The Economics Of Money, Banking, And Financial Markets, Thirteenth Edition
By Frederic S. Mishkin
Contents in Detail:
PART 1 Introduction 49
CHAPTER 1
Why Study Money, Banking, and Financial Markets? 50
1.1 Why Study Financial Markets? ………………………………………………………………………………….50
Debt Markets and Interest Rates ……………………………………………………………………………….51
The Stock Market …………………………………………………………………………………………………..51
1.2 Why Study Financial Institutions and Banking? ……………………………………………………..53
Structure of the Financial System ……………………………………………………………………………..54
Banks and Other Financial Institutions ………………………………………………………………………54
Financial Innovation ………………………………………………………………………………………………54
Financial Crises ……………………………………………………………………………………………………..55
1.3 Why Study Money and Monetary Policy? ………………………………………………………………55
Money and Business Cycles ……………………………………………………………………………………..55
Money and Inflation ……………………………………………………………………………………………….56
Money and Interest Rates …………………………………………………………………………………………58
Conduct of Monetary Policy …………………………………………………………………………………….58
Fiscal Policy and Monetary Policy ……………………………………………………………………………..59
1.4 Why Study International Finance? …………………………………………………………………………..60
The Foreign Exchange Market ………………………………………………………………………………….61
The International Financial System ……………………………………………………………………………62
1.5 Money, Banking, and Financial Markets and Your Career ……………………………………62
1.6 How We Will Study Money, Banking, and Financial Markets ………………………………63
Concluding Remarks ………………………………………………………………………………………………………….64
Summary 64 • Key Terms 64 • Questions 64 • Applied Problems 65 •
Data Analysis Problems 66
APPENDIX TO CHAPTER 1
Defining Aggregate Output, Income, the Price Level,
and the Inflation Rate 67
Aggregate Output and Income………………………………………………………………………………………….67
Real Versus Nominal Magnitudes…………………………………………………………………………………….67
Aggregate Price Level………………………………………………………………………………………………………….68
Growth Rates and the Inflation Rate…………………………………………………………………………………69
CHAPTER 2
An Overview of the Financial System 70
2.1 Function of Financial Markets ………………………………………………………………………………….70
2.2 Structure of Financial Markets ………………………………………………………………………………….73
Debt and Equity Markets …………………………………………………………………………………………73
Primary and Secondary Markets ……………………………………………………………………………….73
Exchanges and Over-the-Counter Markets ………………………………………………………………….74
Money and Capital Markets ……………………………………………………………………………………..75
2.3 Financial Market Instruments …………………………………………………………………………………..75
Money Market Instruments ……………………………………………………………………………………..75
Following the Financial News Money Market Rates 76
Capital Market Instruments ……………………………………………………………………………………..77
Following the Financial News Capital Market Interest Rates 78
2.4 Internationalization of Financial Markets ……………………………………………………………….79
Global Are U.S. Capital Markets Losing Their Edge? 80
International Bond Market, Eurobonds, and Eurocurrencies …………………………………………80
World Stock Markets ………………………………………………………………………………………………81
2.5 Function of Financial Intermediaries: Indirect Finance ………………………………………..81
Following the Financial News Foreign Stock Market Indexes 82
Transaction Costs …………………………………………………………………………………………………..82
Global The Importance of Financial Intermediaries Relative to Securities Markets:
An International Comparison 83
Risk Sharing ………………………………………………………………………………………………………….84
Asymmetric Information: Adverse Selection and Moral Hazard ……………………………………..84
Economies of Scope and Conflicts of Interest ……………………………………………………………..86
2.6 Types of Financial Intermediaries …………………………………………………………………………….86
Depository Institutions ……………………………………………………………………………………………86
Contractual Savings Institutions ……………………………………………………………………………….88
Investment Intermediaries ……………………………………………………………………………………….89
2.7 Regulation of the Financial System ………………………………………………………………………….90
Increasing Information Available to Investors ………………………………………………………………90
Ensuring the Soundness of Financial Intermediaries …………………………………………………….91
Financial Regulation Abroad …………………………………………………………………………………….93
Summary 93 • Key Terms 94 • Questions 94 • Applied Problems 95 •
Data Analysis Problems 96
CHAPTER 3
What Is Money? 97
3.1 Meaning of Money …………………………………………………………………………………………………….97
3.2 Functions of Money …………………………………………………………………………………………………..98
Medium of Exchange ………………………………………………………………………………………………98
Unit of Account ……………………………………………………………………………………………………..99
Store of Value ………………………………………………………………………………………………………100
3.3 Evolution of the Payments System …………………………………………………………………………101
Commodity Money ………………………………………………………………………………………………101
Fiat Money ………………………………………………………………………………………………………….101
Checks ……………………………………………………………………………………………………………….101
Electronic Payment ……………………………………………………………………………………………….102
E-Money …………………………………………………………………………………………………………….102
FYI Are We Headed for a Cashless Society? 103
APPLICATION Will Bitcoin or Other Cryptocurrencies Become
the Money of the Future?……………………………………………………………………….103
3.4 Measuring Money …………………………………………………………………………………………………….104
The Federal Reserve’s Monetary Aggregates ………………………………………………………………105
Following the Financial News The Monetary Aggregates 105
FYI Where Are All the U.S. Dollars? 106
Summary 107 • Key Terms 108 • Questions 108 • Applied Problems 109 •
Data Analysis Problems 110
PART 2 Financial Markets 111
CHAPTER 4
The Meaning of Interest Rates 112
4.1 Measuring Interest Rates …………………………………………………………………………………………112
Present Value ……………………………………………………………………………………………………….113
APPLICATION Simple Present Value ………………………………………………………………114
APPLICATION How Much Is That Jackpot Worth? ………………………………………….115
Four Types of Credit Market Instruments …………………………………………………………………115
Yield to Maturity ………………………………………………………………………………………………….116
APPLICATION Yield to Maturity on a Simple Loan ………………………………………….116
APPLICATION Yield to Maturity and the Yearly Payment on a
Fixed-Payment Loan ……………………………………………………………………………..118
