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BANKING, AND FINANCIAL MARKETS Te n t h E d i t i o n Frederic S Mishkin Columbia University Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto Delhi Mexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo Editorial Director: Sally Yagan Editor in Chief: Donna Battista Acquisitions Editor: Noel Kamm Seibert Editorial Project Manager: Carolyn Terbush Editorial Assistant: Emily Brodeur VP/Director of Marketing: Patrice Jones Director of Marketing: Maggie Moylan Executive Marketing Manager: Lori DeShazo Marketing Assistant: Kim Lovato Senior Managing Editor: Nancy H Fenton Senior Production Project Manager: Kathryn Dinovo Permissions Project Supervisor: Michael Joyce Senior Manufacturing Buyer: Carol Melville Cover Designer: Jonathan Boylan Text Designer: Cenveo Publisher Services/Nesbitt Graphics, Inc Media Director: Susan Schoenberg Senior Media Producer: Melissa Honig Content Lead, MyEconLab: Noel Lotz Supplements Editors: Alison Eusden and Kathryn Dinovo Full-Service Project Management/Composition: Cenveo Publisher Services/Nesbitt Graphics, Inc Printer/Binder: R R Donnelley/Willard Cover Printer: Lehigh-Phoenix Color/Hagerstown Text Font: ITC Berkeley Oldstyle Std Cover Art: Federal Reserve Seal, Nomad_Soul/Shutterstock; Wall Street Bull, © emin kuliyev/Shutterstock.com; Euro Banknotes, © vinz89/Shutterstock.com; Rubik’s Cube, © Icefields/Dreamstime.com Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on the appropriate page within text or on page C-1 Microsoft® and Windows® are registered trademarks of the Microsoft Corporation in the U.S.A and other countries Screen shots and icons reprinted with permission from the Microsoft Corporation This book is not sponsored or endorsed by or affiliated with the Microsoft Corporation Copyright © 2013, 2010, 2007 by Frederic S Mishkin All rights reserved Manufactured in the United States of America This publication is protected by Copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise To obtain permission(s) to use material from this work, please submit a written request to Pearson Education, Inc., Permissions Department, One Lake Street, Upper Saddle River, New Jersey 07458, or you may fax your request to 201-236-3290 Many of the designations by manufacturers and sellers to distinguish their products are claimed as trademarks Where those designations appear in this book, and the publisher was aware of a trademark claim, the designations have been printed in initial caps or all caps Library of Congress Cataloging-in-Publication Data Mishkin, Frederic S The economics of money, banking & financial markets / Frederic S Mishkin – 10th ed.(and the 3rd ed of the business ed.) p cm Includes bibliographical references and index ISBN 13: 978-0-13-277024-8 (main ed : alk paper) ISBN 10: 0-13-277024-5 (main ed : alk paper) ISBN 13: 978-0-13-274137-8 (business ed : alk paper) ISBN 10: 0-13-274137-7 (business ed : alk paper) Finance Money Banks and banking I Title II Title: The economics of money, banking, and financial markets HG173.M632 2013 332–dc23 2011045340 10 www.pearsonhighered.com ISBN 10: 0-13-277024-5 ISBN 13: 978-0-13-277024-8 To Sally Brief Contents PART INTRODUCTION 1 Why Study Money, Banking, and Financial Markets? 2 An Overview of the Financial System 25 What Is Money? 52 PART FINANCIAL MARKETS PART 161 An Economic Analysis of Financial Structure 162 Financial Crises 185 Banking and the Management of Financial Institutions 213 Economic Analysis of Financial Regulation 242 Banking Industry: Structure and Competition 269 CENTRAL BANKING AND THE CONDUCT OF MONETARY POLICY 13 14 15 16 PART Understanding Interest Rates 66 The Behavior of Interest Rates 88 The Risk and Term Structure of Interest Rates 118 The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis 141 FINANCIAL INSTITUTIONS 10 11 12 PART 65 301 Central Banks and the Federal Reserve System 302 The Money Supply Process 325 The Tools of Monetary Policy 355 The Conduct of Monetary Policy: Strategy and Tactics 380 INTERNATIONAL FINANCE AND MONETARY POLICY 421 17 The Foreign Exchange Market 422 18 The International Financial System 446 PART MONETARY THEORY 19 20 21 22 23 24 25 479 Quantity Theory, Inflation, and the Demand for Money 480 The IS Curve 497 The Monetary Policy and Aggregate Demand Curves 515 Aggregate Demand and Supply Analysis 528 Monetary Policy Theory 570 The Role of Expectations in Monetary Policy 589 Transmission Mechanisms of Monetary Policy 608 vii This page intentionally left blank Contents PART INTRODUCTION CHAP TER Why Study Money, Banking, and Financial Markets? Why Study Financial Markets? The Bond Market and Interest Rates The Stock Market Why Study Financial Institutions and Banking? Structure of the Financial System Financial Crises Banks and Other Financial Institutions Financial Innovation Why Study Money and Monetary Policy? Money and Business Cycles Money and Inflation Money and Interest Rates 10 Conduct of Monetary Policy 10 Fiscal Policy and Monetary Policy 11 Why Study International Finance? 12 The Foreign Exchange Market 12 The International Financial System 14 How We Will Study Money, Banking, and Financial Markets 14 Exploring the Web 15 Collecting and Graphing Data 15 Web Exercises 15 Concluding Remarks 16 Summary 17 • Key Terms 18 • Questions 19 • Applied Problems 20 • Web Exercises 20 • Web References 21 APPEN DIX TO CHA P T E R Defining Aggregate Output, Income, the Price Level, and the Inflation Rate 22 Aggregate Output and Income 22 Real Versus Nominal Magnitudes 22 Aggregate Price Level 23 Growth Rates and the Inflation Rate 24 CHAP TER An Overview of the Financial System 25 Function of Financial Markets 25 Structure of Financial Markets 27 Debt and Equity Markets 27 Primary and Secondary Markets 28 ix ... Miller/Benjamin/North The Economics of Public Issues Mills/Hamilton Urban Economics Mishkin The Economics of Money, Banking, and Financial Markets* The Economics of Money, Banking, and Financial Markets, ... O’Sullivan/Sheffrin/Perez Economics: Principles, Applications and Tools* Bade/Parkin Foundations of Economics* Heilbroner/Milberg The Making of the Economic Society Parkin Economics* Berck/Helfand The Economics of the. .. financial markets / Frederic S Mishkin – 10th ed. (and the 3rd ed of the business ed.) p cm Includes bibliographical references and index ISBN 13: 97 8-0 -1 3-2 7702 4-8 (main ed : alk paper) ISBN 10: 0-1 3-2 7702 4-5