professor yamin ahmad, money and banking – econ 354 econ 354 money and banking lecture 1 syllabus...
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Professor Yamin Ahmad, Money and Banking – ECON 354
ECON 354
Money and BankingMoney and Banking
• Lecture 1
Syllabus
Introduction to Financial Markets and Money
Real World Observations and Basic Definitions
Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Resources Needed For This Class
• Aplia Website:http://econ.aplia.comUse course code: M363-5FTK-EX38
• Mishkin, Frederick S. (2010), The Economics of Money, Banking and Financial Markets, 9th Edition, Pearson8th edition is also fine if you have it.
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Success in an (Any!) Economics Course
To do well in Economics, you need to be able to do 3 things well (in conjunction):
1. Think Mathematically: Don’t be afraid of equations!
2. Think graphically!
3. Abstract Logic! (Often the hardest part)
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
A Model of the Economy
• As in Principles of Macro, divide the economy into different sectors and see how those sectors interact:
“Agents” in the Economy
Markets where Agents Interact
Equilibrium
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
The Agents in the System…
• There are four agents that we will focus on when constructing a model of the economy:Households
Firms
Government
“The Rest of the World” (ROW)
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Markets
• There are three markets that we typically focus on in macroeconomics:
The Factor Market
The Goods Market
The Financial Market (- we examine in detail in this course)
604/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
The Economy
HOUSEHOLDS
FIRMS
GOVERNMENT
Overview of the Course
Financial Markets:
-Interest Rates-Risk
-Expectations
Financial Institutions
- Financial Intermediaries
Central Banking & Monetary Policy
REST OF THEWORLD
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Overview of the Course
• Money
• Monetary Theory and Monetary Policy
• Financial Markets and Financial Intermediaries
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Some Definitions• Money: Anything that is generally accepted in payment
for goods and services
• In the United States: M1 = Currency + Traveler's Checks + Demand Deposits +
Other Checkable Deposits
M2 = M1 + Small denomination time deposits & repurchase agreements + Savings Deposits and money market deposit accounts + retail Money Market mutual fund shares
• There also used to be a broader measure of money, M3 which was discontinued as of March 2006.
• See: http://www.federalreserve.gov/releases/h6/hist/ 1004/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Role of Money
• Medium of exchange Form of transaction technology
• Unit of account
• Store of value Purchasing Power
Hence money helps to: Lower transaction costs Increase Liquidity in an economy
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Overview of the Course
• Money
• Monetary Theory and Monetary Policy
• Financial Markets and Financial Intermediaries
1204/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Monetary Theory and Policy
• Why study Monetary Theory and Policy?
Influence on business cycles, inflation, and interest rates.
How Central Bank (Fed) can have a big influence on the economy?.
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Money and Business Cycles
• Shaded areas represent Recessions• Note: Figure above shows a decline in money growth rate
prior to every recession (except the most recent one)! 1404/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Money and the Price Level
• Note: Positive Relationship between Money and the Aggregate Price Level
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Money Growth and Inflation
• Note: Across different countries, positive correlation between avg. money growth rates and avg. inflation rates
1604/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Money Growth and Interest Rates
• Positive correlation between money growth rates and interest rates in 1960’s & 1970’s
• Relationship breaks down in 1980’s1704/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Surpluses and Deficits • Figure 10(a) shows the
changing surplus and deficit of the federal and provincial governments in the United States since 1971.
• Persistent federal deficit during the 1970s through 1990s.
• Surplus from 1998 to 2001
• More deficits following.
Source: Congressional Budget Office
1980’s expansion
1990’s expansion
2002 – 2007 expansion
2001 – 2002 Recession
1991 Recession1982
Recession
OPEC Recession
18Note: These notes are incomplete without having attended lectures04/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Surpluses and Deficits
International Surplus and Deficit• If a nation imports more than it exports, it has an
international (trade) deficit.• If a nation exports more than it imports, it has an
international (trade) surplus.
• The current account deficit or surplus is the balance of exports minus imports plus net interest paid to and received from the rest of the world.
19Note: These notes are incomplete without having attended lectures04/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Surpluses and Deficits • Figure 10(b) shows
The U.S. current account balance since 1960.
