© 2004 Pearson Addison-Wesley. All rights reserved 1-1 ECON 304 Money and Banking Instructor: Bernard Malamud –Office: BEH 502 Phone (702) 895 –3294 Fax: 895 – 1354 » Website: Office hours: M 2:30 – 4:30 pm; W 3:30 – 5:30 pm And by appointment

© 2004 Pearson Addison-Wesley. All rights reserved 1-2 Money,Banking, and Financial Markets Why Study Financial Markets? 1.Channel funds from savers to investors, thereby promoting economic efficiency 2.Affect personal wealth and behavior of business firms 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 Why Study Money and Monetary Policy? 1.Influence on business cycles, inflation, and interest rates

© 2004 Pearson Addison-Wesley. All rights reserved 1-3 Function of Financial Markets 1. Allows transfers of funds from person or business without investment opportunities to one who has them 2. Improves economic efficiency

© 2004 Pearson Addison-Wesley. All rights reserved 1-4 Bond Market

© 2004 Pearson Addison-Wesley. All rights reserved 1-5 Stock Market

© 2004 Pearson Addison-Wesley. All rights reserved 1-6 Classifications of Financial Markets 1. Debt Markets Short-term (maturity < 1 year) Money Market Long-term (maturity > 1 year) Capital Market 2.Equity Markets Common stocks 1.Primary Market New security issues sold to initial buyers 2.Secondary Market Securities previously issued are bought and sold 1.Exchanges Trades conducted in central locations (e.g., New York Stock Exchange) 2.Over-the-Counter Markets Dealers at different locations buy and sell

© 2004 Pearson Addison-Wesley. All rights reserved 1-7 Function of Financial Intermediaries Financial 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 Transactions Costs 1.Financial intermediaries make profits by reducing transactions costs 2.Reduce transactions costs by developing expertise and taking advantage of economies of scale Risk Sharing 1.Create and sell assets with low risk characteristics and then use the funds to buy assets with more risk (also called asset transformation). 2.Also lower risk by helping people to diversify portfolios

© 2004 Pearson Addison-Wesley. All rights reserved 1-8 Why Debt Exceeds Equity: Adverse Selection,and Moral Hazard Adverse Selection 1.Before transaction occurs 2.Potential borrowers most likely to produce adverse outcomes are ones most likely to seek loans and be selected Moral Hazard 1.After transaction occurs 2.Hazard that borrower has incentives to engage in undesirable (immoral) activities making it more likely that won’t pay loan back Financial intermediaries reduce adverse selection and moral hazard problems, enabling them to make profits

© 2004 Pearson Addison-Wesley. All rights reserved 1-9 Size of Financial Intermediaries

© 2004 Pearson Addison-Wesley. All rights reserved 1-10 Financial Intermediaries

© 2004 Pearson Addison-Wesley. All rights reserved 1-11 Regulation of Financial Markets and Intermediaries 1.Increase information to investors A.Decreases adverse selection and moral hazard problems B.SEC forces corporations to disclose information 2.Ensuring the soundness of financial intermediaries A.Prevents financial panics B.Chartering, reporting requirements, restrictions on assets and activities, deposit insurance, and anti-competitive measures But, the trend … … financial innovation and deregulation

© 2004 Pearson Addison-Wesley. All rights reserved 1-12 Money: What and Why Economist’s Meaning of Money 1.Anything that is generally accepted in payment for goods and services 2.Not the same as wealth or income Functions of Money 1.Medium of exchange 2.Unit of account 3.Store of value Evolution of Payments System 1.Precious metals like gold and silver 2.Paper currency (fiat money) 3.Checks 4.Electronic means of payment 5.Electronic money: Debit cards, Stored-value cards, Smart cards, E- cash

© 2004 Pearson Addison-Wesley. All rights reserved 1-13 Federal Reserve’s Monetary Aggregates

© 2004 Pearson Addison-Wesley. All rights reserved 1-14 Growth Rates of Fed’s Monetary Aggregates

© 2004 Pearson Addison-Wesley. All rights reserved 1-15

© 2004 Pearson Addison-Wesley. All rights reserved 1-16

© 2004 Pearson Addison-Wesley. All rights reserved 1-17 Money and Business Cycles

© 2004 Pearson Addison-Wesley. All rights reserved 1-18 Money and the Price Level

© 2004 Pearson Addison-Wesley. All rights reserved 1-19 Money Growth and Inflation

© 2004 Pearson Addison-Wesley. All rights reserved 1-20 Money Growth and Interest Rates

© 2004 Pearson Addison-Wesley. All rights reserved 1-21 Fiscal Policy and Monetary Policy