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Visit www.pearson.com/mylab/economics to learn more A01_MISH4200_05_BSE_FM.indd 27/10/17 6:03 PM THE ECONOMICS OF MONEY, BANKING, AND FINANCIAL MARKETS Business School Edition Fifth Edition Frederic S Mishkin Columbia University New York, NY A01_MISH4200_05_BSE_FM.indd 31/10/17 11:13 AM www.ebookslides.com Vice President, Business, Economics, and UK Courseware: Donna Battista Director of Portfolio Management: Adrienne D’Ambrosio Senior Portfolio Manager: Christina Masturzo Editorial Assistant: Courtney Paganelli Vice President, Product Marketing: Roxanne McCarley Senior Product Marketer: Tricia Murphy Product Marketing Assistant: Marianela Silvestri Manager of Field Marketing, Business Publishing: Adam Goldstein Executive Field Marketing Manager: Senior Field Marketing Manager: Carlie Marvel Vice President, Production and Digital Studio, Arts and Business: Etain O’Dea Director of Production, Business: Jeff Holcomb Managing Producer, Business: Alison Kalil Content Producer: Carolyn 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authorization, or promotion of Pearson’s products by the owners of such marks, or any relationship between the owner and Pearson Education, Inc., or its affiliates, authors, licensees, or distributors Cataloging-in-Publication Data is available on file at the Library of Congress 1 17 ISBN 10: 0-13-473420-3 ISBN 13: 978-0-13-473420-0 A01_MISH4200_05_BSE_FM.indd 27/10/17 6:03 PM www.ebookslides.com To Sally A01_MISH4200_05_BSE_FM.indd 27/10/17 6:03 PM www.ebookslides.com This page intentionally left blank A01_MISH4182_11_GE_FM.indd 10/06/15 11:46 am About the Author Frederic S Mishkin is the Alfred Lerner Professor of Banking and Financial Institutions at the Graduate School of Business, Columbia University He is also a Research Associate at the National Bureau of Economic Research, co-director of the U.S Monetary Policy Forum, a member of the Squam Lake Working Group on Financial Reform, and past president of the Eastern Economics Association Since receiving his Ph.D from the Massachusetts Institute of Technology in 1976, he has taught at the University of Chicago, Northwestern University, Princeton University, and Columbia He has also received an honorary professorship from the People’s (Renmin) University of China From 1994 to 1997, he was Executive Vice President and Director of Research at the Federal Reserve Bank of New York and an associate economist of the Federal Open Market Committee of the Federal Reserve System From September 2006 to August 2008, he was a member (governor) of the Board of Governors of the Federal Reserve System Professor Mishkin’s research focuses on monetary policy and its impact on financial markets and the aggregate economy He is the author of more than twenty books, including Macroeconomics: Policy and Practice, Second Edition (Pearson, 2015); Financial Markets and Institutions, Ninth Edition (Pearson, 2018); Monetary Policy Strategy (MIT Press, 2007); The Next Great Globalization: How Disadvantaged Nations Can Harness Their Financial Systems to Get Rich (Princeton University Press, 2006); Inflation Targeting: Lessons from the International Experience (Princeton University Press, 1999); Money, Interest Rates, and Inflation (Edward Elgar, 1993); and A Rational Expectations Approach to Macroeconometrics: Testing Policy Ineffectiveness and Efficient Markets Models (University of Chicago Press, 1983) In addition, he has published more than 200 articles in such journals as American Economic Review, Journal of Political Economy, Econometrica, Quarterly Journal of Economics, Journal of Finance, and Journal of Monetary Economics Professor Mishkin has served on the editorial board of American Economic Review and has been an associate editor at Journal of Business and Economic Statistics, Journal of Applied Econometrics, Journal of Economic Perspectives, Journal of International Money and Finance, and Journal of Money, Credit and Banking; he also served as the editor of the Federal Reserve Bank of New York’s Economic Policy Review He is currently an associate editor (member of the editorial board) at six academic journals, including International Finance; Finance India; Review of Development Finance; Borsa Economic Review; PSU