chap01 Why Study Money,Banking and Financial Markets

Why Study Money, Banking, and Financial Markets To examine how financial markets such as bond, stock and foreign exchange markets work To examine how financial institutions such as banks and insurance companies work To examine the role of money in the economy

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Financial Markets Markets in which funds are transferred from people who have an excess of available funds to people who have a shortage of funds

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The Bond Market and Interest Rates A security (financial instrument) is a claim on the issuer’s future income or assets A bond is a debt security that promises to make payments periodically for a specified period of time An interest rate is the cost of borrowing or the price paid for the rental of funds

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FIGURE 1 Interest Rates on

Selected Bonds, 1950–2008

Sources: Federal Reserve Bulletin; www.federalreserve.gov/releases/H15/data.htm.

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The Stock Market Common stock represents a share of ownership in a corporation A share of stock is a claim on the earnings and assets of the corporation

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FIGURE 2 Stock Prices as Measured by the Dow Jones Industrial Average, 1950–2008

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Financial Institutions and Banking Financial Intermediaries: institutions that borrow funds from people who have saved and make loans to other people:– Banks: accept deposits and make loans – Other Financial Institutions: insurance companies, finance companies, pension funds, mutual funds and investment banks

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Financial Crises Financial crises are major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms.

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Money and Business Cycles Evidence suggests that money plays an important role in generating business cycles Recessions (unemployment) and expansions affect all of us Monetary Theory ties changes in the money supply to changes in aggregate economic activity and the price level

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FIGURE 4 Aggregate Price Level and the Money Supply in the United States, 1950– 2008

Sources: http://www.77cn.com.cn/fred/data/gdp/gdpdef; www.federalreserve.gov/r

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Money and Inflation The aggregate price level is the average price of goods and services in an economy A continual rise in the price level (inflation) affects all economic players Data shows a connection between the money supply and the price level

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FIGURE 5 Average Inflation Rate Versus Average Rate of Money Growth for Selected Countries, 1997–2007

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FIGURE 6 Money Growth (M2 Annual Rate) and Interest Rates (Long-Term U.S. Treasury Bonds), 1950–2008

Sources: Federal Reserve Bulletin, p. A4, Table 1.10; www.federalreserve.gov/releases/h6/hist/h6hist1.txt.

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Money and Interest Rates Interest rates are the price of money Prior to 1980, the rate of money growth and the interest rate on long-term Treasury bonds were closely tied Since then, the relationship is less clear but the rate of money growth is still an important determinant of interest rates

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FIGURE 7 Government Budget Surplus or Deficit as a Percentage of Gross Domestic Product, 1950–2008

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