• Persistent current account deficit since 1983
• The deficit has swollen during the past few years
OPEC Recession 1981-82
Recession
1991 Recession
2001 – 2002 Recession
1990’s Expansion
1980’s Expansion
2008 Recession
Source: Bureau of Economic Analysis 20Note: These notes are incomplete without having attended lectures04/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Interaction of Monetary and Fiscal Policy
• Surpluses – good? Deficits – bad?
• Examine how fiscal irresponsibility can lead to the onset of financial crises.
• Why deficits might lead to a higher money growth rate, a higher rate of inflation and higher interest rates?.
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Overview of the Course
• Money
• Monetary Theory and Monetary Policy
• Financial Markets and Financial Intermediaries
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
• Why Study Financial Markets? Channel funds from savers to investors, thereby
promoting economic efficiencyAffect personal wealth and behavior of business firms
• Brief Introduction to:Bond MarketStock MarketForeign Exchange Market
Financial Markets
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Function of Financial Markets: Flow of Funds
• Allows transfers of funds from person or business without investment opportunities to one who has them.
• Improves economic efficiency.
Lender-Savers• Households• Firms• Government• Foreigners
FinancialMarkets
Borrowers-Spenders• Business-Firms• Government• Households• Foreigners
Direct Finance
Indirect Finance
FinancialIntermediaries
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Bond Market: 1953 - 2010
• Bonds, securities…. what are they?
• Bond Market (and Money Markets):
determines interest rates2504/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Stock Market: 1950 - 2010
• Stocks: Share of ownership in a
corporation/firm.
• Stock Price volatility
• “Bull Market” vs. “Bear Market”
• Stock Price “Bubbles” Technology bubble in
1990’s?
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Foreign Exchange Market
• Foreign Exchange Market:
Transfer funds from one country to another
• Changes in Exchange rate:
Changes in relative prices2704/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Some Basic Definitions
Debt Instrument:
1. Debt Instrument: Contractual agreement by borrower to pay holder of the instrument a fixed dollar amount at regular intervals (principal + interest), until a specified date Example: Car loan
2. The maturity of a debt instrument is the number of years (term) until the instrument expires
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Classifications of Financial Markets1. Primary Market
New security issues sold to initial buyers (often behind closed doors)
Investment banks typically underwrite securities (i.e. guarantees a price for the security and then sells it to the public)
2. Secondary Market Securities previously issued are bought and sold E.g.: NASDAQ, Futures, Options, Foreign Exchange Exchanges
o Trades conducted in central locations (e.g., New York Stock Exchange, NYSE; London Stock Exchange, LSE)
Over-the-Counter Marketso Dealers at different locations buy and sell
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Methods of Raising Private Sector Funds• Debt Markets
Short-term (maturity < 1 year): Money Market Intermediate-term (1year < maturity < 10 years) Long-term (maturity > 10 years)
• Equity Markets Common stocks: claims to share in assets and net income No maturity date; periodic payments known as dividends
• Capital Market: Intermediate + Long Term Debt + Equity
• Examples: Bonds, mortgages3004/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Financial Market Instruments
What are the kinds of securities traded in financial markets?
• Money Market Instruments Because of short term to maturity, debt instruments traded in the
money market do not have much fluctuation in their prices, and hence are the least risky
• Capital Market Instruments Debt and equity instruments with maturities greater than a year;
these have much greater fluctuations in their prices (compared to money market instruments) and as such are considered more risky
Note: These notes are incomplete without having attended lectures3104/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Examples: Money Market Instruments
• US Treasury Bills Issued by US govt, with 1, 3, and 6 month maturities. Pay a set amount at maturity, and have no interest
payments; effectively pay interest by selling at a discount.
• Negotiable Bank Certificates of Deposit CD’s are debt instruments sold by banks to depositors that
pays an annual interest of a given amount, and pays back the original purchase price at maturity
• Commercial Paper Short term debt instrument issued by large banks and well
known corporations (e.g. Microsoft, GM).
Note: These notes are incomplete without having attended lectures3204/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Examples: Money Market Instruments
• Repurchase AgreementsRepos are effectively short term loans (usually with a
maturity of less than 2 weeks) for which T-bills serve as collateral. The most important lenders in this market are usually large corporations.
