1. Financial Institutions and Markets FIN 304 Dr. Andrew L. H. Parkes Day 4 “How do financial markets work?” 卜安吉

2. Financial Institutions & Markets, Misc2 Price Indices GDP deflator Uses Current Year Quantities – Bought today Uses Current Year Quantities – Bought today Consumer Price Index Uses Base Year Quantities – Bought in the Base Year Uses Base Year Quantities – Bought in the Base Year Are they the same? Shanghai Dow Stock Index - WSJ

3. Financial Institutions & Markets, Misc3 What did you buy in 1967? OK then try 1982? OK then try 1982? These are the base years These are the base years Were the goods the same? Were the goods the same? Notice even our example! Notice even our example! Chain Weighted GDP Price index now Chain Weighted GDP Price index now Dow Jones World Stock Index

4. Financial Institutions & Markets, Misc4 What did today’s purchase cost in 1982? 1967? That ’ s the Paasche Index That ’ s the Paasche Index Today ’ s goods, base year prices Today ’ s goods, base year prices An MP3 player in 1982? An MP3 player in 1982? A digital Camera? A digital Camera? So there are problems with Price indices … So there are problems with Price indices …

5. Financial Institutions & Markets, Misc5 What happened yesterday in the U. S.? The Fed did what? The Fed did what? Lowered the Fed Funds Rate – the interest rate that banks borrow reserves from each other (at the Fed) Lowered the Fed Funds Rate – the interest rate that banks borrow reserves from each other (at the Fed) Lowered the Discount Rate Lowered the Discount Rate Graph source: WSJ

6. Financial Institutions & Markets, Misc6 What happened yesterday in the U. S.? Usually both move together Usually both move together Fed lowered Discount Rate alone.5% once a few months ago Fed lowered Discount Rate alone.5% once a few months ago Notice inflation – going in the opposite direction – this is NOT a good sign! Notice inflation – going in the opposite direction – this is NOT a good sign! Source: NY Times

7. Financial Institutions & Markets, Misc7 Economic Growth Slowing – AND … "Economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending," the Fed said. "Moreover, strains in financial markets have increased in recent weeks." (Fed Statement) "Economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending," the Fed said. "Moreover, strains in financial markets have increased in recent weeks." (Fed Statement) Sources: Fed and BLS

8. Financial Institutions & Markets, Misc8 Inflation Risks remain – More? At the same time, "some inflation risks remain" due to elevated energy and commodity prices. (Fed Statement) At the same time, "some inflation risks remain" due to elevated energy and commodity prices. (Fed Statement) Unlike last October, when the Fed said the risks of weaker growth and higher inflation were roughly balanced, implying no predisposition to cut rates again, Tuesday it elected not to assess the balance of risks. It said it "will continue to assess the effects of financial and other developments on economic prospects and will act as needed." Unlike last October, when the Fed said the risks of weaker growth and higher inflation were roughly balanced, implying no predisposition to cut rates again, Tuesday it elected not to assess the balance of risks. It said it "will continue to assess the effects of financial and other developments on economic prospects and will act as needed." Sources: Fed and BLS

9. Financial Institutions & Markets, Misc9 What have I Hammered ON in Class? 3 Goals of any Macroeconomy 3 Goals of any Macroeconomy Full Employment Full Employment Economic Growth Economic Growth Price Stability Price Stability Sources: WSJ and BLS

10. Financial Institutions & Markets, Misc10 Anemic new jobs? New private-sector jobs increased an "anemic" 64,000 last month, he said. The average monthly increase for private-sector jobs has been 74,000 this year through November, compared with an average gain of 169,000 jobs a month last year -- a 56% decline. New private-sector jobs increased an "anemic" 64,000 last month, he said. The average monthly increase for private-sector jobs has been 74,000 this year through November, compared with an average gain of 169,000 jobs a month last year -- a 56% decline. Sources: WSJ and BLS

11. Financial Institutions & Markets, Misc11 Notice “They” always help me! Whatever I Teach Whatever I Teach The Markets help The Markets help The Fed helps The Fed helps Actually, it really happens every single day! Actually, it really happens every single day! Sources: WSJ and BLS The Labor Department reported that employment at nonfarm businesses rose by 94,000 jobs in November. That followed revised increases of 170,000 in October and 44,000 in September; those gains were initially estimated at 166,000 and 96,000, respectively. The unemployment rate stayed at 4.7% for the third-consecutive month.

