Economics 330 – Money and Banking T and Th from 9:30am to 10:45am Text: Mishkin, Frederic: The Economics of Money, Banking, and Financial Markets, Addison-Wesley, Business School Edition, 2nd or 3 rd edition, 2010.

Who am I ? Dr. John Neri Office Hours: T and Th from 3:30pm to 4:30pm. Office: Morrill Hall, Room 1102B

Who you are: (182 students) as of 1/19/15 Accounting – 13 MGMT - 4 Computer Science – 10 Undecided - 26 IAP - 18 Economics - 50 Finance – 27 G & P – 6 Intl. Bus - 2 Marketing – 8 Math/Math Stat - 4

Course Webpage NOTE: upper-case E

Can you define each of the following? Federal Reserve System FOMC Federal Funds Federal Funds Rate Discount Loan Discount Rate Open Market Operation Quantitative Easing  QE 1, 2 and 3 Operation Twist MBS Money Market Capital Market Sub-prime Mortgage QE 4 Shadow Banking System MMMF Large Scale Asset Purchase

What is this?

Chapter 1 Why Study Money, Banking, and Financial Markets?

Why Study Money, Banking & Financial Markets To understand how financial markets work - Obviously, there are many financial markets. - We focus primarily on bond and credit markets To examine how financial institutions work - Many types of financial institutions - We focus primarily on commercial banks To examine the role of money in the economy - How the Federal Reserve System works

Five Parts of the Financial System 1.Money An asset used to pay for purchases, repay of debt, pay taxes - a store of wealth - a medium of exchange 2.Financial Instruments Used to transfer wealth from savers/lenders to investors/borrowers and to transfer risk to those best equipped to bear it.

Five Parts of the Financial System 3. Financial Markets Allow us to buy and sell financial instruments quickly and cheaply. Funds are transferred from people who have an excess of available funds to people who have a shortage of funds 4. Financial Institutions. Firms that provide access to financial markets

Five Parts of the Financial System 5. Central Banks  monitor and stabilize the economy,  monitor financial institutions.

Well Functioning Financial System Promotes Economic Efficiency Facilitate Payments – commercial bank checking accounts Channel Funds from Savers to Borrowers Enable Risk Sharing - Classic examples are insurance and forward markets

The Bond Market and Interest Rates A bond is a debt security that promises to make payments periodically for a specified period of time  A security (a financial instrument) is a claim on the issuer’s future income or assets The interest rate is the cost of borrowing.  Price paid for the rental of funds, expressed as a percentage.  Pay $5.00 to rent $100 for one year - 5.0% interest

Interest Rates on Selected Bonds, 1950–2015 Three things this graph demonstrates?? 3-month Bill 10-year Treasury 10-year Corporate Baa

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The Stock Market Common stock represents a share of ownership in a corporation  An equity security (financial instrument) that is a claim on the earnings and assets of the corporation  Residual claim Firms can issue new shares to finance investment spending

Shiller: Real Terms. Note the behavior of price relative to earnings. Mishkin starts at 1950.

Financial Institutions and Banking Financial Intermediaries: institutions that “borrow funds from” (“issue liabilities to”) people who save and make loans to other people:  Commercial Banks: accept deposits and make loans  Other financial institutions: insurance companies, finance companies, pension funds, mutual funds and investment banks

deposits Loans Insurance Policies Bonds Stocks Retirement Plans StocksShares Bonds Stocks Commercial paper T-Bills Shares/ “deposits” Commercial Banks Insurance Companies Pension FundsMutual Funds Money Market Mutual Funds

Money and Economic Activity (Business Cycles) Evidence suggests that money plays an important role in generating business cycles  Recessions and expansions in economic activity Monetary Theory ties changes in the money supply to changes in aggregate economic activity and the price level

Money Growth (M2 Annual Rate) and the Business Cycle in the United States, 1950–2008 Note: Shaded areas represent recessions.

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

Average Inflation Rate Versus Average Rate of Money Growth for Selected Countries, 1997–2007 Source: International Financial Statistics.

Examples of Hyperinflation: 1980s and Early 1990s

M2 Money Growth and Inflation - US

Money and Interest Rates 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 the rate of money growth is still an important determinant of interest rates

FIGURE 6 Money Growth (M2 Annual Rate) and Interest Rates (Long-Term U.S. Treasury Bonds), 1950–2008

Mankiw Inflation and Nominal Interest Rates

Inflation and Nominal Interest rates