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Economics of Money and Banking
Outline of Lecture 1: Why Study Money, Banking,
and Financial Markets?
This lecture is an introduction to the subject of money and banking.
Its goal is to highlight the important roles money, banks, and financial
markets play in the economy.
Following the lecture, you should have a good understanding of
a. What is money and why it is important?
b. What is a bank and why is it important?
c. What is a financial market and why is it important?
a. Money and its importance
· Definition
· Money and Business Cycles
· Money and Inflation
· Money and Interest rates
· Conduct of Monetary Policy
· Budget Deficits and Monetary Policy
b. Banks and their importance
· Financial Intermediation
· Banking and the Money Supply
· Financial Innovation
c. Financial markets and their importance
· Bond Market
· Stock Market
· Foreign Exchange market
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Economics of Money and Banking
Outline of Lecture 2: An Overview of the
Financial System
This lecture explains our financial system, its components, its importance,
and why it is so heavily regulated.
a. What is a financial system and what roles it plays in the economy
· Collection of financial markets and financial intermediaries
· Transfer of funds from savers (lenders) to investors (borrowers)
· Provision of information
· Opportunity for risk-sharing (portfolio diversification)
b. Types of Financial Markets
· Debt and Equity Markets
· Primary and Secondary Markets
· Organized-Exchanges and Over-the Counter Markets
· Money and Capital Markets
c. Instruments of Financial Markets
· Money Market Instruments
· Capital Market Instruments
d. Functions of Financial Intermediaries
· Reduce Transactions Costs
· Reduce Asymmetric Information problems
- Adverse Selection and Moral Hazard
e. Types of Financial Intermediaries
· Depository Institutions
· Contractual Savings Institutions
· Investment Intermediaries
f. Why is the Financial System so heavily regulated?
· Increasing Information Available to Investors
· Ensuring the Soundness of Financial Intermediaries
· Improving Control of Monetary Policy
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Economics of Money and Banking
Outline of Lecture 3: What is money?
This lecture explains what money is, how it differs from other assets,
its functions, its historical development, and its measurement.
a. What is Money?
· Meaning of Money
· Functions of Money
- Medium of Exchange
- Unit of Account
- Store of Value
b. Evolution of the Payment System
· Commodity money
· Fiat money
· Paper money and checks
· Electronic Means of Payment (EMOP): CHIPS, SWIFT, ACH
· Electronic Money: Debit Cards, Stored-Value Cards, Electronic
Cash, Electronic Checks
c. Measuring Money
· The Federal Reserve's Monetary Aggregates
· Reliability of monetary aggregates: data revision
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Economics of Money and Banking
Outline of Lecture 4: Understanding Interest
Rates
This lecture explains the computation of interest rates for alternative
IOUs, and shows the difference between the interest rate and rate of return.
Measuring Interest Rates
Types of IOUs
Present Value
Yield to Maturity
Other Measures of Interest Rates
Current Yield
Yield on Discount Basis
The Distinction between Interest Rates and Returns
Maturity and Volatility of Bond Returns: Interest Rate Risk
The Distinction between Real and Nominal Interest Rates
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Economics of Money and Banking
Chapter 5: The Behavior of Interest Rates
Determinants of the Demand for an Asset
Wealth
Expected Returns
Risk
Liquidity
Loanable Funds Framework: Supply and Demand in the Bond Market
Demand Curve
Supply Curve
Market Equilibrium
Supply and Demand Analysis
Changes in Equilibrium Interest Rates
Shifts in Demand for Bonds
Shifts in the Supply of Bonds
Changes in the Equilibrium Interest Rate
Liquidity Preference Framework: Supply and Demand in the Market for
Money
Changes in Equilibrium Interest Rates
Shifts in the Demand for Money
Shifts in the Supply of Money
Changes in the Equilibrium Interest Rate
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Economics of Money and Banking
Outline of Lecture 6: The Risk and Term Structure
of Interest Rates
This lecture shows that the interest rate on IOUs can vary due to differences
in risk structure or in term structure. It also shows the effect of risk
and maturity on interest rates.
Risk Structure of Interest Rates
Default Risk
Application: The Stock Market Crash of 1987 and the Junk Bond-Treasury
Spread
Application: What If Treasury Securities Were No Longer Default Free?
Liquidity
Income Tax Considerations
Summary
Application: Effects of the Clinton Tax Increases on Bond Interest Rates
Term Structure of Interest Rates
Following the Financial News: Yield Curves
Expectations Theory
Segmented Markets Theory
Liquidity Premium Theory
Evidence on the Term Structure
Summary
Application: Interpreting Yield Curves, 1980-2000
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Economics of Money and Banking
Outline of Lecture 7: The Foreign Exchange
market
This lecture explains what an exchange rate is, and what factors influence
its value in both long-run and short-run.
Foreign Exchange market
What are Foreign Exchange Rates?
Why are Exchange Rates Important?
How is Foreign Exchange Traded?
Exchange Rates in the Long-Run
Low of One Price
Theory of Purchasing Power Parity
Weaknesses of the Purchasing Power Parity Theory
Other Factors that Affect Exchange Rates in the Long-Run
Exchange Rates in the short-Run
Interest parity condition
Market for foreign exchange
Factors that affect the demand and supply
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Economics of Money and Banking
Outline of Lecture 8: An Economic Analysis
of Financial Structure
This lecture outlines eight facts regarding the structure of our financial
system. Then it explains the facts in terms of transactions costs and
information costs prevalent in the financial system.
