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 Market Interest

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:

Goods Money 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), 700-637 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 1368-1399 (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)

4. Valuable relative to its weight (cement, stones)

5. Divisible (diamonds, pay for bread)

Properties of a Good Medium of Exchange

1) Medium of Exchange2) Unit of account3) Store of Value New York Note, 1776

4) 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 1368-1399 (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 16th of October 2015

Money supply (M2)M1 + Time deposits (TL and Foreign Currency)

1,201,033,332,400 TL on 16th of October 2015

Money Supply Today

2005 2006 2007 2008 2009 2010 2011 20120

100000000

200000000

300000000

400000000

500000000

600000000

700000000

800000000

M1M2

M1 and M2 in Turkey

Nov.

Dec.

Jan.

201

1Fe

b.Mar

.Apr

.May

June Ju

lyAug

.Se

p.Oct

.Nov

.Dec

.

Jan.

201

2Fe

b.Mar

.Apr

.May

June Ju

lyAug

.Se

p.Oct

.0

2000

4000

6000

8000

10000

12000

M1M2

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

Assets Liabilities

Reserves Deposits

Loans Short and long term borrowing

Building and Equipment Other Liabilities

Other Assets

Total Liabilities

Stock holders equities

Total Assets Total 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 Assets Change Liabilities

Reserves +1000

Deposits +1000

Loans

Total Assets +1000

Total 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 Assets Change Liabilities

Reserves + 150

Deposits +1000

Loans + 850

Total Assets +1000

Total Liabilities +1000

Change Assets Change Liabilities

Reserves +850 Deposits +850

Loans

Total Assets +850

Total Liabilities +850

The new loan comes back to Bank Two

Change Assets Change Liabilities

Reserves +127.5 (850*0.15)

Deposits +850

Loans +722.5 (850*0.85)

Total Assets +850 Total Liabilities +850New loans of 722.5 TL are created by

Bank Two

Total change in the deposits:

1000+ (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 supplyMS= 1000

Money demandMD= L(Y, i) orMD= 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 supplyMS= 1000

Money demandMD= L(Y, i) orMD= 5*Y – 3*I

(For a given Y level you will be able to determine equilibrium interest rate)

I

Q of money

Assets Liabilities

FX and Gold Reserves Currency in Circulation

Government Required Reserves

Open Market Operations Free Reserves

Other Capital

Central Bank Balance sheet

Central Bank (TCMB) Balance Sheet

Central Bank

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 AEd= Y equality

Other variables:Cd, Id, Gd, NXd, 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

ISLM

Expansionary Monetary Policy

IS-LM equilibrium

i

Y

ISLM

Expansionary Fiscal Policy:

IS-LM equilibrium

i

Y

ISLM

See class notes and homework assignment

Mathematical model of the IS-LM