Economics of Money and Banking ECF3143
Notes
CHAPTER 1: WHY STUDY MONEY, BANKING AND FINANCIAL MARKETS?
• Financial Markets
• Financial Intermediaries
• Importance of Money, Banking and Financial Markets
CHAPTER 2: AN OVERVIEW OF THE FINANCIAL SYSTEM
• Direct vs Indirect Finance
• Structure and Components of the Financial System
• Function of Financial Intermediaries
CHAPTER 3: WHAT IS MONEY?
• Functions of Money
• Different Types of Payment Systems
• Measuring Money
CHAPTER 4: THE MEANING OF INTEREST RATES
• Measuring Interest Rates
• Distinction between interest rates and returns
• Distinction between real and nominal interest rates
CHAPTER 5: THE BEHAVIOUR OF INTEREST RATES
• Determinants of Asset Demand
• Supply and Demand in the bond market
• Supply and Demand in the money market
• Liquidity Preference Framework
• Money and interest rates
CHAPTER 6: RISK AND TERM STRUCTURE OF INTEREST RATES
• Risk Structure of Interest Rates
• Term Structure of Interest Rates
CHAPTER 7: THE STOCK MARKET, THE THEORY OF RATIONAL EXPECTATIONS, AND THE
EFFICIENT MARKET HYPOTHESIS
• Computing the Price of Common stock
• Efficient Market Hypothesis
• Condition of Efficient Market Hypothesis
CHAPTER 12: FINANCIAL CRISIS IN ADVANCED ECONOMIES
• Dynamics of a financial crisis
• Global Financial Crisis
• Stabilising the Global Financial System: Long-term responses
CHAPTER 13: FINANCIAL CRISIS IN EMERGING ECONOMIES
• Dynamics of Financial Crisis in emerging economies
• Preventing Emerging Market Financial Crisis
CHAPTER 14: CENTRAL BANKS
• Origins of the Central Banking System
• The European Central Bank (ECB)
• The Federal Reserve
• Independence of Central Banks
CHAPTER 15: THE MONEY SUPPLY PROCESS
• Three Players in the Money Supply Process
, • Money Multiplier
• Factors that affect the money supply
CHAPTER 16: TOOLS OF MONETARY POLICY
• Market for Reserves and the Federal Funds Rate
• Non-Conventional Monetary Policy Tools
• Conventional Monetary Policy Tools
• Derecognition of Assets
• Accounting for Netting
• Hedge Accounting
• IFRS 7
CHAPTER 17: THE CONDUCT OF MONETARY POLICY: STRATEGY AND TACTICS
• The Price Stability Goal and the Nominal Anchor
• Hierarchical vs Dual Mandates
• Other Goals of Monetary Policy
• Inflation Targeting
• Choosing Policy Instruments
• Repurchase agreements (repos)
CHAPTER 20: QUANTITY THEORY, INFLATION, AND THE DEMAND FOR MONEY
• Quantity Theory of Money
• Keynesian Theories of Money Demand
• Portfolio Theories of Money Demand
CHAPTER 21: THE IS CURVE
• Planned Expenditure and Aggregate Demand
• The Components of Aggregate Demand
• Goods market equilibrium
• Understanding the IS curve
• Factors that shift the IS Curve
CHAPTER 22: THE MONETARY POLICY CURVE AND AGGREGATE DEMAND CURVE
• The MP Curve
• Shifts in the MP Curve
CHAPTER 23: AGGREGATE DEMAND AND SUPPLY ANALYSIS
• The aggregate demand curve
• The aggregate supply curve
• Equilibrium in the AD-AS Model
• Self-Correcting Mechanism
CHAPTER 24: MONETARY POLICY THEORY
• Response of Monetary Policy to Shocks
• Policy Conduct: Rules or Discretion
• How actively should Policymakers try to stabilize economic activity?
