ECON 304Money and Banking

Instructor: Bernard Malamud

–Office: BEH 502

Phone (702) 895 –3294

Fax: 895 – 1354

»Email: bernard.malamud@unlv.edu

Website: www.unlv.edu/faculty/bmalamud

Office hours: TR 12 - 1 pm; 2:30 - 3:30 pm; and by appointment

Money, Banking, and Financial Markets

The role of money and monetary policy in The role of money and monetary policy in the economythe economy

TRUSTTRUST

How financial markets such as bond, stock How financial markets such as bond, stock and foreign exchange markets workand foreign exchange markets work

TRUSTTRUST

How financial institutions such as banks and How financial institutions such as banks and insurance companies workinsurance companies work

TRUSTTRUST

A A securitysecurity (financial instrument) is a claim on (financial instrument) is a claim on the issuer’s future income or assetsthe issuer’s future income or assets

A A bondbond is a debt security that is a debt security that promisespromises to to make specified payments over timemake specified payments over time

– An An interest rateinterest rate is the cost of borrowing or the is the cost of borrowing or the price paid for the rental of fundsprice paid for the rental of funds

Common stockCommon stock represents a share of represents a share of ownership in a corporationownership in a corporation

– A share of stock is a claim on the earnings and A share of stock is a claim on the earnings and assets of the corporationassets of the corporation

Banking and Financial InstitutionsBanking and Financial Institutions

Financial Intermediaries—institutions that Financial Intermediaries—institutions that borrow funds from people who have saved and borrow funds from people who have saved and make loans to other people and businessesmake loans to other people and businesses

Banks—accept deposits and make loansBanks—accept deposits and make loans

Other Financial Institutions—insurance Other Financial Institutions—insurance companies, finance companies, pension funds, companies, finance companies, pension funds, mutual funds and investment banksmutual funds and investment banks

Financial InnovationFinancial Innovation– The information age and e-financeThe information age and e-finance

– DerivativesDerivatives

– SecuritizationSecuritization

Money and Business CyclesMoney and Business CyclesRecessions (unemployment) and booms (inflation) affect Recessions (unemployment) and booms (inflation) affect all of usall of us

Monetary Theory ties changes in the money supply to Monetary Theory ties changes in the money supply to changes in aggregate economic activity and the price levelchanges in aggregate economic activity and the price level

Money and InflationMoney and InflationThe aggregate price level is an average price The aggregate price level is an average price of goods and services in an economyof goods and services in an economy

A continual rise in the price level (inflation) A continual rise in the price level (inflation) affects all economic playersaffects all economic players

Monetary and Fiscal PoliciesMonetary and Fiscal Policies

Monetary policy is the management of the money Monetary policy is the management of the money supply and interest ratessupply and interest rates– Conducted by the Federal Reserve Bank (Fed)Conducted by the Federal Reserve Bank (Fed)

Fiscal policy is government spending and taxation Fiscal policy is government spending and taxation – Any deficit must be financed by borrowing … Any deficit must be financed by borrowing …

government borrowing affects interest ratesgovernment borrowing affects interest rates

Bernanke’s FocusBernanke’s Focus

Inflation TargetingInflation Targeting– Adjust “real” rate of interest with eye on pre-Adjust “real” rate of interest with eye on pre-

announced target rate of inflationannounced target rate of inflation– Wiggle room for other objectives/emergenciesWiggle room for other objectives/emergencies– Transparency and accountabilityTransparency and accountability

Joined by Mishkin on Board of GovernorsJoined by Mishkin on Board of Governors

Other Governors:Other Governors:www.federalreserve.govwww.federalreserve.gov/bios/bios

– Oppose Oppose DeDeflationflation

Great Depression and clogged credit channelGreat Depression and clogged credit channel

Core Principles of Money and BankingCore Principles of Money and Banking

• Time has Value Time has Value Interest rateInterest rate• Risk Requires CompensationRisk Requires Compensation• Financial decisions are based on Financial decisions are based on