• Federal (Fed) FundsThese are typically overnight loans of reserves
between banks, of their deposits at the Federal Reserve.
Note: These notes are incomplete without having attended lectures3304/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Table 1 Principal Money Market Instruments
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Professor Yamin Ahmad, Money and Banking – ECON 354
Examples: Capital Market Instruments• Stocks
These are equity claims on net income and assets of a corporation. Issue of new stocks in any given year is typically quite small, although the
total value of stocks exceed that of any other type of security in the capital markets.
• Mortgages Mortgage market is the largest debt market in the US Residential mortgages are approximately 4 times the amount of commercial
and farm combined.
• Corporate Bonds Long term bonds issued by corporations with very strong credit ratings. Typical corporate bond sends the holder an interest payment twice a year
and pays off the face value when the bond matures. Some “convertible” corporate bonds allows the holder to convert them into a
specified number of shares of stock at any time up to the maturity date.
Note: These notes are incomplete without having attended lectures3504/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Examples: Capital Market Instruments• US Government Securities
These are long term debt instruments issued by the US Treasury to finance the deficits of the government.
• US Government Agency Securities Issued by various agencies such as Ginnie Mae, the Federal Farm Credit
Bank, etc, to finance such items as mortgages, farm loans or power generating equipment.
Many of the securities are guaranteed by the federal government.
• State and Local bonds Also called municipal bonds, which are long term debt instruments issued
by the state and local governments to finance expenditures on roads, schools, and other programs.
Interest payments from these bonds are exempt from federal income tax and generally from the state taxes issuing the bond.
• Consumer and Bank loansNote: These notes are incomplete without having attended lectures
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Professor Yamin Ahmad, Money and Banking – ECON 354
Table 2 Principal Capital Market Instruments
37Note: These notes are incomplete without having attended lectures04/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Internationalization of Financial MarketsInternational Bond Market• Foreign bonds: bonds sold in a foreign country and
denominated in that country’s currency.• Eurobonds:
Now larger than U.S. corporate bond market
World Stock Markets• U.S. stock markets are no longer always the largest:
Japan sometimes larger• E.g. Dow Jones Industrial Average (U.S.); Financial
Times Stock Exchange (FTSE - London); Nikkei (Tokyo)
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Common Confusions
• Eurobond: bond denominated in a currency other than that of the country in which it is sold E.g. Bond denominated in Sterling, sold in the U.S.
• Eurocurrencies: foreign currencies deposited in banks outside the home country E.g.: Eurodollar Market – U.S. dollars deposited in foreign banks
outside the U.S.
• Different to the Euro which is the national currency adopted in Europe after monetary union in 2002.
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Function of Financial Markets: Flow of Funds
Lender-Savers• Households• Firms• Government• Foreigners
FinancialMarkets
Borrowers-Spenders• Business-Firms• Government• Households• Foreigners
Direct Finance
Indirect Finance
FinancialIntermediaries
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Function of Financial IntermediariesFinancial Intermediaries:
1. Engage in process of indirect finance
2. More important source of finance than securities markets
3. Needed because of transactions costs and asymmetric information
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Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Role of Financial Intermediaries
1. Transaction Costs
2. Risk Sharing
3. Asymmetric Information
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Professor Yamin Ahmad, Money and Banking – ECON 354
Primary Assets and Liabilities of Financial IntermediariesType of Intermediary Primary Liabilities Primary Assets
Depository Institutions (banks)
Commercial Banks Deposits Business and consumer loans, mortgages, US Govt securities and municipal bonds
Savings and Loans Institutions Deposits Mortgages
Mutual Savings Banks Deposits Mortgages
Credit Unions Deposits Consumer Loans
Contractual Savings Institutions
Life Insurance Companies Premium from Policies Corporate bonds and mortgages
Fire and Casualty Insurance Companies Premium from Policies Municipal bonds, corporate bonds and stocks, US Govt securities
Pension Funds, Government Retirement Funds Employee and Employer Contributions
Corporate bonds and stock
Investment Intermediaries