APPLICATION Yield to Maturity and Bond Price for a Coupon Bond …………………119
APPLICATION Yield to Maturity on a Perpetuity ……………………………………………..121
APPLICATION Yield to Maturity on a Discount Bond ………………………………………122
4.2 The Distinction Between Interest Rates and Returns …………………………………………..123
Global Negative Interest Rates? Japan First, Then the United States,
Then Europe 124
Maturity and the Volatility of Bond Returns: Interest-Rate Risk …………………………………….126
Summary …………………………………………………………………………………………………………….127
4.3 The Distinction Between Real and Nominal Interest Rates ………………………………..128
APPLICATION Calculating Real Interest Rates …………………………………………………129
Summary 131 • Key Terms 131 • Questions 131 • Applied Problems 132 •
Data Analysis Problems 133
CHAPTER 4 APPENDIX
Measuring Interest-Rate Risk: Duration
Go to MyLab Economics
CHAPTER 5
The Behavior of Interest Rates 134
5.1 Determinants of Asset Demand ……………………………………………………………………………..134
Wealth ………………………………………………………………………………………………………………..135
Expected Returns …………………………………………………………………………………………………135
Risk ……………………………………………………………………………………………………………………135
Liquidity …………………………………………………………………………………………………………….136
Theory of Portfolio Choice …………………………………………………………………………………….136
5.2 Supply and Demand in the Bond Market ……………………………………………………………..137
Demand Curve …………………………………………………………………………………………………….137
Supply Curve ………………………………………………………………………………………………………138
Market Equilibrium ………………………………………………………………………………………………139
Supply and Demand Analysis …………………………………………………………………………………140
5.3 Changes in Equilibrium Interest Rates …………………………………………………………………..140
Shifts in the Demand for Bonds ………………………………………………………………………………140
Shifts in the Supply of Bonds …………………………………………………………………………………144
APPLICATION Changes in the Interest Rate Due to a Change in
Expected Inflation: The Fisher Effect ……………………………………………………..146
APPLICATION Changes in the Interest Rate Due to a Business Cycle Expansion….148
APPLICATION Explaining Current Low Interest Rates in Europe, Japan,
and the United States: Low Inflation and Secular Stagnation ……………………..149
5.4 Supply and Demand in the Market for Money:
The Liquidity Preference Framework ……………………………………………………………………..150
5.5 Changes in Equilibrium Interest Rates in the Liquidity
Preference Framework ……………………………………………………………………………………………..153
Shifts in the Demand for Money ……………………………………………………………………………..153
Shifts in the Supply of Money ………………………………………………………………………………..153
APPLICATION Changes in the Equilibrium Interest Rate Due to
Changes in Income, the Price Level, or the Money Supply ………………………..154
Changes in Income ……………………………………………………………………………………………….155
Changes in the Price Level ……………………………………………………………………………………..155
Changes in the Money Supply ………………………………………………………………………………..155
5.6 Money and Interest Rates ……………………………………………………………………………………….156
APPLICATION Does a Higher Rate of Growth of the
Money Supply Lower Interest Rates? ………………………………………………………158
Summary 161 • Key Terms 161 • Questions 161 • Applied Problems 162 •
Data Analysis Problems 163
CHAPTER 5 APPENDIX
Loanable Funds Framework
Go to MyLab Economics
CHAPTER 6
The Risk and Term Structure of Interest Rates 165
6.1 Risk Structure of Interest Rates ……………………………………………………………………………….165
Default Risk …………………………………………………………………………………………………………166
FYI Conflicts of Interest at Credit-Rating Agencies and the Global Financial Crisis 169
APPLICATION The Coronavirus Pandemic and the Baa–Treasury Spread ……………170
Liquidity …………………………………………………………………………………………………………….170
Income Tax Considerations ……………………………………………………………………………………171
Summary …………………………………………………………………………………………………………….172
APPLICATION Effects of the Trump Tax Cuts on Bond Interest Rates ………………..172
6.2 Term Structure of Interest Rates ……………………………………………………………………………..173
Following the Financial News Yield Curves 173
Expectations Theory ……………………………………………………………………………………………..175
Segmented Markets Theory ……………………………………………………………………………………178
Liquidity Premium and Preferred Habitat Theories …………………………………………………….179
Evidence on the Term Structure ……………………………………………………………………………..182
FYI The Yield Curve as a Forecasting Tool for Inflation and the Business Cycle 183
Summary …………………………………………………………………………………………………………….183
APPLICATION Interpreting Yield Curves, 1980–2020 ………………………………………183
Summary 185 • Key Terms 185 • Questions 185 • Applied Problems 187 •
Data Analysis Problems 187
CHAPTER 7
The Stock Market, the Theory of Rational Expectations,
and the Efficient Market Hypothesis 189
7.1 Computing the Price of Common Stock ……………………………………………………………….189
The One-Period Valuation Model ……………………………………………………………………………190
The Generalized Dividend Valuation Model ………………………………………………………………191
The Gordon Growth Model ……………………………………………………………………………………191
7.2 How the Market Sets Stock Prices ………………………………………………………………………….192
APPLICATION Monetary Policy and Stock Prices …………………………………………….194
APPLICATION The Coronavirus Stock Market Crash of 2020 ……………………………194
7.3 The Theory of Rational Expectations ……………………………………………………………………..194
Formal Statement of the Theory ……………………………………………………………………………..196
Rationale Behind the Theory ………………………………………………………………………………….196
Implications of the Theory …………………………………………………………………………………….197
7.4 The Efficient Market Hypothesis: Rational Expectations in Financial Markets …198
Rationale Behind the Hypothesis …………………………………………………………………………….199
Random-Walk Behavior of Stock Prices ……………………………………………………………………200
Global Should Foreign Exchange Rates Follow a Random Walk? 201
APPLICATION Practical Guide to Investing in the Stock Market ………………………..201
How Valuable Are Reports Published by Investment Advisers? …………………………………….201
Should You Be Skeptical of Hot Tips? ………………………………………………………………………202
FYI Should You Hire an Ape as Your Investment Adviser? 203
Do Stock Prices Always Rise When There Is Good News? ……………………………………………203
Efficient Market Prescription for the Investor …………………………………………………………….203
