Economics 330 Money and Banking T and Th from 9:30am to 10:45a Text: Mishkin, Economics of Money, Banking, and Financial Markets, Pearson, 4th Business School Edition. Who am I? Dr. John Neri Office Hours: T and Th from 3:30pm to 4:30pm. Office: Morrill Hall, Room 1106 Who you are: 191 as of 1/15/18 Accounting 8 Computer Science 8 IAP - 10 LTSC - 22 Sup MGMT - 1 Economics 81 Foreign Exch - 2 Finance 29 Psychology - 2 G & P 3 Journalism - 2 Intl. Bus 2 Crim. Justice - 1 Marketing/Int. Bus/Mgnt 16 Math - 1 1
Course Webpage http://www.terpconnect.umd.edu/~jneri/econ330 NOTE: upper-case E Students using DSS, please see me within the first 2 weeks of class. 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 Financial Intermediary Money Market Capital Market MMMF Large Scale Asset Purchase Term Structure What is this? 2
Chapter 1 Why Study Money, Banking, and Financial Markets? Preview Study how financial markets work. bond, stock, foreign exchange markets. We focus on the bond market. To examine how financial institutions such as banks, investment and insurance companies work - we focus on banks. To examine the role of money in the economy Why Study Financial Markets? Financial markets are markets in which funds are transferred from people and firms who have an excess of available funds to people and firms who have a need of funds Also, transfer risk from individuals and firms that do not want to bear risk to parties willing to take on risk. 3
The Bond Market and Interest Rates A security (financial instrument) is a claim on the issuer s future income or assets. A bond is a debt security that promises to make specified payments on specified dates for a specified period of time. An interest rate is the cost of borrowing or the price paid for the rental of funds. price paid for the rental of funds, expressed as a percentage. pay $5.00 to rent $100 for one year, 5.0% interest Interest Rates on Selected Bonds, 1950 2015 Three things this graph demonstrates?? 3-month Treasury Bill 10-year Treasury Bond 10-year Corporate Baa 4
The Stock Market Common stock represents a share of ownership in a corporation. A share of stock is a claim on the residual earnings and assets of the corporation. Figure 2 Stock Prices as Measured by the Dow Jones Industrial Average, 1950 2014 Source: Federal Reserve Bank of St. Louis, FRED database: http://research.stlouisfed.org/fred2 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 5
Commercial Banks Insurance Companies Loans deposits Bonds Stocks Insurance Policies Pension Funds Mutual Funds Stocks Retirement Plans Bonds Stocks Shares Money Market Mutual Funds Commercial paper T-Bills Shares/ deposits Why Study Financial Institutions and Banking? Financial crises major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms. Why Study Money and Monetary Policy? Evidence suggests that money plays an important role in generating business cycles. Recessions (unemployment) and expansions in economic activity. Monetary theory ties changes in the money supply to changes in aggregate economic activity and the price level. 6
Money and Aggregate Economic Activity Money Growth (M2 Annual Rate) and the Business Cycle in the United States 1950 2014 Source: Federal Reserve Bank of St. Louis, FRED database: http://research.stlouisfed.org/fred2 Money, the Price Level, and Inflation The aggregate price level is the average price of goods and services in an economy Inflation is a continual rise in the price level Data shows a connection between the money supply and the price level Aggregate Price Level and the Money Supply in the United States, 1950 2014 Source: Federal Reserve Bank of St. Louis, FRED database: http://research.stlouisfed.org/fred2 7
Inflation Rate and the Rate of Money Growth, Selected Countries, 2003-2013 Average Inflation Rate Versus Average Rate of Money Growth for Selected Countries, 1997 2007 Source: International Financial Statistics. Examples of Hyperinflation:1980s and Early 1990s 8
M2 Money Growth and Inflation - US Money and Interest Rates Interest rates are the price of money Prior to 1980, the rate of money growth and the interest rate on long-term Treasury bonds were closely tied Since then, the relationship is less clear but the rate of money growth is still an important determinant of interest rates Money Growth (M2 Annual Rate) and Interest Rates (Long-Term U.S. Treasury Bonds), 1950 2014 Source: Federal Reserve Bank of St. Louis, FRED database: http://research.stlouisfed.org/fred2 9
Inflation and Nominal Interest Rates Mankiw Inflation and Nominal Interest rates Appendix 1: Defining Aggregate Output, Income, the Price Level, and the Inflation Rate 10
Aggregate Output and Income The most commonly reported measure of aggregate output, the gross domestic product (GDP), is the market value of all final goods and services produced in a country during the course of a year. Aggregate income, the total income of factors of production (land, labor, and capital) from producing goods and services in the economy during the course of the year, is equal to aggregate output. Real versus Nominal Magnitudes When the total value of final goods and services is calculated using current prices, the resulting GDP measure is referred to as nominal GDP. The word nominal indicates that values are measured using current prices. Real versus Nominal Magnitudes A more reliable measure of economic production expresses values in terms of prices for an arbitrary base year, currently 2005. GDP measured with constant prices is referred to as real GDP, the word real indicating that values are measured in terms of fixed prices. 11
Aggregate Price Level The aggregate price level is a measure of average prices in the economy. Three measures of the aggregate price level are commonly encountered in economic data: The GDP deflator The PCE deflator The Consumer Price Index (CPI) 12