Finance Companies Commercial paper, stock, bonds
Consumer and business loans
Mutual Funds Shares Stocks and bonds
Money Market Mutual Funds Shares Money market instruments
Note: These notes are incomplete without having attended lectures4304/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Financial Intermediaries and Value of Their AssetsValue of Assets (Billions of $)
Type of Intermediary 1970 1980 1990 2007 2010Q1
Depository Institutions (banks)
Commercial Banks 517 1481 3334 11809.5 14438
Savings and Loans Institutions and Mutual Savings Banks 250 792 1365 1815.0 1262.3
Credit Unions 18 67 215 758.7 892.4
Contractual Savings Institutions
Life Insurance Companies 201 464 1367 4952.5 4919.0
Fire and Casualty Insurance Companies 50 182 533 1381.0 1386.1
Pension Funds (Private) 112 504 1629 6410.6 5726.7
State and local Government Retirement Funds 60 197 737 3198.8 2793.9
Investment Intermediaries
Finance Companies 64 205 610 1911.2 1665.8
Mutual Funds 47 70 654 7829.0 7311.9
Money Market Mutual Funds 0 76 498 3033.1 2930.7Note: These notes are incomplete without having attended lectures
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Professor Yamin Ahmad, Money and Banking – ECON 354
Regulatory AgenciesRegulatory Agency Subject of Regulation Nature of RegulationSecurities and Exchange Commission (SEC)
Organized Exchanges and Financial Markets
Requires disclosure of information; restricts insider trading
Commodities Futures Trading Commission (CFTC)
Futures Markets Exchanges Regulates procedures for trading in futures markets
Office of the Comptroller of the Currency
Federally charted commercial banks
Charters and examines the books of federally chartered commercial banks and imposes restrictions on assets they can hold
National Credit Union Administration (NCUA)
Federally chartered credit unions
Charters and examines the books of federally chartered credit unions and imposes restrictions on assets they can hold
State banking and Insurance Commissions
State chartered depository institutions
Charters and examines the books of state chartered banks and insurance companies; imposes restrictions on assets they can hold and imposes restrictions on branching
Note: These notes are incomplete without having attended lectures4504/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Regulatory Agencies
Regulatory Agency Subject of Regulation Nature of RegulationFederal Deposit Insurance Corporation (FDIC)
Commercial banks, mutual savings banks, savings and loans associations
Provides insurance for each depositor. Currently it is set to $250000 per depositor, until 12/31/2013, whereas it will revert back to the pre-crisis level of $100000 per depositor; examines the books of insured banks and imposes restrictions on assets they can hold
Office of Thrift Supervision Savings and Loans Associations Examines the books of savings and loans associations and imposes restrictions on assets they can hold
Federal Reserve System All depository institutions Examines the books of commercial banks that are members of the system; sets reserve requirements for all banks
Note: These notes are incomplete without having attended lectures4604/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Regulatory Agencies
Regulatory Agency Subject of Regulation New PowersFederal Deposit Insurance Corporation (FDIC)
Commercial banks, mutual savings banks, savings and loans associations
Will be able to unwind giant financial firms in the same way it takes down banks.
Federal Reserve System All depository institutions Fed will have powers to crack down on interchange fees, which retailers pay to banks to cover the operational cost of transferring money. Fed can cap the fees
Consumer Financial Protection Bureau
Consumer loans and credit cards Establishes an independent Consumer Financial Protection Bureau housed inside the Federal Reserve. Fees paid by banks fund the agency, which would set rules to curb unfair practices in consumer loans and credit cards. It would not have power over auto dealers.
Government Accountability Office Federal Reserve (excluding FOMC and Monetary Policy)
Allows Congress to order the Government Accountability Office to review Fed activities, excluding monetary policy. Audits would be allowed two years after the Fed makes emergency loans and gives financial help to ailing financial firms.
Note: These notes are incomplete without having attended lectures
• The new Dodd-Frank Banking reform bill that was passed during June 2010 gives the following agencies additional power:
4704/19/23
Professor Yamin Ahmad, Money and Banking – ECON 354
Note: These notes are incomplete without having attended lectures
Banking and Financial Institutions
• Financial Intermediation Helps get funds from savers to investors through
bond/equity/foreign exchange markets
• Banks and Money Supply Crucial role in creation of money
• Financial Innovation
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