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

2 Why Study Money, Banking, and Financial Markets  To examine how financial markets such as bond, stock and foreign exchange markets work  To examine how financial institutions such as banks and insurance companies work  To examine the role of money in the economy

3 Financial Markets  Markets in which funds are transferred from people who have an excess of available funds to people who have a shortage of funds

4 The Bond Market and Interest Rates  A security is a claim on the issuer’s future income or assets  A bond is a debt security that promises to make pre-determined fixed payment(s) at a specific date in future (maturity).  An interest rate is the cost of borrowing or the price paid for the rental of financial capital. Currently, int. rate is 5.75% in TR.

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6 Interest Rates on Turkish TBills and Gov. Bonds

7 The Stock Market  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  A stock market is where stocks are traded in a “secondary market”

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9 ISE Stock Prices

10 The Foreign Exchange Market  The foreign exchange market is where funds are converted from one currency into another  The foreign exchange rate is the price of one currency in terms of another currency. Currently, 1.77 TL / $  The foreign exchange rate is determined in the foreign exchange market.

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12 Value of Lira against Dollar  See: Dolar htm  : 2.82 TL / $  1960 – August 1970: 9.08 TL / $  August 1970 – December 1971: TL/$  December 1971 – May 1974: TL / $  After 1980 variable (depreciations).

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14 Banking and Financial Institutions  Financial Intermediaries—institutions that borrow funds from people who have saved and make loans to people who need credit.  Banks—institutions that accept deposits and make loans. (not all financial intermediaries accept deposits). Investment banks, insurance companies, etc. do not accept deposits.  Other Financial Intermediaries—insurance companies, mortgage companies, pension funds, mutual funds and investment banks  Financial Innovation—in particular, the advent of computers and internet globalized the market, sped up transactions, introduced new financial instruments.

15 Money Supply and Business Cycles  Evidence suggests that money plays an important role in generating business cycles.  Business cycles: Recessions (unemployment) and booms (inflation) affect all of us.

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17 Money Supply and Inflation  Monetary Theory relates changes in the money supply to changes in total output (=total income) and the price level  The aggregate price level (P) is a weighted average of the prices of goods and services produced in an economy  Quantity theory of money (MV = PY) suggests and empirical data shows a connection between the money supply and the price level.

18 Money supply and price level in TR

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20 Money Supply And İnflation in TR

21 Inflation İs The Rate Of Change of The Price Level

22 Turkey

23 Monetary Policy and Fiscal Policy  Monetary policy is the control of the money supply. It is conducted by the Central bank. CB uses interest rates and other instruments to control the money supply. The Purpose of Mon. Pol. Is to control inflation which is the rate of change of the price level. Conducted in Turkey by CBRT, In the U.S. by the Federal Reserve Bank (Fed) Why is it important to control the money supply?

24 Monetary Policy and Fiscal Policy  Fiscal policy is the management of the govt. budget: 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. Before 1994, Turkish Treasury could borrow from the CB: CB printed money and lent to the govt by buying govt. bonds from Treasury. But this was abolished partially after 1994, and fully after Now CB is more independent from the govt.

25 GOVERNMENT BUDGET CONSTRAINT At any year t, govt. budget must satisfy G t + rB t-1 = T t + B t -B t-1 G t : govt. expenditures B t-1 : govt.’s outstanding stock of debt. rB t-1 : interest payment on outstanding debt (r:real int. rate) T t : taxes (revenues) B t -B t-1 : newly issued debt during year t

26 Source: HM, Turkish Government’s Budget Billion TRL Revenues Tax Revenues Other Expenditures Expenditures excl. İnterest P Interest Payments (IP) Budget Balance Budget Balance excl. IP (FDF) Cash Balance Financing Foreign Borrowing Net Domestic Borrıowing Net Other Financing FDF/GDP (%) Budget Deficit / GDP

27 Turkish Government’s Budget STOCK of DEBT & DEBT/GDP (billion dollars) Total public debt Domestic public debt Foreign public debt Public Debt/GDP CBRT Foreign Debt Private sector foreign debt Private sector foreign debt/GDP USD Exchange rate GDP Source: Mahfi Eğilmez, “Borcumuz Ne Kadar?” Radikal, 16 Şubat 2010 Salı

28 US Government’s Budget