12. Financial Institutions & Markets, Misc12 Recession – 38% Risk so … “Maybe” Macroeconomic Advisers, a widely-followed forecasting firm, said Tuesday it now expects the economy to contract slightly in the current quarter, the first time it would have done so since the recession of 2001. It expects growth to return to 1.8% in the first quarter of next year. Macroeconomic Advisers, a widely-followed forecasting firm, said Tuesday it now expects the economy to contract slightly in the current quarter, the first time it would have done so since the recession of 2001. It expects growth to return to 1.8% in the first quarter of next year. Sources: http://online.wsj.com/article/SB119739876442121375.html?mod=hps_us_whats_newshttp://online.wsj.com/article/SB119739876442121375.html?mod=hps_us_whats_news Accessed on December 12, 2008 at 6:02 am ONE Quarter of Negative Growth THIS QUARTER – 4 th !

13. Financial Institutions & Markets, Misc13 Inflationary Expectations? Inflation expectations for the coming year rose to 3.5%, while long-term expectations increased as well. The share of people who say that now is a good time to buy a house because of low prices or a good deal hit 55%, a record high. Inflation expectations for the coming year rose to 3.5%, while long-term expectations increased as well. The share of people who say that now is a good time to buy a house because of low prices or a good deal hit 55%, a record high. Source: WSJ see slide 12

14. Financial Institutions & Markets, Misc14 WAGE Inflation? The Labor Department said that average hourly earnings jumped a substantial $0.08, or 0.5%, to $17.63. But earnings are up just 3.8% from a year ago, suggesting that wage pressures are in check. That gives the Federal Reserve additional leeway to cut interest rates at next Tuesday's meeting. The Labor Department said that average hourly earnings jumped a substantial $0.08, or 0.5%, to $17.63. But earnings are up just 3.8% from a year ago, suggesting that wage pressures are in check. That gives the Federal Reserve additional leeway to cut interest rates at next Tuesday's meeting. Source: Wall Street Journal Source: http://online.wsj.com/article/SB119703361873717116.html?mod=theafternoonreporthttp://online.wsj.com/article/SB119703361873717116.html?mod=theafternoonreport Accessed on December 12, 2008 at 5:58 am

15. Financial Institutions & Markets, Misc15 TODAY’S MARKET REACTION? Investors reacted by sending stocks plunging and by bidding up Treasury bond prices. The Dow Industrials fell more than 200 points in a matter of minutes and kept sinking through the afternoon, closing off more than 294 points, or 2.1 percent, for the day, according to preliminary figures. Broader indexes like the Standard & Poor's 500 and the Nasdaq Composite fared even worse. Investors reacted by sending stocks plunging and by bidding up Treasury bond prices. The Dow Industrials fell more than 200 points in a matter of minutes and kept sinking through the afternoon, closing off more than 294 points, or 2.1 percent, for the day, according to preliminary figures. Broader indexes like the Standard & Poor's 500 and the Nasdaq Composite fared even worse. Dow Jones Industrials (30) Source: New York Times Source: http://www.nytimes.com/2007/12/11/business/11cnd-fed.html?hphttp://www.nytimes.com/2007/12/11/business/11cnd-fed.html?hp Accessed on December 12, 2008 at 5:54 am

16. Financial Institutions & Markets, Misc16 Problem Set #2 TUTORIAL - Cheers TUTORIAL - Cheers Let’s work on Problem Set #2 in class for a while at least. Let’s work on Problem Set #2 in class for a while at least. U.S. Males around New Years call this College BOWL TIME U.S. Males around New Years call this College BOWL TIME See ESPN See ESPN BOWLING TIME!!! (College - American Football)