• Non-conventional Monetary Policy
• Causes of Monetary Inflationary Policy
• Monetary Policy at a zero-bound
CHAPTER 25: THE ROLE OF EXPECTATIONS IN MONETARY POLICY
• Lucas Critique on Policy Evaluation
• Policy Conduct: Rules or discretion?
• The role of credibility of a nominal anchor
• The Phillips curve
,Week 1: Introduction to Money and the Financial System
Chapter 1: Why study Money, Banking and Financial Markets?
• Key concepts in 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.
A security (financial instrument) is a claim on the issuer’s future income or assets.
• Split into Debt and Equities
A debt security represents money that is borrowed and must be repaid, with conditions depend on
the amount borrowed, the interest rate and the maturity of the debt. Eg. Bond.
Equity securities represent ownership interest held by shareholders in a corporation. Eg. Common
stock and a share of a stock.
Financial intermediaries: institutions that borrow funds from people who have saved and in turn
make loans to people who need funds. Eg. Banks, insurance companies, mutual funds, hedge funds,
pension funds etc.
Financial innovation: The development of new financial products and services.
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.
Importance of money, banking and financial markets
• Understanding monetary policy may help you predict when interest rates will rise or fall,
help you make decisions about whether it is better to borrow now or to wait until later,
know how banks and other financial institutions are managed which may help you get a
better deal when you need to borrow from them and may enable you to make better
investment decisions, whether for yourself or for the company you work for
Chapter 2: An Overview of the Financial System
Compare and contrast direct and indirect finance
• Direct finance: borrowers borrow funds directly from lenders in financial markets by selling
them securities
• Indirect finance: borrowers borrow funds from financial intermediaries who collect money
from lenders.
Function of Financial Markets
, • Performs the essential economic function of channelling funds from households, firms, and
governments that have saved surplus funds by spending less than their income to those that
have a shortage of funds because they wish to spend more than their income.
• Promotes economic efficiency by producing and efficient allocation of capital, which
increases production and efficiency to the overall economy.
• Directly improve the wellbeing of consumers by allowing them to time purchases better…
consumption smoothing
Structure and components of the financial system
Financial markets can be distinguished by the type of security that is being traded…
Debt and Equity Markets
• Debt instruments are a contractual agreement by the borrower to pay the holder of the
instrument fixed dollar amounts at regular intervals (interest and principle payments) until a
specified date (the maturity date), when a final payment is made. Eg. Bonds and mortgages.
• Equities are claims to share in the net income and assets of a business. Owing stock means
that you own a portion of the firm and thus have the right to vote on issues important to the
firm and to elect its directors.
Whether the traded securities are newly issued or not…
• Primary Market is a financial market in which new issues of a security, such as a bond or a
stock, are sold to initial buyers by the corporation or government agency borrowing the
funds.
➢ Primary markets for securities are not well known to the public because selling these
securities to initial buyers usually takes place behind closed doors, and the financial
institution that assists in the initial sale of securities in these markets are investment
banks, whereby they do this in their underwriting process. The investment bank
guarantees a price for a corporation’s securities and then sells them to the public.
• Secondary Market is a financial market in which securities that have been previously issued
can be resold.
➢ Brokers are the agent of investors who match buyers with sellers of securities
➢ Dealers link buyers and sellers by buying and selling securities at stated prices.
➢ Secondary markets are important because they make securities more liquid and
determine the price for newly issues securities. Types of secondary markets are
Over the counter (OTC) markets, and Exchanges.
The maturity of the traded securities…
• Money Market is a financial market in which only short-term debt instruments are traded.
Money market securities tend to be more liquid and traded more frequently, and hence
‘safer’ investments
• Capital Market is the financial market in which longer-term debt and equity instruments are
traded. Capital market securities are often held by financial intermediaries which have little
uncertainty about the amount of funds they will have available in the future.
Function of Financial Intermediaries (Indirect Finance)
• Lower transaction costs: Financial Intermediaries can substantially reduce transaction costs
because they have developed expertise in lowering them and because their large size allows
Notes
CHAPTER 1: WHY STUDY MONEY, BANKING AND FINANCIAL MARKETS?
