 Anything of value owned by firms and households. Assets

 Anything of value owned by firms and households.  Financial Assets are ‘instruments’ of value bought and sold in financial markets. Assets

 What do financial markets do?  Transfer savings to borrowers,  Companies access financial resources to invest, meet payroll, and develop new products.  Players: individuals, organizations and everybody are key players in the financial markets. Financial Markets

 Let’s take a closer look at this market. Money Market  Financial Markets Bond Market Equities Market Financial Asset Markets

 Let’s take a closer look at this market. Money Market No interest  Financial Markets Bond Market Equities MarketInterest Financial Asset Markets

Goods and Money Markets

Money Market  What is money? Without it, modern economies could not function

 No Money: Barter Economy (goods for goods)  Money as a medium of Exchange: GoodsMoney Goods.  How did all start? (shells, barley, peppercorns, gold, and silver)  Precious metals, (Metals objects were introduced as money around 5000 B.C. By 700 BC, the Lydians became the first in the Western world to make coins.)  Historical Development of Money

History of money  Precious metals, (Metals objects were introduced as money around 5000 B.C. By 700 BC, the Lydians became the first in the Western world to make coins.)  Standardized amounts, e.g. 10 grms of gold, eg.Ephesus, Lydia, 650 BC.[2] Ancient India 6th century BC.  How? hammering, milling (pressing) or casting.  This is called MINTING technology.  Lydian Coin (Western Turkey), B.C.

 Precious metals, (Metals objects were introduced as money around 5000 B.C. By 700 BC, the Lydians became the first in the Western world to make coins.)  Paper money (fully) backed by gold,  Paper money fractionally backed by gold,  Fiat money, Chinese note (size of a sheet of notebook paper) History of money

1.Acceptable 2.Standardized quality (diamonds, clear or not) 3.Durable (fish, strawberry, do they last) 1.Valuable relative to its weight (cement, stones) 2.Divisible (diamonds, pay for bread) Properties of a Good Medium of Exchange

1) Medium of Exchange 2) Unit of account 3) Store of Value New York Note, ) Standard of deferred payments Precious metals are easily divisible into standardized coins and do not loose value when made into smaller units : COINS The Functions of Money

 Coins,  “Bank Notes” start of Paper money,  Fully backed by gold.  Fractionally backed by gold, ... later...  Fiat Money What is the supply? (more efficient) Initial stages of development of paper money

 Precious metals, (Metals objects were introduced as money around 5000 B.C. By 700 BC, the Lydians became the first in the Western world to make coins.)  Paper money (fully) backed by gold,  Paper money fractionally backed by gold,  Fiat money, Chinese note (size of a sheet of notebook paper) History of money

 Using standardized coins or paper bills made it easier to determine prices of goods and services,  the amount of money in the system also plays an important role in setting prices of goods and Price Level of an economy.  Percentage changes in the price levels Inflation or deflation Why is money important?

Delegated to Central Banks Money Supply

 Money supply (M1) Currency (in circulation) + demand deposits (TL and Foreign Currency) 309,631,666,100 TL on 16 th of October 2015  Money supply (M2) M1 + Time deposits (TL and Foreign Currency) 1,201,033,332,400 TL on 16 th of October 2015 Money Supply Today

M1 and M2 in Turkey

US Money Supply

 YES!!!  HOW?  With some tools known as monetary policy tools. (Tools are instruments that a policy maker can change in order to influence the workings of an economy) Can the Central Bank change MS?

1.Discount Rate, 2.Reserve Requirement ratio, 3.Open Market Operations. How do they work? Need to look at how banking system work and money changes hands… Monetary Policy Tools

 Banks are profit seeking institutions.  They accept deposits,  They give loans  Public Banks (Ziraat, Halk …) and Private banks (IsBank, Akbank, Garanti …) Commercial Banks and creation of Deposit Money

AssetsLiabilities ReservesDeposits LoansShort and long term borrowing Building and EquipmentOther Liabilities Other Assets Total Liabilities Stock holders equities Total AssetsTotal liabilities + stock holders’ equities Commercial Banks Balance Sheets

 Hold the required reserve ratio determined by Central Bank. If required reserve ratio (rr) is 15%, then in equilibrium (Reserves/ Deposits)*100 ratio=15 %. e.g. If Total Deposits are 2000 billion TL, then reserves need to be 300 billion TL. (Reserves/ Deposits)*100 ratio=(300/2000)*100=15 % Rules that commercial banks follow:

A new deposit comes into Bank One Change AssetsChange Liabilities Reserves +1000Deposits Loans Total Assets +1000Total Liabilities +1000

(Reserves/deposits)*100= 15 %. Result: Creates a new loan equal to 850. Bank One uses this new deposits in giving out new loans Change AssetsChange Liabilities Reserves + 150Deposits Loans Total Assets +1000Total Liabilities +1000

Change AssetsChange Liabilities Reserves +850Deposits +850 Loans Total Assets +850Total Liabilities +850 The new loan comes back to Bank Two Change AssetsChange Liabilities Reserves (850*0.15)Deposits +850 Loans (850*0.85) Total Assets +850Total Liabilities +850 New loans of TL are created by Bank Two

 Total change in the deposits: (0.85*1000)+(0.85*1000) 2 +(0.85*1000) 3 +… (0.85*1000) ∞  Total change =  Change in total deposits=  Money Multiplier= This will repeat ∞ times

Money supply  Money market  Tools to increase the MS 1)Discount rate increase, 2)Reserve requirement ratio decrease, 3)Open Market Operations (Buy bonds) I Q of money

Money demand  Money market  Types of Money demand 1)Transaction demand, 2)Speculative demand, 3)Precautionary demand,  MD= L(Y, i) or  MD= 5*Y – 3*i I Q of money

Money demand  Money market  If Y increases, then MD curve shifts to the right  MD= L(Y, i) or  MD= 5*Y – 3*i I Q of money

Money market equilibrium  Money market MS=MD  Money supply MS= 1000  Money demand MD= L(Y, i) or MD= 5*Y – 3*I (For a given Y level you will be able to determine equilibrium interest rate) I Q of money

Money market equilibrium  Money market MS=MD  Money supply MS= 1000  Money demand MD= L(Y, i) or MD= 5*Y – 3*I (For a given Y level you will be able to determine equilibrium interest rate) I Q of money

AssetsLiabilities FX and Gold ReservesCurrency in Circulation GovernmentRequired Reserves Open Market OperationsFree Reserves OtherCapital Central Bank Balance sheet

Central Bank (TCMB) Balance Sheet

Central Bank

 Equilibrium in 1. GOODS and SERVICES Market and 2.MONEY Market (Demand side of the economy) Determination of output

Goods and Money Markets

What is in the model? GOODS MARKET  The AE d = Y equality  Other variables: C d, I d, G d, NX d, T, YD, IS Curve MONEY MARKET  MD=MS equality  Other variables: Y, i LM Curve

IS – LM model  Goods market  Money Market i Y i Y IS LM

IS curve

 Equilibrium in both markets IS-LM equilibrium i Y IS LM

 Expansionary Monetary Policy IS-LM equilibrium i Y IS LM

 Expansionary Fiscal Policy: IS-LM equilibrium i Y IS LM

 See class notes and homework assignment Mathematical model of the IS-LM