Economics of money banking and financial markets

Editor in Chief: Denise Clinton Acquisitions Editor: Victoria Warneck Executive Development Manager: Sylvia Mallory Development Editor: Jane Tufts Production Supervisor: Meredith Gertz Text Design: Studio Montage Cover Design: Regina Hagen Kolenda and Studio Montage Composition: Argosy Publishing Senior Manufacturing Supervisor: Hugh Crawford Senior Marketing Manager: Barbara LeBuhn Cover images: © PhotoDisc Media Producer: Melissa Honig Supplements Editor: Diana Theriault Credits to copyrighted material appear on p C-1, which constitutes a continuation of the copyright page Library of Congress Cataloguing-in-Publication Data Mishkin, Frederic S The economics of money, banking, and financial markets / Frederic S Mishkin.—7th ed p cm — (The Addison-Wesley series in economics) Supplemented by a subscription to a companion web site Includes bibliographical references and index ISBN 0-321-12235-6 Finance Money Banks and banking I Title II Series HG173.M632 2004 332—dc21 2003041912 Copyright © 2004 by Frederic S Mishkin All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher Printed in the United States of America To Sally Introduction Why Study Money, Banking, and Financial Markets? An Overview of the Financial System 23 What Is Money? 44 Financial Markets 59 Understanding Interest Rates 61 The Behavior of Interest Rates 85 The Risk and Term Structure of Interest Rates 120 The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis 141 Financial Institutions 167 An Economic Analysis of Financial Structure 169 Banking and the Management of Financial Institutions 201 Banking Industry: Structure and Competition 229 Economic Analysis of Banking Regulation 260 Nonbank Finance 287 Financial Derivatives 309 Central Banking and the Conduct of Monetary Policy 333 Structure of Central Banks and the Federal Reserve System 335 Multiple Deposit Creation and the Money Supply Process 357 Determinants of the Money Supply 374 Tools of Monetary Policy 393 Conduct of Monetary Policy: Goals and Targets 411 International Finance and Monetary Policy 433 The Foreign Exchange Market 435 The International Financial System 462 Monetary Policy Strategy: The International Experience 487 viii Contents in Brief Monetary Theory 515 The Demand for Money 517 The Keynesian Framework and the ISLM Model 536 Monetary and Fiscal Policy in the ISLM Model 561 Aggregate Demand and Supply Analysis 582 Transmission Mechanisms of Monetary Policy: The Evidence 603 Money and Inflation 632 Rational Expectations: Implications for Policy 658 Introduction CHAPTER WHY STUDY MONEY, BANKING, AND FINANCIAL MARKETS? Appendix to Chapter Defining Aggregate Output, Income, the Price Level, and the Inflation Rate 20 x Contents CHAPTER AN OVERVIEW OF THE FINANCIAL SYSTEM 23 Following the Financial News Foreign Stock Market Indexes 30 The Importance of Financial Intermediaries to Securities Markets: An International Comparison 31 CHAPTER WHAT IS MONEY? 44 Birth of the Euro: Will It Benefit Europe? 49 Contents Why Are Scandinavians So Far Ahead of Americans in Using Electronic Payments? 50 Are We Headed for a Cashless Society? 52 Following the Financial News The Monetary Aggregates 54 Financial Markets 59 CHAPTER UNDERSTANDING INTEREST RATES 61 Negative T-Bill Rates? Japan Shows the Way 69 Application Reading the Wall Street Journal: The Bond Page 72 Following the Financial News Bond Prices and Interest Rates 73 Helping Investors to Select Desired Interest-Rate Risk 79 With TIPS, Real Interest Rates Have Become Observable in the United States 82 CHAPTER THE BEHAVIOR OF INTEREST RATES 85 xi xii Contents Application Changes in the Equilibrium Interest Rate Due to Expected Inflation or Business Cycle Expansions 99 Application Explaining Low Japanese Interest Rates 103 Application Reading the Wall Street Journal “Credit Markets” Column 103 Following the Financial News The “Credit Markets” Column 104 Application Changes in the Equilibrium Interest Rate Due to Changes in Income, the Price Level, or the Money Supply 108 Following the Financial News Forecasting Interest Rates 111 Application Money and Interest Rates 112 CHAPTER THE RISK AND TERM STRUCTURE OF INTEREST RATES 120 Application The Enron Bankruptcy and the Baa-Aaa Spread 124 ... constitutes a continuation of the copyright page Library of Congress Cataloguing-in-Publication Data Mishkin, Frederic S The economics of money, banking, and financial markets / Frederic S Mishkin.—7th... written permission of the publisher Printed in the United States of America To Sally Introduction Why Study Money, Banking, and Financial Markets? An Overview of the Financial System... An Economic Analysis of Financial Structure 169 Banking and the Management of Financial Institutions 201 Banking Industry: Structure and Competition