Information and on Information and on TRUSTTRUST• Markets set prices and allocate Markets set prices and allocate

resources resources • Stability reduces risk and spurs Stability reduces risk and spurs

enterpriseenterprise

Where to Find the NumbersWhere to Find the Numbers

http://research.stlouisfed.org/fred2/http://research.stlouisfed.org/fred2/www.federalreserve.gov/releases/www.federalreserve.gov/releases/ www.economist.comwww.economist.comwww.bea.doc.govwww.bea.doc.govhttp://http://www.gpoaccess.gov/eopwww.gpoaccess.gov/eop//

Function of Financial MarketsFunction of Financial MarketsChannel funds from economic players that Channel funds from economic players that have saved surplus funds to those that have a have saved surplus funds to those that have a shortage of fundsshortage of funds

Promotes economic efficiency by producing Promotes economic efficiency by producing an efficient allocation of capitalan efficient allocation of capital

– increases production increases production

Improves consumer well-beingImproves consumer well-being

– allows them to time purchases betterallows them to time purchases better

Structure of Financial MarketsStructure of Financial Markets

Debt and Equity MarketsDebt and Equity Markets

Primary and Secondary MarketsPrimary and Secondary Markets– Investment Banks Investment Banks underwriteunderwrite securities in primary securities in primary

marketsmarkets– Brokers and dealers work in secondary marketsBrokers and dealers work in secondary markets

Exchanges and Over-the-Counter (OTC) MarketsExchanges and Over-the-Counter (OTC) Markets

Money and Capital MarketsMoney and Capital Markets– Money markets deal in short-term debt instrumentsMoney markets deal in short-term debt instruments– Capital markets deal in longer-term debt and Capital markets deal in longer-term debt and

equity instrumentsequity instruments

Internationalization of Financial MarketsInternationalization of Financial Markets

Foreign Bonds—sold in a foreign country and Foreign Bonds—sold in a foreign country and denominated in that country’s currencydenominated in that country’s currency

Eurobond—bond denominated in a currency other Eurobond—bond denominated in a currency other than that of the country in which it is soldthan that of the country in which it is sold

Eurocurrencies—foreign currencies deposited in Eurocurrencies—foreign currencies deposited in banks outside the home countrybanks outside the home country– Eurodollars—U.S. dollars deposited in foreign banks Eurodollars—U.S. dollars deposited in foreign banks

outside the U.S. or in foreign branches of U.S. banksoutside the U.S. or in foreign branches of U.S. banks

World Stock MarketsWorld Stock Markets

Function of Financial Intermediaries: Indirect Function of Financial Intermediaries: Indirect FinanceFinance

Lower transaction costsLower transaction costs– Economies of scaleEconomies of scale– Liquidity servicesLiquidity services

Reduce RiskReduce Risk– Risk Sharing (Asset Transformation)Risk Sharing (Asset Transformation)– DiversificationDiversification

Asymmetric InformationAsymmetric Information– Adverse Selection (before the transaction)—more likely Adverse Selection (before the transaction)—more likely

to select risky borrowerto select risky borrower– Moral Hazard (after the transaction)—less likely Moral Hazard (after the transaction)—less likely

borrower will repay loanborrower will repay loan

Regulation of the Financial SystemRegulation of the Financial System

To increase the information available to investors:To increase the information available to investors:– Reduce adverse selection and moral hazard Reduce adverse selection and moral hazard

problemsproblems– Reduce insider tradingReduce insider trading

To ensure the soundness of financial intermediaries:To ensure the soundness of financial intermediaries:– Restrictions on entryRestrictions on entry– DisclosureDisclosure– Restrictions on Assets and ActivitiesRestrictions on Assets and Activities– Deposit InsuranceDeposit Insurance– Limits on CompetitionLimits on Competition– Restrictions on Interest RatesRestrictions on Interest Rates