Basic Puzzles About Financial Structure
Transactions Costs and their Roles
How Transactions Costs Influence Financial Structure
How Financial Intermediaries Reduce Transactions Costs
Asymmetric Information: Adverse Selection and Moral Hazard
Effect of Adverse Selection on Financial Structure
The Lemons Problem in the Stock and Bond Markets
Solutions to the Adverse Selection Problems
Effect of Moral Hazard on the Choice of Debt vs. Equity Contracts
Moral Hazard in Equity Contracts: The Principal-Agent Problem
Solutions to Principal-Agent Problem
Effect of Moral Hazard on Financial Structure in Debt Market
Solutions to Moral Hazard in Debt Contracts
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Economics of Money and Banking
Outline of Lecture 9: The Banking Firm and the
Management of Financial Institutions
This lecture provides an overview of the principles of bank management,
including management of assets, liabilities, liquidity, default risk,
and market risk.
The Bank Balance Sheet
Liabilities
Assets
Basic Operation of Bank
General Principles of Bank Management
Liquidity Management and the Role of Reserves
Asset Management
Managing Capital Adequacy
Managing Bank Capital
Managing Credit Risk
Screening and Monitoring
Long-Term Customer Relationships
Loan Commitments
Collateral And Compensating Balances
Credit rationing
Managing Interest-Rate Risk
Gap and Duration Analysis
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Economics of Money and Banking
Outline of Lecture 10: Banking Industry: Structure
and Competition
Historical Development of the Banking System
Multiple Regulatory Agencies
Structure of the Commercial Banking Industry
Restrictions on Branching
Response to Branching Restrictions
Bank Consolidation and Nationwide Banking
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
What Will the Structure of the U.S. Banking Industry Look Like in the
Future?
Are Bank Consolidation and Nationwide Banking a Good Thing?
Separation of Banking and Other Financial Service Industries
Erosion of Glass-Steagall
The Gramm-Leach-Bliley, Financial Services Modernization Act of 1999:
Repeal of Glass-Steagall
Box 2: The Citicorp-Travelers Merger
Implications for Financial Consolidation
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PART IV. THE MONEY SUPPLY PROCESS
Economics of Money and Banking
Outline of Lecture 14: Structure of the
Central Banks and the Federal Reserve System
This lecture provides an overview of the origin, structure, and nature
of our central bank.
Origins of the Federal Reserve System
Formal Structure of the Federal Reserve System
How Independent Is the FED?
Explaining Central bank Behavior
Should the FED be Independent?
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Economics of Money and Banking
Outline of Lecture 15: Multiple Deposit
Creation and Money Supply Process
The lecture explains the process of deposit creation and the role of
private and central banks in that process.
Four Players in the Money Supply Process
The FED's Balance Sheet and the Monetary Base
Control of the Monetary Base
Multiple Deposit Creation: a simple model
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Economics of Money and Banking
Outline of Lecture 16: Determinants of the Money
Supply
This lecture develops the money supply model and explains its components
(the base and the multiplier) and the factors that influence each.
The Money Supply Model and the Money Multiplier
Factors that Determine the Money Multiplier
Behavior of Currency Ratio (k=C/DD)
Effect of a Change in Wealth
Effect of a Change in Expected Return
Explaining Bank Behavior
Determinants of Excess Reserves (e=ER/DD)
Determinants of Discount Loan Borrowing
The Complete Money Supply Model
Determinants of Money Supply
Interplay of Determinants
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Economics of Money and Banking
Chapter 17: Tools of Monetary Policy
This lecture explains the tools that the central bank uses in conducting
monetary policy. It also explains the advantages and disadvantages of
each tool. In particular, it shows how using the tools, the Fed is able
to change the federal funds rate.
Open Market Operations
Advantages of OMO
Discount Policy
Operation of the Discount Window
Lender of Last Resort
Advantages and disadvantages of Discount Loan Policy
Reserve Requirement Policy
Advantages and Disadvantages
The Market for reserve and the federal funds rate
The Market for reserve and the federal funds rate
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Outline of Lecture 18:
Conduct of Monetary Policy: Goals and Targets
This lecture summarizes the goals of monetary policy, and explains how
the Fed tries to achieve the goals using its policy instruments. It also
provides a historical overview of the Fed's policy procedures.
Goals of Monetary Policy
High Employment
Economic Growth
Price Stability
Interest rate Stability
Stability of Financial markets
Stability in Foreign Exchange Markets
Conflict Among Goals
The Fed's Strategy: Use of Targets
Choosing the Targets
Criteria for Choosing Intermediate targets
Criteria for Choosing Operating Targets
Fed's Policy procedures: A Historical Perspective
The Early Years: Discount Policy as the Primary Tool
Discovery of the Open Market Operations
The Great Depression
Reserve Requirements as a Policy Tool
War Finance and the Pegging of Interest Rates: 1942-51
Targeting Money Market Conditions: the 1950s and 1960s
Targeting Monetary Aggregates: The 1970s
New Fed's Operating Procedures: October 1979-October 1982
De-emphasis of Monetary Aggregates: October 1982 and Beyond
The Taylor's rule, NAIRU, and the Phillips Curve
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