– Adverse Selection (before the transaction)—more likely to select
risky borrower
– Moral Hazard (after the transaction)—less likely borrower will
repay loan
Principal Financial Intermediaries and Value of Their Assets
Regulation of the Financial System
• To increase the information available to investors:
– Reduce adverse selection and moral hazard problems
– Reduce insider trading
• To ensure the soundness of financial intermediaries:
– Restrictions on entry
– Disclosure
– Restrictions on Assets and Activities
– Deposit Insurance
– Limits on Competition
– Restrictions on Interest Rates