7.5 Why the Efficient Market Hypothesis Does Not Imply That
Financial Markets Are Efficient ………………………………………………………………………………..204
APPLICATION What Do Stock Market Crashes Tell Us
About the Efficient Market Hypothesis and the Efficiency
of Financial Markets? ……………………………………………………………………………205
7.6 Behavioral Finance …………………………………………………………………………………………………..205
Summary 206 • Key Terms 207 • Questions 207 • Applied Problems 208 •
Data Analysis Problems 209
PART 3 Financial Institutions 211
CHAPTER 8
An Economic Analysis of Financial Structure 212
8.1 Basic Facts About Financial Structure Throughout The World …………………………..212
8.2 Transaction Costs ………………………………………………………………………………………………………215
How Transaction Costs Influence Financial Structure …………………………………………………215
How Financial Intermediaries Reduce Transaction Costs …………………………………………….216
8.3 Asymmetric Information: Adverse Selection and Moral Hazard ……………………….217
8.4 The Lemons Problem: How Adverse Selection Influences Financial Structure .217
Lemons in the Stock and Bond Markets ……………………………………………………………………218
Tools to Help Solve Adverse Selection Problems ………………………………………………………..219
FYI The Enron Implosion 220
8.5 How Moral Hazard Affects the Choice Between Debt and Equity Contracts …..223
Moral Hazard in Equity Contracts: The Principal–Agent Problem …………………………………223
Tools to Help Solve the Principal–Agent Problem ………………………………………………………224
8.6 How Moral Hazard Influences Financial Structure in Debt Markets …………………226
Tools to Help Solve Moral Hazard in Debt Contracts ………………………………………………….226
Summary …………………………………………………………………………………………………………….228
APPLICATION Financial Development and Economic Growth ………………………….229
FYI The Tyranny of Collateral 230
APPLICATION Is China a Counterexample to the Importance of Financial
Development? ………………………………………………………………………………………231
Summary 232 • Key Terms 233 • Questions 233 • Applied Problems 234 •
Data Analysis Problems 235
CHAPTER 9
Banking and the Management of Financial Institutions 236
9.1 The Bank Balance Sheet …………………………………………………………………………………………..236
Liabilities …………………………………………………………………………………………………………….236
Assets …………………………………………………………………………………………………………………239
9.2 Basic Banking …………………………………………………………………………………………………………….240
9.3 General Principles of Bank Management ……………………………………………………………..243
Liquidity Management and the Role of Reserves ………………………………………………………..243
Asset Management ………………………………………………………………………………………………..246
Liability Management ……………………………………………………………………………………………247
Capital Adequacy Management ………………………………………………………………………………248
APPLICATION Strategies for Managing Bank Capital ……………………………………….250
APPLICATION How a Capital Crunch Caused a Credit Crunch During the
Global Financial Crisis ………………………………………………………………………….251
9.4 Managing Credit Risk ……………………………………………………………………………………………….251
Screening and Monitoring ……………………………………………………………………………………..252
Long-Term Customer Relationships …………………………………………………………………………253
Loan Commitments ………………………………………………………………………………………………254
Collateral and Compensating Balances …………………………………………………………………….254
Credit Rationing …………………………………………………………………………………………………..254
9.5 Managing Interest-Rate Risk …………………………………………………………………………………..255
Gap and Duration Analysis …………………………………………………………………………………….256
APPLICATION Strategies for Managing Interest-Rate Risk …………………………………257
9.6 Off-Balance-Sheet Activities ……………………………………………………………………………………257
Loan Sales …………………………………………………………………………………………………………..258
Generation of Fee Income ……………………………………………………………………………………..258
Trading Activities and Risk Management Techniques ………………………………………………….258
Global Barings, Daiwa, Sumitomo, Société Générale, and JP Morgan Chase:
Rogue Traders and the Principal–Agent Problem 259
Summary 260 • Key Terms 261 • Questions 261 • Applied Problems 262 •
Data Analysis Problem 263
CHAPTER 9 APPENDIX 1
Duration Gap Analysis
Go to MyLab Economics
CHAPTER 9 APPENDIX 2
Measuring Bank Performance
Go to MyLab Economics
CHAPTER 10
Economic Analysis of Financial Regulation 264
10.1 Asymmetric Information as a Rationale for Financial Regulation …………………..264
Government Safety Net …………………………………………………………………………………………264
Global The Spread of Government Deposit Insurance Throughout the World:
Is This a Good Thing? 266
Drawbacks of the Government Safety Net ………………………………………………………………..267
10.2 Types of Financial Regulation ……………………………………………………………………………….269
Restrictions on Asset Holdings ……………………………………………………………………………….269
Capital Requirements ……………………………………………………………………………………………270
Global Where Is the Basel Accord Heading After the Global Financial Crisis? 271
Prompt Corrective Action ………………………………………………………………………………………272
Financial Supervision: Chartering and Examination …………………………………………………..272
Assessment of Risk Management …………………………………………………………………………….273
Disclosure Requirements ……………………………………………………………………………………….274
Consumer Protection …………………………………………………………………………………………….275
Restrictions on Competition …………………………………………………………………………………..275
Summary …………………………………………………………………………………………………………….276
Global International Financial Regulation 277
Summary 279 • Key Terms 280 • Questions 280 • Applied Problems 281 •
Data Analysis Problems 281
CHAPTER 10 APPENDIX
Banking Crises Throughout the World
Go to MyLab Economics
CHAPTER 11
Banking Industry: Structure and Competition 283
11.1 Historical Development of the Banking System ………………………………………………..283
Multiple Regulatory Agencies …………………………………………………………………………………285
11.2 Financial Innovation and the Growth of the “Shadow Banking System” ………..286
Responses to Changes in Demand Conditions: Interest-Rate Volatility …………………………..287
Responses to Changes in Supply Conditions: Information Technology ………………………….288
Securitization and the Shadow Banking System …………………………………………………………290
Avoidance of Existing Regulations …………………………………………………………………………..292
FYI Bruce Bent and the Money Market Mutual Fund Panic of 2008 294
Financial Innovation and the Decline of Traditional Banking ……………………………………….294
