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MB Summer I 2010 Chapter 1 Introduction
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Why study Money and Banking?

• To examine how financial markets such as bond,
  stock and international markets work
• To examine how financial institutions such as
  banks and insurance companies work
• To examine the role of money in the economy

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• Why Study Financial Markets?
• Financial markets channel funds from savers to
  investors, thereby promoting economic efficiency
• 2. Financial markets affect personal wealth and
  behavior of business firms

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Financial markets some terms

• A security (financial instrument) is a claim on
  the issuers future income or assets
• A bond is a debt security that promises to make
  payments periodically for a specified period of
  time
• An interest rate is the cost of borrowing or the
  price paid for the rental of funds

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The bondmarkets

• Sources Federal Reserve Bulletin
  www.federalreserve.gov/releases/H15/data.htm.

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The stockmarket

• 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

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The US stockmarket

• Source Dow Jones Indexes http//finance.yahoo.co
  m/?u.

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• Why Study Banking and Financial Institutions?
• 1. Financial Intermediation
• Helps get funds from savers to investors
• 2. Banks and Money Supply
• Crucial role in creation of money
• 3. Financial Innovation
• ATMs, electronic banking, internet banking

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Financial intermediation

• Financial Intermediariesinstitutions that borrow
  funds from people who have saved and make loans
  to other people
• Banksinstitutions that accept deposits and make
  loans
• Other Financial Institutionsinsurance companies,
  finance companies, pension funds, mutual funds
  and investment banks
• Financial Innovationin particular, the advent of
  the information age and e-finance

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• Why Study Money and Monetary Policy?
• Influence on business cycles, inflation, and
  interest rates
• Understanding the media

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Money Growth (M2 Annual Rate) and the Business
Cycle in the United States, 19502008

• Note Shaded areas represent recessions.
• Source Federal Reserve Bulletin, p. A4, Table
  1.10 www.federalreserve.gov/releases/h6/hist/h6hi
  st1.txt.

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Money and inflation

• The aggregate price level is the average price
  of goods and services in an economy
• A continual rise in the price level (inflation)
  affects all economic players
• Data shows a connection between the money supply
  and the price level

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Money and the Price Level
Sources www.stls.frb.org/fred/data/gdp/gdpdef
www.federalreserve.gov/releases/h6/hist/h6hist10.
txt.
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International evidenceAverage Inflation Rate
Versus Average Rate of Money Growth for Selected
Countries, 19972007

• Source International Financial Statistics.

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Money and interest rates

• Interest rates are the price of money
• Prior to 1980, the rate of money growth and the
  interest rate on long-term Treasury bonds were
  closely tied
• Since then, the relationship is less clear but
  still an important determinant of interest rates

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Money and interest rates Money Growth (M2 Annual
Rate) and Interest Rates (Long-Term U.S. Treasury
Bonds), 19502008

• Sources Federal Reserve Bulletin, p. A4, Table
  1.10 www.federalreserve.gov/releases/h6/hist/h6hi
  st1.txt.

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Monetary and fiscal policy

• Monetary policy is the management of the money
  supply and interest rates
• Conducted in the U.S. by the Federal Reserve Bank
  (Fed)
• Fiscal policy is government spending and
  taxation
• Budget deficit is the excess of expenditures over
  revenues for a particular year
• Budget surplus is the excess of revenues over
  expenditures for a particular year
• Any deficit must be financed by borrowing

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The US budget balance

• Source www.gpoaccess.gov/usbudget/fy06/sheets/his
  t01z2.xls

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How We Study Money and Banking

• Basic Analytic Framework
• A simplified approach to the demand for assets
• The concept of equilibrium
• Basic supply and demand to explain behavior in
  financial markets
• The search for profits
• An approach to financial structure based on
  transaction costs and asymmetric information

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Quick Review (1)

• Aggregate Output
• Gross Domestic Product (GDP) Value of all final
  goods and services produced in domestic economy
  during year
• Aggregate Income
• Total income of factors of production (land,
  capital, labor) during year
• National income accounting identity
• aggregate output aggregate expenditure
  aggregate income

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Quick Review (2)

• Distinction Between Nominal and Real
• Nominal values measured using current prices
• Real quantities, measured with constant prices
• Aggregate Price Level
• nominal GDP
• GDP Deflator
• real GDP
• 9 trillion
• e.g. GDP Deflator 1.50
• 6 trillion
• Consumer Price Index (CPI) price of basket of
  consumer goods and services

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FIGURE 9 Federal Reserve Board Website
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FIGURE 10 Excel Spreadsheet with Interest-Rate
Data
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FIGURE 11 Excel Graph of Interest-Rate Data