Mishkin s economics of money, banking and financial markets

Seventh Edition The Addison-Wesley Series in Economics Abel/Bernanke Macroeconomics Bade/Parkin Foundations of Microeconomics Bade/Parkin Foundations of Macroeconomics Bierman/Fernandez Game Theory with Economic Applications Binger/Hoffman Microeconomics with Calculus Boyer Principles of Transportation Economics Branson Macroeconomic Theory and Policy Bruce Public Finance and the American Economy Byrns/Stone Economics Carlton/Perloff Modern Industrial Organization Caves/Frankel/Jones World Trade and Payments: An Introduction Chapman Environmental Economics: Theory, Application, and Policy Cooter/Ulen Law and Economics Downs An Economic Theory of Democracy Eaton/Mishkin Online Readings to Accompany The Economics of Money, Banking, and Financial Markets Ehrenberg/Smith Modern Labor Economics Ekelund/Tollison Economics: Private Markets and Public Choice Fusfeld The Age of the Economist Gerber International Economics Ghiara Learning Economics: A Practical Workbook Gordon Macroeconomics Gregory Essentials of Economics Gregory/Stuart Russian and Soviet Economic Performance and Structure Hartwick/Olewiler The Economics of Natural Resource Use Hubbard Money, the Financial System, and the Economy Hughes/Cain American Economic History Husted/Melvin International Economics Jehle/Reny Advanced Microeconomic Theory Klein Mathematical Methods for Economics Krugman/Obstfeld International Economics: Theory and Policy Laidler The Demand for Money: Theories, Evidence, and Problems Leeds/von Allmen The Economics of Sports Lipsey/Courant/Ragan Economics McCarty Dollars and Sense: An Introduction to Economics Melvin International Money and Finance Miller Economics Today Miller/Benjamin/North The Economics of Public Issues Mills/Hamilton Urban Economics Mishkin The Economics of Money, Banking, and Financial Markets Parkin Economics Parkin/Bade Economics in Action Software Perloff Microeconomics Phelps Health Economics Riddell/Shackelford/Stamos/ Schneider Economics: A Tool for Critically Understanding Society Ritter/Silber/Udell Principles of Money, Banking, and Financial Markets Rohlf Introduction to Economic Reasoning Ruffin/Gregory Principles of Economics Sargent Rational Expectations and Inflation Scherer Industry Structure, Strategy, and Public Policy Schotter Microeconomics: A Modern Approach Stock/Watson Introduction to Econometrics Studenmund Using Econometrics: A Practical Guide Tietenberg Environmental and Natural Resource Economics Tietenberg Environmental Economics and Policy Todaro/Smith Economic Development Waldman/Jensen Industrial Organization: Theory and Practice Williamson Macroeconomics Frederic S Mishkin Columbia University 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 10—DOW—06050403 To Sally CONTENTS IN BRIEF PA RT I Introduction 1 Why Study Money, Banking, and Financial Markets? An Overview of the Financial System 23 What Is Money? 44 PA RT I I 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 PA RT I I I Financial Institutions 167 An Economic Analysis of Financial Structure 169 Banking and the Management of Financial Institutions 201 10 Banking Industry: Structure and Competition 229 11 Economic Analysis of Banking Regulation 260 12 Nonbank Finance 287 13 Financial Derivatives 309 PA RT I V Central Banking and the Conduct of Monetary Policy 333 14 Structure of Central Banks and the Federal Reserve System 335 15 Multiple Deposit Creation and the Money Supply Process 357 16 Determinants of the Money Supply 374 17 Tools of Monetary Policy 393 18 Conduct of Monetary Policy: Goals and Targets 411 PA RT V International Finance and Monetary Policy 433 19 The Foreign Exchange Market 435 20 The International Financial System 462 21 Monetary Policy Strategy: The International Experience 487 vii viii Contents in Brief PA RT V I Monetary Theory 515 22 The Demand for Money 517 23 The Keynesian Framework and the ISLM Model 536 24 Monetary and Fiscal Policy in the ISLM Model 561 25 Aggregate Demand and Supply Analysis 582 26 Transmission Mechanisms of Monetary Policy: The Evidence 603 27 Money and Inflation 632 28 Rational Expectations: Implications for Policy 658 CONTENTS PA RT I Introduction CHAPTER WHY STUDY MONEY, BANKING, AND FINANCIAL MARKETS? Preview Why Study Financial Markets? The Bond Market and Interest Rates The Stock Market The Foreign Exchange Market Why Study Banking and Financial Institutions? Structure of the Financial System Banks and Other Financial Institutions Financial Innovation Why Study Money and Monetary Policy? Money and Business Cycles Money and Inflation 10 Money and Interest Rates 12 Conduct of Monetary Policy 12 Fiscal Policy and Monetary Policy 12 How We Will Study Money, Banking, and Financial Markets 13 Exploring the Web 14 Concluding Remarks 17 Summary, Key Terms, Questions and Problems, and Web Exercises 17 Appendix to Chapter Defining Aggregate Output, Income, the Price Level, and the Inflation Rate 20 Aggregate Output and Income 20 Real Versus Nominal Magnitudes 20 Aggregate Price Level 21 Growth Rates and the Inflation Rate 22 ix x Contents CHAPTER AN OVERVIEW OF THE FINANCIAL SYSTEM 23 Preview 23 Function of Financial Markets 23 Structure of Financial Markets 25 Debt and Equity Markets 25 Primary and Secondary Markets 26 Exchanges and Over-the-Counter Markets 27 Money and Capital Markets 27 Internationalization of Financial Markets 28 International Bond Market, Eurobonds, and Eurocurrencies 28 World Stock Markets 29 Function of Financial Intermediaries 29 Transaction Costs 29 Following the Financial News Foreign Stock Market Indexes 30 Box Global: The Importance of Financial Intermediaries to Securities Markets: An International Comparison 31 Risk Sharing 31 Asymmetric Information: Adverse Selection and Moral Hazard 32 Financial Intermediaries 34 Depository Institutions 34 Contractual Savings Institutions 35 Investment Intermediaries 37 Regulation of the Financial System 37 Increasing Information Available to Investors 39 Ensuring the Soundness of Financial Intermediaries 39 Financial Regulation Abroad 40 Summary, Key Terms, Questions and Problems, and Web Exercises 41 CHAPTER WHAT IS MONEY? 44 Preview 44 Meaning of Money 44 Functions of Money 45 Medium of Exchange 45 Unit of Account 46 Store of Value 47 Evolution of the Payments System 48 Commodity Money 48 Fiat Money 48 Checks 48 Box Global: Birth of the Euro: Will It Benefit Europe? 49 Electronic Payment 50 ... University, John McArthur of Wofford College, and me, which includes chapter synopses and completions, exercises, self-tests, and answers to the exercises and self-tests Readings in Money, Banking, ... and sold for foreign currencies Why Study Banking and Financial Institutions? Part III of this book focuses on financial institutions and the business of banking Banks and other financial institutions... willingness to spend The stock market is also an important factor in business investment decisions, because the price of shares affects the amount of funds that can be raised by selling newly issued stock