11.3 Structure of the U.S. Commercial Banking Industry ………………………………………….297
Restrictions on Branching ………………………………………………………………………………………299
Response to Branching Restrictions …………………………………………………………………………299
11.4 Bank Consolidation and Nationwide Banking …………………………………………………..300
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ……………………..302
What Will the Structure of the U.S. Banking Industry Look Like in the Future? ……………..302
Global Comparison of Banking Structure in the United States and Abroad 303
Are Bank Consolidation and Nationwide Banking Good Things? ………………………………….303
11.5 Separation of Banking and Other Financial Service Industries ………………………..304
Erosion of Glass-Steagall ………………………………………………………………………………………..304
The Gramm-Leach-Bliley Financial Services Modernization Act of 1999: Repeal of
Glass-Steagall ………………………………………………………………………………………………….305
Implications for Financial Consolidation ………………………………………………………………….305
Separation of Banking and Other Financial Services Industries Throughout the World ……305
FYI The Global Financial Crisis and the Demise of Large, Free-Standing
Investment Banks 306
11.6 Thrift Industry: Regulation and Structure ……………………………………………………………306
Savings and Loan Associations ………………………………………………………………………………..307
Mutual Savings Banks ……………………………………………………………………………………………307
Credit Unions ………………………………………………………………………………………………………307
11.7 International Banking …………………………………………………………………………………………….308
Eurodollar Market ………………………………………………………………………………………………..308
Global Ironic Birth of the Eurodollar Market 309
Structure of U.S. Banking Overseas ………………………………………………………………………….309
Foreign Banks in the United States ………………………………………………………………………….310
Summary 311 • Key Terms 312 • Questions 312 • Data Analysis Problems 313
CHAPTER 12
Financial Crises in Advanced Economies 315
Global The European Sovereign Debt Crisis 316
12.1 What is a Financial Crisis? ……………………………………………………………………………………..316
12.2 Dynamics of Financial Crises ………………………………………………………………………………..317
Stage One: Initial Phase …………………………………………………………………………………………317
Stage Two: Banking Crisis ………………………………………………………………………………………319
Stage Three: Debt Deflation ……………………………………………………………………………………321
APPLICATION The Mother of All Financial Crises: The Great Depression ………….321
The U.S. Stock Market Crash ………………………………………………………………………………….321
Worldwide Decline in Asset Prices …………………………………………………………………………..321
Bank Failures ……………………………………………………………………………………………………….323
Economic Contraction and Debt Deflation ……………………………………………………………….323
12.3 The Global Financial Crisis of 2007–2009 …………………………………………………………..323
Causes of the 2007–2009 Financial Crisis ………………………………………………………………..324
FYI Collateralized Debt Obligations (CDOs) and Credit Default Swaps 325
Effects of the 2007–2009 Financial Crisis …………………………………………………………………326
Inside the Fed Was the Fed to Blame for the Housing Price Bubble? 327
Height of the 2007–2009 Financial Crisis ………………………………………………………………..330
APPLICATION Could the Coronavirus Pandemic Have Led to a Financial Crisis?……..332
12.4 Government Intervention and the Recovery ……………………………………………………..333
Short-Term Responses and Recovery ……………………………………………………………………….333
Global Latvia’s Different and Controversial Response: Expansionary Contraction 334
12.5 Stabilizing the Global Financial System: Long-Term Responses ………………………334
Global Financial Regulatory Framework …………………………………………………………………..334
Policy Areas at the National Level ……………………………………………………………………………335
FYI The LIBOR Scandal 337
12.6 Future Regulations and Policy Areas at the International Level ………………………337
Bilateral and Multilateral Supervisory Cooperation …………………………………………………….338
Collective Supervisory Cooperation …………………………………………………………………………338
Collectively Coordinated Macroeconomic Stability Plans …………………………………………….338
Self-Discipline ……………………………………………………………………………………………………..338
Summary 339 • Key Terms 340 • Questions 340 • Data Analysis Problems 341
CHAPTER 13
Financial Crises in Emerging Market Economies 342
13.1 Dynamics of Financial Crises in Emerging Market Economies ……………………… 342
Stage One: Initial Phase………………………………………………………………………………………… 343
Stage Two: Currency Crises…………………………………………………………………………………… 346
Stage Three: Full-Fledged Financial Crisis……………………………………………………………….. 347
APPLICATION Crisis in South Korea, 1997–1998…………………………………………… 348
Financial Liberalization and Globalization Mismanaged…………………………………………….. 349
Perversion of the Financial Liberalization and Globalization Process: Chaebols and the
South Korean Crisis…………………………………………………………………………………………. 350
Stock Market Decline and Failure of Firms Increase Uncertainty…………………………………. 352
Adverse Selection and Moral Hazard Problems Worsen and the Economy Contracts………. 353
Currency Crisis Ensues………………………………………………………………………………………… 353
Final Stage: Currency Crisis Triggers Full-Fledged Financial Crisis……………………………… 353
Recovery Commences………………………………………………………………………………………….. 355
Global China and the “Noncrisis” in 1997–1998 355
APPLICATION The Argentine Financial Crisis, 2001–2002……………………………… 356
Severe Fiscal Imbalances………………………………………………………………………………………. 356
Adverse Selection and Moral Hazard Problems Worsen……………………………………………… 356
Bank Panic Begins……………………………………………………………………………………………….. 357
Currency Crisis Ensues………………………………………………………………………………………… 357
Currency Crisis Triggers Full-Fledged Financial Crisis………………………………………………. 357
Recovery Begins………………………………………………………………………………………………….. 359
Global When an Advanced Economy Is Like an Emerging Market Economy:
The Icelandic Financial Crisis of 2008 360
13.2 Preventing Emerging Market Financial Crises…………………………………………………… 361
Beef Up Prudential Regulation and Supervision of Banks…………………………………………… 361
Encourage Disclosure and Market-Based Discipline…………………………………………………… 362
Limit Currency Mismatch……………………………………………………………………………………… 362
Sequence Financial Liberalization…………………………………………………………………………… 362
Summary 363 • Key Terms 363 • Questions 363 • Data Analysis Problems 364
