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Mishkin Econ12e PPT 01
Mishkin Econ12e PPT 01
Financial Markets
Twelfth Edition
Chapter 1
Why Study Money, Banking,
and Financial Markets?
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• Examine how financial markets work
– bond markets
– stock market
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Financial Markets and Institutions
• … help transfer funds from economic agents (i.e.,
households, firms, government, foreigners) who have an
excess of available funds to other agents who need funds to
finance expenditures
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Flow of Funds Through the Financial System
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Functions of Financial System
• Channel funds from savers to borrowers
– more efficient allocation of capital
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The Bond Market and Interest Rates
• A bond is a debt security that promises to make payments
periodically for a specified period of time.
– Treasury bills, government bonds
– Corporate bonds
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Interest Rates on Selected Bonds, 1950–2017
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The Stock Market
• Stocks/shares/equity represent ownership in a company.
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Dow Jones Industrial Average, 1950–2017
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S&P 500 index, 2012-2021
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Mutual funds and ETFs
• Buying and selling
individual stocks can be
costly and risky.
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1-11
Financial Institutions and Banking
• Financial intermediaries:
– Banks (depository institutions): accept deposits and make loans
– Other financial institutions: insurance companies, finance
companies, pension funds, mutual funds and investment
companies
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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.
– E.g., Financial crisis of 2007-08
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Banking crises are common across the world
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Money and Monetary Policy
• Money plays an important role in facilitating transactions
– Medium of exchange role
• The amount of money/liquidity available in the economy
affects interest rates and asset prices, and is a crucial
determinant of business cycles (expansions/recessions).
• Monetary theory ties changes in the money supply to
changes in aggregate economic activity and to inflation
(changes in the overall price level).
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Average Inflation Rate Versus Average Rate of Money
Growth for Selected Countries, 2006–2016
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Aggregate Price Level and the Money Supply in
the United States, 1960–2017
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Low inflation (or deflation) during recent
recessions despite large monetary stimulus
Money and Interest Rates
Short-term
• Liquidity effect: increase in money supply reduces the
“price” of obtaining funds, thereby lowering short-term
interest rates
Long-term
• Fisher effect: higher money supply (growth) may raise
inflationary expectations and inflation, and thereby increase
interest rates in the long run
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Money Growth (M2 Annual Rate) and Interest Rates
(Long-Term U.S. Treasury Bonds), 1950–2017
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Central Banks
• The Federal Reserve and other central banks control the
availability of money and credit to ensure low inflation, high
growth and stability of the financial system.
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Federal Reserve Board in Washington DC
and the 12 regional Federal Reserve Banks
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Expansionary monetary policy during recessions
Fed’s latest
projections
“Dot plot”
Quantitative Easing following the financial crisis of 2007-8
and the coronavirus pandemic
18-
30
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Fiscal Policy
• Monetary policy refers to the management of the money
supply and interest rates
– conducted by central banks (e.g., the Federal Reserve)
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Federal Government Budget Surplus or Deficit as a Percentage of
Gross Domestic Product
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Federal Debt projected to grow even higher in
the next 30 years
Deficits projected to increase over time
Foreign Exchange Market
• Markets where funds are converted from one currency into
another
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USD appreciated at the start of the coronavirus crisis,
but has depreciated since.
Appendix 1:
Defining Aggregate Output, Income, the Price Level, and
the Inflation Rate
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Real vs. Nominal GDP
GDP is the market value of all final goods and
services produced in a given period in a country.
41
Aggregate Price Level
• The aggregate price level is a measure of average prices
in the economy.
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Calculating the Real Growth Rate and the
Inflation rate
• Growth rate of Real GDP
RGDPt − RGDPt −1
gt = %∆Yt =
RGDPt −1
Pt − Pt −1
π t = %∆Pt =
Pt −1
Business Cycle Fluctuations
The GDP deflator, CPI, and PCE deflator