Economics 135. Course Review. Professor Kevin D. Salyer. June UC Davis. Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 1 / 11
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1 Economics 135 Course Review Professor Kevin D. Salyer UC Davis June 2007 Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 1 / 11
2 Course Review Two goals Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 2 / 11
3 Course Review Two goals 1 Introduce you to modern theories of the role of nancial intermediaries in the macro-economy. Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 2 / 11
4 Course Review Two goals 1 Introduce you to modern theories of the role of nancial intermediaries in the macro-economy. 2 Bridge (slightly) the gap between undergrad and grad economic analysis. Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 2 / 11
5 Course Review Two goals 1 Introduce you to modern theories of the role of nancial intermediaries in the macro-economy. 2 Bridge (slightly) the gap between undergrad and grad economic analysis. Since modern theories of banking highlight role of information and uncertainty, we needed some basics. Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 2 / 11
6 Basic Topics Probability Concepts: De nition of pdf and cdf. Calculating Expected Value; Mean, Variance, Covariance. The bene ts of diversi cation. Law of Large Numbers. Expected utility; risk aversion; relative and absolute risk aversion. Certainty Equivalence. Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 3 / 11
7 Demand for Insurance Pro ts are zero for insurance companies: actuarially fair premium. Slope of budget line = ratio of probabilities. Optimum is full insurance, risk averse agents want to eliminate all risk. Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 4 / 11
8 Two models of Banking Role of banks: to provide liquidity insurance. Understand budget constraints in market economy. Understand resource constraint in social planner problem. How can banks achieve Pareto optimum? Role of banks: to lower the cost of capital due to adverse selection problem Understand the role of self- nance as a signal. Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 5 / 11
9 Next - Begin to study the role of banks in macroeconomy The simple money multiplier in a fractional reserve banking system. Then a richer model of the banking industry in a general equilibrium setting. Banks as pro t maximizers. Two behavioral functions: demand for deposits and supply of loans. Household and Firm behavior. Equilibrium: money multiplier smaller than that predicted by the simple money multiplier. Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 6 / 11
10 The transmission mechanism of monetary policy: Basic models The money channel: the IS-LM model The credit channel: the Bernanke-Blinder model. Bernanke-Blinder + Perfectly competitive banking system with endogenous money interest rate as tool of monetary policy. Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 7 / 11
11 Banks and the Macroeconomy: the role of asymmetric information Williamson model - banks provide e cient monitoring. Understand the four equations that de ne equilibrium. Know basic structure of two-state model: what di erentiates state 1 from state 2. why does the banking sector cause business cycles? Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 8 / 11
12 Banks and the Macroeconomy: the role of asymmetric information Gertler and Hubbard model. Understand Figures 1 and 2 - the role of net worth. Understand the Incentive Compatibility constraint. Understand the message implied by Tables 2 and 3. Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 9 / 11
13 Study Suggestions Understand homeworks...you will be prepared. Review midterm...make sure you understand answers. For each model, identify endogenous and exogenous elements. the characterization of asymmetric information is di erent across models - know the di erences. be able to summarize each model in a few sentences - what is the point of the model? Re-read the Greenbaum and Thakor article for general overview of information economics. Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 10 / 11
14 For Exam Exam: 1:30PM on Wednesday, June 13. Bring Blue Book. Calculator is OK. I will hold extra o ce hours on Tuesday from 1-3PM. Professor Kevin D. Salyer (UC Davis) Money and Banking 06/07 11 / 11
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