PART 4 Central Banking and the Conduct of Monetary Policy 365
CHAPTER 14
Central Banks 366
14.1 Origins of the Central Banking System ………………………………………………………………..366
Global Who Should Own Central Banks? 367
14.2 Variations in the Functions and Structures of Central Banks ……………………………368
The European Central Bank, the Euro System, and the European System
of Central Banks ………………………………………………………………………………………………368
Decision-making Bodies of the ECB ………………………………………………………………………..369
How Monetary Policy Is Conducted within the ECB …………………………………………………..372
Global The Importance of the Bundesbank within the ECB 372
Global Are Non-Euro Central Banks Constrained by Membership of the EU? 374
The Federal Reserve System ……………………………………………………………………………………374
Difference between the ECB and the Fed ………………………………………………………………….375
The Bank of England …………………………………………………………………………………………….376
Global Brexit and the BoE 376
14.3 Structure of Central Banks of Larger Economies ……………………………………………….377
The Bank of Canada ……………………………………………………………………………………………..377
The Bank of Japan ………………………………………………………………………………………………..378
The People’s Bank of China …………………………………………………………………………………….379
14.4 Structure and Independence of Central Banks of Emerging
Market Economies …………………………………………………………………………………………………380
14.5 Central Banks Independence ……………………………………………………………………………….380
The Case for Independence ……………………………………………………………………………………381
The Case against Independence ………………………………………………………………………………381
The Trend toward Greater Independence ………………………………………………………………….381
Summary 382 • Key Terms 383 • Questions 383 • Data Analysis Problems 383
CHAPTER 15
The Money Supply Process 384
15.1 Three Players in the Money Supply Process ……………………………………………………….384
15.2 The Fed’s Balance Sheet ………………………………………………………………………………………..385
Liabilities …………………………………………………………………………………………………………….385
Assets …………………………………………………………………………………………………………………386
15.3 Control of the Monetary Base ………………………………………………………………………………387
Federal Reserve Open Market Operations …………………………………………………………………387
Shifts from Deposits into Currency ………………………………………………………………………….388
Loans to Financial Institutions ………………………………………………………………………………..389
Other Factors That Affect the Monetary Base …………………………………………………………….390
Overview of the Fed’s Ability to Control the Monetary Base …………………………………………390
15.4 Multiple Deposit Creation: A Simple Model ………………………………………………………391
Deposit Creation: The Single Bank ………………………………………………………………………….391
Deposit Creation: The Banking System …………………………………………………………………….392
Deriving the Formula for Multiple Deposit Creation ………………………………………………….395
Critique of the Simple Model …………………………………………………………………………………396
15.5 Factors that Determine the Money Supply ………………………………………………………..397
Changes in the Nonborrowed Monetary Base, MBn …………………………………………………….397
Changes in Borrowed Reserves, BR, from the Fed ………………………………………………………397
Changes in the Required Reserve Ratio, rr ………………………………………………………………..397
Changes in Excess Reserves ……………………………………………………………………………………398
Changes in Currency Holdings ……………………………………………………………………………….398
15.6 Overview of the Money Supply Process ……………………………………………………………..398
15.7 The Money Multiplier ……………………………………………………………………………………………399
Deriving the Money Multiplier ……………………………………………………………………………….399
Intuition Behind the Money Multiplier …………………………………………………………………….401
Money Supply Response to Changes in the Factors …………………………………………………….402
APPLICATION Quantitative Easing and the Money Supply During the
Global Financial and the Coronavirus Crises……………………………………………403
Summary 405 • Key Terms 406 • Questions 406 • Applied Problems 407 •
Data Analysis Problems 408
CHAPTER 15 APPENDIX 1
The Fed’s Balance Sheet and the Monetary Base
Go to MyLab Economics
CHAPTER 15 APPENDIX 2
The M2 Money Multiplier
Go to MyLab Economics
CHAPTER 15 APPENDIX 3
Explaining the Behavior of the Currency Ratio
Go to MyLab Economics
CHAPTER 15 APPENDIX 4
The Great Depression Bank Panics, 1930–1933, and the Money Supply
Go to MyLab Economics
CHAPTER 16
Tools of Monetary Policy 409
16.1 The Market for Reserves and the Federal Funds Rate ……………………………………….409
Demand and Supply in the Market for Reserves ………………………………………………………..410
How Changes in the Tools of Monetary Policy Affect the Federal Funds Rate …………………411
APPLICATION How the Federal Reserve’s Operating Procedures Limit
Fluctuations in the Federal Funds Rate …………………………………………………..415
16.2 Conventional Monetary Policy Tools …………………………………………………………………..416
Open Market Operations ……………………………………………………………………………………….417
Inside the Fed A Day at the Trading Desk 418
Discount Policy and the Lender of Last Resort …………………………………………………………..419
Inside the Fed Using Discount Policy to Prevent a Financial Panic 421
Reserve Requirements ……………………………………………………………………………………………422
Interest on Excess Reserves …………………………………………………………………………………….422
16.3 Nonconventional Monetary Policy Tools and Quantitative Easing in the
Wake of the Global Financial Crisis and the Coronavirus Pandemic ………………..423
Liquidity Provision ……………………………………………………………………………………………….423
Large-Scale Asset Purchases ……………………………………………………………………………………424
Inside the Fed Fed Lending Facilities During the Global Financial and
Coronavirus Crises 425
Quantitative Easing Versus Credit Easing ………………………………………………………………….426
Forward Guidance ………………………………………………………………………………………………..428
Negative Interest Rates on Banks’ Deposits ……………………………………………………………….429
16.4 Monetary Policy Tools of the European Central Bank ………………………………………430
Open Market Operations ……………………………………………………………………………………….430
Lending to Banks ………………………………………………………………………………………………….431
Interest on Excess Reserves …………………………………………………………………………………….431
Reserve Requirements ……………………………………………………………………………………………431
Summary 431 • Key Terms 432 • Questions 432 • Applied Problems 433 •
Data Analysis Problems 434
CHAPTER 17
The Conduct of Monetary Policy: Strategy and Tactics 435
