1. Economics 330 – Money and Banking
M and W from 3:30pm to 4:45pm
Text: Cecchetti and Schoenholtz: Money, Banking, and Financial Markets, McGraw Hill, 5th and 4th editions.

2. Who am I ?
Dr. John Neri
Office Hours: M and W from 10:30qm to 11:30am.
Office: Morrill Hall, Room 1106

3. Who you are: 230 as of 8/15/17 Accounting – 8 Info Sys – 3
Computer Science – IAP - 20
LTSC Sup MGMT - 1
Economics – Foreign Exch - 7
Finance – 41
G & P – 2
Intl. Bus - 2
Marketing/Int. Bus/Mgnt – 11
Math - 1

4. Course Webpage http://www.terpconnect.umd.edu/~jneri/Econ330
Students using DSS, please see me within the first 2 weeks of class.
NOTE: upper-case E

5. Can you define each of the following?
Federal Reserve System
FOMC
Federal Funds Market
Federal Funds Rate
Discount Loan
Discount Rate
Open Market Operation
Quantitative Easing
QE 1, 2 and 3
Financial Intermediary
Money Market
Capital Market
MMMF
Large Scale Asset Purchase
Term Structure

6. What is this?

7. https://www. c-span. org/video/

8. Cecchetti - Chapter One
An Introduction to Money and
the Financial System

9. Six Parts of the Financial System
Money
Financial Instruments
3. Financial Markets
Financial Institutions
Regulatory Agencies
Central Banks

10. Six Parts of the Financial System
Money
Facilitates transactions, used to buy stuff
Store wealth.
Money has changed over time from gold/silver coins to paper currency to electronic funds.

11. Six Parts of the Financial System
Financial instruments
Contracts used to transfer resources from savers to investors
Loans, bonds, stocks (this is financial capital)
Contracts used to transfer risk
Insurance policies
Derivative contracts

12. Six Parts of the Financial System
Financial Markets
make buying and selling financial instruments easy
Went from being in coffee houses and taverns to well organized markets like the New York Stock Exchange.
Now transactions are mostly handled by electronic markets.
As the cost of processing financial transactions has fallen a broader array of financial instruments available.

13. Six Parts of the Financial System
Financial Institutions
Provide providing access to financial markets and gathering information
Take a few minutes to list some FIs and describe what they do

14. Six Parts of the Financial System
Government regulatory agencies
Make sure the financial system operates safely and reliably.
Government regulatory agencies were introduced by federal government after the Great Depression.
Wide-ranging financial regulation: rules, supervision, examine banks – how the use funds and manage risk.

15. Six Parts of the Financial System
Central banks
Central banks control the availability of money and credit to promote low inflation, high growth and stability of financial system.

16. Cecchetti’s Five Core Principles of Money and Banking
Time has value.
Risk requires compensation.
Information is the basis for decisions.
Markets determine prices and allocation resources.
Stability improves welfare.

17. Core Principle 1: Time has value
Time affects the value of financial instruments.
Interest is paid to compensate the lenders for the time the borrowers have their money.
Chapter 4 develops an understanding of interest rates and how to use them.

18. Core Principle 2: Risk requires compensation
In a world of uncertainty, individuals will accept risk only if they are compensated.
In the financial world, compensation comes in the form of explicit payments: the higher the risk the bigger the payment.

19. Core Principle 3: Information is the basis for decisions
The more important the decision, the more information we gather.
Collection and processing of information is the foundation of the financial system.

20. Core Principle 4: Markets determine prices and allocate resources
Markets are the core of the economic system.
Markets channel resources and minimize the cost of gathering information and making transactions.
In general, the better developed the financial markets, the faster the country will grow.

21. Core Principle 5: Stability improves welfare
A stable economy reduces risk and improves everyone's welfare.
Financial instability in the autumn of 2008 triggered the worse global downturn since the Great Depression.
A stable economy grows faster than an unstable one.
One of the main roles of central banks is stabilizing the economy.

22. Bottom Line: A well Functioning Financial System Promotes Economic Efficiency
Facilitate Payments – currency, commercial bank checking accounts
Channel Funds from Savers to Borrowers
Enable Risk Sharing - Classic examples are insurance and forward markets

23. 1. Facilitate Payments
Cash transactions (Trade value for value). Could hold a lot of cash on hand to pay for things.
Financial intermediaries provide checking accounts, credit cards, debit cards, ATMs
Make transactions easier.

24. 2. CHANNEL FUNDS FROM SAVERS TO BORROWERS
Lending is a form of trade ( Trade value for a promise)
Give up purchasing power today in exchange for purchasing power in the future.
Savers: have more funds than they currently need; would like to earn capital income
Borrowers: need more funds than they currently have; willing and able to repay with interest in the future.

25. 3. Risk Sharing
The world is an uncertain place. The financial system allows trade in risk.
Two principal forms of trade in risk are
insurance and forward contracts.
Trade value for a Promise

26. Take a few minutes to list some approaches to address this risk.
Risk Sharing Example
Consider the following:
Suppose everyone has a 1/1000 chance of dying by age 40 and one would need $1 million to replace lost income to provide for their family.
Take a few minutes to list some approaches to address this risk.
Self-insurance – save and accumulate a large amount of
precautionary wealth in case you die.
- No insurance: rely on charity, the state, or family for
help.
- Financial system offers a better alternative: life insurance.
Everyone pays $1000 premium, and receives $1 million in
case of death. In between, life insurance company can
invest premiums and earn returns.

27. 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 % interest 27

28. Interest Rates on Selected Bonds, 1950–2015 Three things this graph demonstrates??
3-month Bill
10-year Treasury
10-year Corporate Baa 28

30. 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 30

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

32. 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 32

33. Money Growth (M2 Annual Rate) and the Business Cycle in the United States, 1950–2008
Note: Shaded areas represent recessions. 33

34. 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 34

35. Average Inflation Rate Versus Average Rate of Money Growth for Selected Countries, 1997–2007
Source: International Financial Statistics. 35

36. Examples of Hyperinflation:1980s and Early 1990s

37. M2 Money Growth and Inflation - US

38. Inflation and Nominal Interest Rates
Mankiw

39. Inflation and Nominal Interest rates