• Financial Markets
• Financial Intermediaries
• Importance of Money, Banking and Financial Markets
CHAPTER 2: AN OVERVIEW OF THE FINANCIAL SYSTEM
• Direct vs Indirect Finance
• Structure and Components of the Financial System
• Function of Financial Intermediaries
CHAPTER 3: WHAT IS MONEY?
• Functions of Money
• Different Types of Payment Systems
• Measuring Money
CHAPTER 4: THE MEANING OF INTEREST RATES
• Measuring Interest Rates
• Distinction between interest rates and returns
• Distinction between real and nominal interest rates
CHAPTER 5: THE BEHAVIOUR OF INTEREST RATES
• Determinants of Asset Demand
• Supply and Demand in the bond market
• Supply and Demand in the money market
• Liquidity Preference Framework
• Money and interest rates
CHAPTER 6: RISK AND TERM STRUCTURE OF INTEREST RATES
• Risk Structure of Interest Rates
• Term Structure of Interest Rates
CHAPTER 7: THE STOCK MARKET, THE THEORY OF RATIONAL EXPECTATIONS, AND THE
EFFICIENT MARKET HYPOTHESIS
• Computing the Price of Common stock
• Efficient Market Hypothesis
• Condition of Efficient Market Hypothesis
CHAPTER 12: FINANCIAL CRISIS IN ADVANCED ECONOMIES
• Dynamics of a financial crisis
• Global Financial Crisis
• Stabilising the Global Financial System: Long-term responses
CHAPTER 13: FINANCIAL CRISIS IN EMERGING ECONOMIES
• Dynamics of Financial Crisis in emerging economies
• Preventing Emerging Market Financial Crisis
CHAPTER 14: CENTRAL BANKS
• Origins of the Central Banking System
• The European Central Bank (ECB)
• The Federal Reserve
• Independence of Central Banks
CHAPTER 15: THE MONEY SUPPLY PROCESS
• Three Players in the Money Supply Process
, • Money Multiplier
• Factors that affect the money supply
CHAPTER 16: TOOLS OF MONETARY POLICY
• Market for Reserves and the Federal Funds Rate
• Non-Conventional Monetary Policy Tools
• Conventional Monetary Policy Tools
• Derecognition of Assets
• Accounting for Netting
• Hedge Accounting
• IFRS 7
CHAPTER 17: THE CONDUCT OF MONETARY POLICY: STRATEGY AND TACTICS
• The Price Stability Goal and the Nominal Anchor
• Hierarchical vs Dual Mandates
• Other Goals of Monetary Policy
• Inflation Targeting
• Choosing Policy Instruments
• Repurchase agreements (repos)
CHAPTER 20: QUANTITY THEORY, INFLATION, AND THE DEMAND FOR MONEY
• Quantity Theory of Money
• Keynesian Theories of Money Demand
• Portfolio Theories of Money Demand
CHAPTER 21: THE IS CURVE
• Planned Expenditure and Aggregate Demand
• The Components of Aggregate Demand
• Goods market equilibrium
• Understanding the IS curve
• Factors that shift the IS Curve
CHAPTER 22: THE MONETARY POLICY CURVE AND AGGREGATE DEMAND CURVE
• The MP Curve
• Shifts in the MP Curve
CHAPTER 23: AGGREGATE DEMAND AND SUPPLY ANALYSIS
• The aggregate demand curve
• The aggregate supply curve
• Equilibrium in the AD-AS Model
• Self-Correcting Mechanism
CHAPTER 24: MONETARY POLICY THEORY
• Response of Monetary Policy to Shocks
• Policy Conduct: Rules or Discretion
• How actively should Policymakers try to stabilize economic activity?