17.1 The Price Stability Goal and the Nominal Anchor …………………………………………….435
The Role of a Nominal Anchor ……………………………………………………………………………….436
The Time-Inconsistency Problem ……………………………………………………………………………436
17.2 Other Goals of Monetary Policy …………………………………………………………………………..437
High Employment and Output Stability …………………………………………………………………..437
Economic Growth ………………………………………………………………………………………………..438
Stability of Financial Markets …………………………………………………………………………………438
Interest-Rate Stability …………………………………………………………………………………………….438
Stability in Foreign Exchange Markets ……………………………………………………………………..439
17.3 Should Price Stability be the Primary Goal of Monetary Policy? …………………….439
Hierarchical Versus Dual Mandates ………………………………………………………………………….439
Price Stability as the Primary, Long-Run Goal of Monetary Policy …………………………………440
17.4 Inflation Targeting ………………………………………………………………………………………………….440
Inflation Targeting in New Zealand, Canada, and the United Kingdom …………………………441
Advantages of Inflation Targeting ……………………………………………………………………………443
Disadvantages of Inflation Targeting ………………………………………………………………………..445
17.5 The Evolution of the Federal Reserve’s Monetary Policy Strategy …………………..446
The Fed’s “Just Do It” Monetary Policy Strategy …………………………………………………………446
The Long Road to Inflation Targeting ………………………………………………………………………448
Inside the Fed Ben Bernanke’s Advocacy of Inflation Targeting 449
Global The European Central Bank’s Monetary Policy Strategy 449
17.6 Lessons for Monetary Policy Strategy from the Global Financial Crisis ………….450
Implications for Inflation Targeting …………………………………………………………………………451
Inside the Fed The Fed’s New Monetary Policy Strategy: Average Inflation
Targeting 452
17.7 Should Central Banks Try to Stop Asset-Price Bubbles? ……………………………………453
Two Types of Asset-Price Bubbles …………………………………………………………………………….453
The Debate over Whether Central Banks Should Try to Pop Bubbles …………………………….454
17.8 Tactics: Choosing the Policy Instrument ……………………………………………………………..457
Criteria for Choosing the Policy Instrument ……………………………………………………………..459
17.9 Tactics: The Taylor Rule ………………………………………………………………………………………….460
Inside the Fed The Fed’s Use of the Taylor Rule 462
Summary 463 • Key Terms 464 • Questions 464 • Applied Problems 465 •
Data Analysis Problems 465
CHAPTER 17 APPENDIX 1
Monetary Targeting
Go to MyLab Economics
CHAPTER 17 APPENDIX 2
A Brief History of Federal Reserve Policymaking
Go to MyLab Economics
PART 5 International Finance and Monetary Policy 467
CHAPTER 18
The Foreign Exchange Market 468
18.1 Foreign Exchange Market ……………………………………………………………………………………..468
Following the Financial News Foreign Exchange Rates 469
What Are Foreign Exchange Rates? ………………………………………………………………………….469
Why Are Exchange Rates Important? ……………………………………………………………………….469
How Is Foreign Exchange Traded? …………………………………………………………………………..470
18.2 Exchange Rates in the Long Run ………………………………………………………………………….471
Theory of Purchasing Power Parity ………………………………………………………………………….471
APPLICATION Burgernomics: Big Macs and PPP …………………………………………….473
Factors That Affect Exchange Rates in the Long Run …………………………………………………..475
18.3 Exchange Rates in the Short Run: A Supply and Demand Analysis ………………..477
Supply Curve for Domestic Assets …………………………………………………………………………..477
Demand Curve for Domestic Assets …………………………………………………………………………478
Equilibrium in the Foreign Exchange Market ……………………………………………………………479
18.4 Explaining Changes in Exchange Rates ……………………………………………………………….479
Shifts in the Demand for Domestic Assets ………………………………………………………………..479
Recap: Factors That Change the Exchange Rate …………………………………………………………482
APPLICATION Effects of Changes in Interest Rates on the Equilibrium
Exchange Rate ……………………………………………………………………………………..484
APPLICATION The Global Financial Crisis and the Dollar ……………………………….486
APPLICATION Brexit and the British Pound ……………………………………………………487
Summary 488 • Key Terms 489 • Questions 489 • Applied Problems 490 •
Data Analysis Problems 490
APPENDIX TO CHAPTER 18
The Interest Parity Condition
Go to MyLab Economics
CHAPTER 19
The International Financial System 491
19.1 Intervention in the Foreign Exchange Market ……………………………………………………491
Foreign Exchange Intervention and the Money Supply ……………………………………………….491
Global Variation in Central Banks’ Activism and Method of Intervention on
Foreign Exchange Markets 492
Unsterilized Intervention ……………………………………………………………………………………….494
Sterilized Intervention …………………………………………………………………………………………..495
19.2 Balance of Payments ……………………………………………………………………………………………..495
Current Account ………………………………………………………………………………………………….496
Financial Account ………………………………………………………………………………………………..496
Global Should We Worry About the Large and Recurrent Trade Deficit? 497
19.3 Exchange Rate Regimes in the International Financial System ……………………….498
Gold Standard ……………………………………………………………………………………………………..498
The Bretton Woods System …………………………………………………………………………………….498
How a Fixed Exchange Rate Regime Works ………………………………………………………………499
Speculative Attacks ……………………………………………………………………………………………….501
APPLICATION The Foreign Exchange Crisis of September 1992 ……………………….501
The Policy Trilemma ……………………………………………………………………………………………..503
APPLICATION How Did China Accumulate $4 Trillion of International Reserves? ……..504
Monetary Unions ………………………………………………………………………………………………….504
Managed Float ……………………………………………………………………………………………………..505
Global Will the Euro Survive? 505
19.4 Capital Controls ……………………………………………………………………………………………………..506
Controls on Capital Outflows …………………………………………………………………………………506
Controls on Capital Inflows …………………………………………………………………………………..506
19.5 The Role of the IMF ……………………………………………………………………………………………….507
Should the IMF Act as an International Lender of Last Resort? …………………………………….507
19.6 International Considerations and Monetary Policy …………………………………………..508
Direct Effects of the Foreign Exchange Market on Monetary Policy ……………………………….508
Exchange Rate Considerations ………………………………………………………………………………..509
19.7 To PEG or Not to Peg: Exchange-Rate Targeting as an Alternative
Monetary Policy Strategy …………………………………………………………………………………………509
Advantages of Exchange-Rate Targeting ……………………………………………………………………509
Disadvantages of Exchange-Rate Targeting ………………………………………………………………..510
When Is Exchange-Rate Targeting Desirable for Industrialized Countries? ……………………..512
When Is Exchange-Rate Targeting Desirable for Emerging Market Countries? ………………..513
Currency Boards …………………………………………………………………………………………………..513
Global Argentina’s Currency Board 514
Dollarization ……………………………………………………………………………………………………….514
Summary 515 • Key Terms 516 • Questions 516 • Applied Problems 517 •
Data Analysis Problems 518
PART 6 Monetary Theory 519
CHAPTER 20
Quantity Theory, Inflation, and the Demand for Money 520
20.1 Quantity Theory of Money …………………………………………………………………………………..520
Velocity of Money and Equation of Exchange ……………………………………………………………520
From the Equation of Exchange to the Quantity Theory of Money ……………………………….522
Quantity Theory and the Price Level ……………………………………………………………………….522
Quantity Theory and Inflation ……………………………………………………………………………….523
APPLICATION Testing the Quantity Theory of Money ……………………………………..524
20.2 Budget Deficits and Inflation ………………………………………………………………………………..526
Government Budget Constraint ………………………………………………………………………………526
FYI Modern Monetary Theory 528
Hyperinflation ……………………………………………………………………………………………………..528
APPLICATION The Zimbabwean Hyperinflation ……………………………………………..529
20.3 Keynesian Theories of Money Demand ……………………………………………………………..529
Transactions Motive ………………………………………………………………………………………………530
Precautionary Motive …………………………………………………………………………………………….530
Speculative Motive ……………………………………………………………………………………………….530
Putting the Three Motives Together …………………………………………………………………………530
20.4 Portfolio Theories of Money Demand ………………………………………………………………..531
Theory of Portfolio Choice and Keynesian Liquidity Preference ……………………………………531
Other Factors That Affect the Demand for Money ………………………………………………………532
Summary …………………………………………………………………………………………………………….532
20.5 Empirical Evidence on the Demand for Money ………………………………………………..533
Interest Rates and Money Demand ………………………………………………………………………….533
Stability of Money Demand ……………………………………………………………………………………534
Summary 534 • Key Terms 535 • Questions 535 • Applied Problems 536 •
Data Analysis Problems 537
CHAPTER 21
The IS Curve 538
21.1 Planned Expenditure and Aggregate Demand …………………………………………………..538
21.2 The Components of Aggregate Demand ……………………………………………………………539
Consumption Expenditure …………………………………………………………………………………….539
FYI Meaning of the Word Investment 540
Planned Investment Spending ………………………………………………………………………………..540
Government Purchases and Taxes ……………………………………………………………………………542
Net Exports …………………………………………………………………………………………………………543
21.3 Goods Market Equilibrium ……………………………………………………………………………………544
Solving for Goods Market Equilibrium …………………………………………………………………….544
Deriving the IS Curve ……………………………………………………………………………………………545
21.4 Understanding the IS Curve ………………………………………………………………………………….545
What the IS Curve Tells Us: Intuition ………………………………………………………………………545
What the IS Curve Tells Us: Numerical Example ……………………………………………………….545
Why the Economy Heads Toward Equilibrium ………………………………………………………….547
21.5 Factors that Shift the IS Curve ………………………………………………………………………………547
Changes in Government Purchases ………………………………………………………………………….547
APPLICATION The Vietnam War Buildup, 1964–1969 ……………………………………..548
Changes in Taxes ………………………………………………………………………………………………….549
APPLICATION The Fiscal Stimulus Package of 2009 ………………………………………..550
Changes in Autonomous Spending ………………………………………………………………………….551
Changes in Financial Frictions ……………………………………………………………………………….553
Summary of Factors That Shift the IS Curve ……………………………………………………………..553
Summary 553 • Key Terms 553 • Questions 554 • Applied Problems 555 •
Data Analysis Problems 556
CHAPTER 22
The Monetary Policy and Aggregate Demand Curves 557
22.1 The Federal Reserve and Monetary Policy …………………………………………………………557
22.2 The Monetary Policy Curve ………………………………………………………………………………….558
Why the Monetary Policy Curve Has an Upward Slope……………………………………………….558
Shifts in the MP Curve …………………………………………………………………………………………..559
Movements Along Versus Shifts in the MP Curve ……………………………………………………….560
APPLICATION Movements Along the MP Curve: The Rise in the Federal
Funds Rate Target, 2004–2006 and 2015–2019 ………………………………………..561
APPLICATION Shift in the MP Curve: Autonomous Monetary Easing During
the Global Financial and Coronavirus Crises …………………………………………..561
22.3 The Aggregate Demand Curve ……………………………………………………………………………..562
Deriving the Aggregate Demand Curve Graphically ……………………………………………………563
FYI Deriving the Aggregate Demand Curve Algebraically 563
Factors That Shift the Aggregate Demand Curve ………………………………………………………..565
Summary 568 • Key Terms 568 • Questions 568 • Applied Problems 570 •
Data Analysis Problems 571
CHAPTER 23
Aggregate Demand and Supply Analysis 572
23.1 Business Cycles and Inflation ……………………………………………………………572
Business Cycles …………………………………………………………………572
Inflation ………………………………………………………………………………575
23.2 Aggregate Demand ………………………………………………………………576
Components of Aggregate Demand …………………………………………………………………………576
Following the Financial News Aggregate Output, Unemployment, and Inflation 576
Deriving the Aggregate Demand Curve …………………………………………………………………….577
Factors That Shift the Aggregate Demand Curve ………………………………………………………..577
FYI What Does Autonomous Mean? 578
23.3 Aggregate Supply ………………………………………………………….581
Long-Run Aggregate Supply Curve ………………………………………………………………………….581
Short-Run Aggregate Supply Curve …………………………………………………………………………582
Price Stickiness and the Short-Run Aggregate Supply Curve ………………………………………..584
23.4 Shifts in the Aggregate Supply Curves …………………………………………………………………584