• Non-conventional Monetary Policy
• Causes of Monetary Inflationary Policy
• Monetary Policy at a zero-bound
CHAPTER 25: THE ROLE OF EXPECTATIONS IN MONETARY POLICY
• Lucas Critique on Policy Evaluation
• Policy Conduct: Rules or discretion?
• The role of credibility of a nominal anchor
• The Phillips curve
,Week 1: Introduction to Money and the Financial System
Chapter 1: Why study Money, Banking and Financial Markets?
• Key concepts in 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.
A security (financial instrument) is a claim on the issuer’s future income or assets.
• Split into Debt and Equities
A debt security represents money that is borrowed and must be repaid, with conditions depend on
the amount borrowed, the interest rate and the maturity of the debt. Eg. Bond.
Equity securities represent ownership interest held by shareholders in a corporation. Eg. Common
stock and a share of a stock.
Financial intermediaries: institutions that borrow funds from people who have saved and in turn
make loans to people who need funds. Eg. Banks, insurance companies, mutual funds, hedge funds,
pension funds etc.
Financial innovation: The development of new financial products and services.
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.
Importance of money, banking and financial markets
• Understanding monetary policy may help you predict when interest rates will rise or fall,
help you make decisions about whether it is better to borrow now or to wait until later,
know how banks and other financial institutions are managed which may help you get a
better deal when you need to borrow from them and may enable you to make better
investment decisions, whether for yourself or for the company you work for
Chapter 2: An Overview of the Financial System
Compare and contrast direct and indirect finance
• Direct finance: borrowers borrow funds directly from lenders in financial markets by selling
them securities
• Indirect finance: borrowers borrow funds from financial intermediaries who collect money
from lenders.
Function of Financial Markets
, • Performs the essential economic function of channelling funds from households, firms, and
governments that have saved surplus funds by spending less than their income to those that
have a shortage of funds because they wish to spend more than their income.
• Promotes economic efficiency by producing and efficient allocation of capital, which
increases production and efficiency to the overall economy.
• Directly improve the wellbeing of consumers by allowing them to time purchases better…
consumption smoothing
Structure and components of the financial system
Financial markets can be distinguished by the type of security that is being traded…
Debt and Equity Markets
• Debt instruments are a contractual agreement by the borrower to pay the holder of the
instrument fixed dollar amounts at regular intervals (interest and principle payments) until a
specified date (the maturity date), when a final payment is made. Eg. Bonds and mortgages.
• Equities are claims to share in the net income and assets of a business. Owing stock means
that you own a portion of the firm and thus have the right to vote on issues important to the
firm and to elect its directors.
Whether the traded securities are newly issued or not…
• Primary Market is a financial market in which new issues of a security, such as a bond or a
stock, are sold to initial buyers by the corporation or government agency borrowing the
funds.
➢ Primary markets for securities are not well known to the public because selling these
securities to initial buyers usually takes place behind closed doors, and the financial
institution that assists in the initial sale of securities in these markets are investment
banks, whereby they do this in their underwriting process. The investment bank
guarantees a price for a corporation’s securities and then sells them to the public.
• Secondary Market is a financial market in which securities that have been previously issued
can be resold.
➢ Brokers are the agent of investors who match buyers with sellers of securities
➢ Dealers link buyers and sellers by buying and selling securities at stated prices.
➢ Secondary markets are important because they make securities more liquid and
determine the price for newly issues securities. Types of secondary markets are
Over the counter (OTC) markets, and Exchanges.
The maturity of the traded securities…
• Money Market is a financial market in which only short-term debt instruments are traded.
Money market securities tend to be more liquid and traded more frequently, and hence
‘safer’ investments
• Capital Market is the financial market in which longer-term debt and equity instruments are
traded. Capital market securities are often held by financial intermediaries which have little
uncertainty about the amount of funds they will have available in the future.
Function of Financial Intermediaries (Indirect Finance)
• Lower transaction costs: Financial Intermediaries can substantially reduce transaction costs
because they have developed expertise in lowering them and because their large size allows