Shifts in the Long-Run Aggregate Supply Curve ………………………………………………………..584
Shifts in the Short-Run Aggregate Supply Curve ………………………………………………………..585
23.5 Equilibrium in Aggregate Demand and Supply Analysis ………………………………….588
Short-Run Equilibrium ………………………………………………………………………………………….589
Aggregate Demand and Supply Analysis Using an Aggregate Output Index ……………………589
How the Short-Run Equilibrium Moves to the Long-Run Equilibrium over Time ……………590
Self-Correcting Mechanism …………………………………………………..593
23.6 Changes in Equilibrium: Aggregate Demand Shocks ………………………………………..593
APPLICATION The Volcker Disinflation, 1980–1986 ……………………………………….595
23.7 Changes in Equilibrium: Aggregate Supply (Inflation) Shocks …………………………596
APPLICATION Negative Supply Shocks, 1973–1975 and 1978–1980 …………………598
23.8 Conclusions from Aggregate Demand and Supply Analysis ……………………………599
APPLICATION AD/AS Analysis of the Great Recession of 2007–2009 …………………600
APPLICATION An AD/AS Analysis of the Covid-19 Recession …………………………..601
Summary 604 • Key Terms 604 • Questions 605 • Applied Problems 605 •
Data Analysis Problems 606
APPENDIX TO CHAPTER 23
The Phillips Curve and the Short-Run Aggregate Supply Curve 607
23.A1 The Phillips Curve……………………………………………………607
Phillips Curve Analysis in the 1960s………………………………………………………………………..607
The Friedman-Phelps Phillips Curve Analysis……………………………………………………………608
FYI The Phillips Curve Trade-Off and Macroeconomic Policy in the 1960s 609
The Phillips Curve After the 1960s…………………………………………………………………………..611
The Modern Phillips Curve…………………………………………………………………………………….611
The Modern Phillips Curve with Adaptive (Backward-Looking) Expectations…………………612
23.A2 The Short-Run Aggregate Supply Curve……………………………………………………………613
CHAPTER 23 APPENDIX 1
The Effects of Macroeconomic Shocks on Asset Prices
Go to MyLab Economics
CHAPTER 23 APPENDIX 2
Aggregate Demand and Supply: A Numerical Example
Go to MyLab Economics
CHAPTER 24
Monetary Policy Theory 615
24.1 Response of Monetary Policy to Shocks …………………………………………………………….615
Response to an Aggregate Demand Shock …………………………………………………………………616
Response to a Supply Shock …………………………………………………………………………………..617
The Bottom Line: The Relationship Between Stabilizing Inflation and
Stabilizing Economic Activity …………………………………………………………………………….620
24.2 How Actively Should Policymakers Try to Stabilize Economic Activity? ………..621
Lags and Policy Implementation ……………………………………………………………………………..622
FYI The Activist/Nonactivist Debate over the Obama Fiscal Stimulus Package 623
24.3 Inflation: Always and Everywhere a Monetary Phenomenon ………………………….623
24.4 Causes of Inflationary Monetary Policy ………………………………………………………………624
High Employment Targets and Inflation …………………………………………………………………..625
APPLICATION The Great Inflation ………………………………………………………………..628
24.5 Monetary Policy at the Effective Lower Bound ………………………………………………….630
Deriving the Aggregate Demand Curve with the Effective Lower Bound ………………………..630
The Disappearance of the Self-Correcting Mechanism at the Effective Lower Bound ………..632
APPLICATION Nonconventional Monetary Policy and Quantitative Easing ………..633
Liquidity Provision ……………………………………………………………………………………………….634
Asset Purchases and Quantitative Easing ………………………………………………………………….635
Management of Expectations ………………………………………………………………………………….636
APPLICATION Abenomics and the Shift in Japanese Monetary Policy in 2013 …….636
Summary 639 • Key Terms 639 • Questions 639 • Applied Problems 640 •
Data Analysis Problems 641
CHAPTER 25
The Role of Expectations in Monetary Policy 642
25.1 Lucas Critique of Policy Evaluation ……………………………………………………………………..642
Econometric Policy Evaluation ……………………………………………………………………………….643
APPLICATION The Term Structure of Interest Rates ………………………………………..643
25.2 Policy Conduct: Rules or Discretion? …………………………………………………………………..644
Discretion and the Time-Inconsistency Problem ………………………………………………………..644
Types of Rules ………………………………………………………………………………………………………645
The Case for Rules ………………………………………………………………………………………………..645
FYI The Political Business Cycle and Richard Nixon 646
The Case for Discretion …………………………………………………………………………………………646
Constrained Discretion ………………………………………………………………………………………….647
Global The Demise of Monetary Targeting in Switzerland 647
25.3 The Role of Credibility and a Nominal Anchor ………………………………………………….648
Benefits of a Credible Nominal Anchor …………………………………………………………………….648
Credibility and Aggregate Demand Shocks ……………………………………………………………….649
Credibility and Aggregate Supply Shocks …………………………………………………………………651
APPLICATION A Tale of Three Oil Price Shocks ……………………………………………..652
Credibility and Anti-Inflation Policy ………………………………………………………………………..654
Global Ending the Bolivian Hyperinflation: A Successful Anti-Inflation Program 655
25.4 Approaches to Establishing Central Bank Credibility ………………………………………..656
Nominal GDP Targeting ………………………………………………………………………………………..656
Appoint “Conservative” Central Bankers …………………………………………………………………..657
Inside the Fed The Appointment of Paul Volcker, Anti-Inflation Hawk 657
Summary 658 • Key Terms 658 • Questions 659 • Applied Problems 660 • Data Analysis Problems 660
CHAPTER 26
Transmission Mechanisms of Monetary Policy 661
26.1 Transmission Mechanisms of Monetary Policy ……………………..662
Traditional Interest-Rate Channels ………………………………………662
Other Asset Price Channels ……………………..663
Credit View …………………………………………666
FYI Consumers’ Balance Sheets and the Great Depression 669
Why Are Credit Channels Likely to Be Important? …………………670
APPLICATION The Great Recession …………………….670
26.2 Lessons for Monetary Policy ……………………………………….671
APPLICATION Applying the Monetary Policy Lessons to Japan’s Two Lost Decades …….672
Summary 673 • Key Terms 673 • Questions 674 • Applied Problems 675 • Data Analysis Problems 675
Chapter 26 APPENDIX
Evaluating Empirical Evidence: The Debate Over the Importance of Money in
Economic Fluctuations
Go to MyLab Economics
Glossary ………………………………………..677
Index ………………………………………….689