Research Review and Emerging Markets, and Finance and Trade He has been a consultant to the Board of Governors of the Federal Reserve System, the World Bank, and the International Monetary Fund, as well as to many central banks throughout the world He was also a member of the International Advisory Board to the Financial Supervisory Service of South Korea and an advisor to the Institute for Monetary and Economic Research at the Bank of Korea Professor Mishkin was a Senior Fellow at the Federal Deposit Insurance Corporation’s Center for Banking Research and was an academic consultant to and serves on the Economic Advisory Panel and Monetary Advisory Panel of the Federal Reserve Bank of New York vii A01_MISH4200_05_BSE_FM.indd 27/10/17 6:03 PM www.ebookslides.com I-26 Index Nominal interest rates, 82f behavior, 86–112 cash flow transmission mechanism and, 629 defined, 80 interest-rate transmission mechanism and, 624 monetary policy and, 632 real interest rates distinguished, 80–81 Nonaccelerating inflation rate of unemployment (NAIRU), 465 Nonactivists, and monetary policy theory, 602, 604b Nonbank finance finance companies, 304 government financial intermediation, 311–313 hedge funds, 309–310 insurance, 293–301 mutual funds, 307–309 pension funds, 301–304 private equity and venture capital funds, 310–311 securities market operations, 305–307 Web references, 316 Nonbank public, shift from deposit into currency, 392 Nonborrowed monetary base (MBn), 394, 401, 403, 411t Nonborrowed reserves (NBR) supply curve of reserves and, 415 targeting on, 461–462, 461f Nonconventional monetary policy tools in economic revival, 633 during Global Financial Crisis of 2007–2009, 427–434 quantitative easing and, 429, 431, 613–616 response to, 614f Nontradable goods/services, 479 Big Mac example, 480–481 Nontransaction deposits and bank balance sheet, 189f, 190 Notes, credit-linked, 338 Z03_MISH4200_05_BSE_IDX.indd 26 Notional principal, interest-rate swaps and, 334 NOW (negotiated order of withdrawal) accounts, 57 required reserves, 425, 425 n.7 NYSE See New York Stock Exchange (NYSE) O Obama, Barack, administration of, 124–125 Obama Fiscal Stimulus Package (2009), 283, 604b Observability, policy instrument criterion, 463 Off-balance-sheet activities, 209–212, 223, 249–250 defined, 209 Office of Credit Ratings (OCR), 354 Office of Federal Housing Enterprise Oversight (OFHEO), 312b Office of the Comptroller of the Currency (OCC), 43–44, 43t, 226, 227, 238–239, 296, 369 Office of Thrift Supervision (OTS), 260 Offshore deposits, 262, 262 n.3 Oil prices, in 1990s, 623 Okun, Arthur, 591 See also Okun’s law Okun’s law, 591–592, 591 n.7, 592f, 592 n.8 Old Age and Survivors’ Insurance Fund (Social Security), 302–304 On-site examinations, financial institutions, 226 One-period valuation model, 142–143 Open-end mutual funds, 308–309 Open interest, financial futures contracts, 323, 323t Open market operations, 366f, 369, 391–392, 421–423, 422b advantages, 427 defensive, 421 defined, 391 dynamic, 421 effects on federal funds rate, 415–416, 416f European Central Bank, 434 purchase from bank, 391 sale, 391–392 trading desk management, 422b Open market purchase, 391 Open market sale, 391–392 Operating instrument See Policy instrument, choosing Opportunities, unexploited profit, 151–152 Opportunity cost, 103 excess reserves, 414 Optimal forecast, 147 Option contracts American vs European, 327 call option vs put option, 328 profits and losses on, 328–331, 328f Option premiums, 327 factors affecting, 332–333 Options, 327–333 credit, 337 futures See Financial futures options premiums, 332–333 stock, 327 swap, 334 Organization for Economic Cooperation and Development (OECD), 223 Organized exchanges See Exchanges and exchange markets Originate-to-distribute business model, 244 Global Financial Crisis of 2007–2009 and, 275–276 Outflows capital, 517 deposit, 195 Output fluctuations in, inflation targeting and, 449–450 26/10/17 5:31 PM www.ebookslides.com Index I-27 natural rate, 442, 556 potential, 442, 556 Output gap, 464–465, 556– 557, 560t, 561–562, 562f, 591, 591 n.7 Output stability financial stability and, 454 as monetary policy goal, 441–442 Over-the-counter (OTC) markets, 26 foreign exchange market organized as, 476 Overnight cash rate, 434 Oversight, supervisory, 356 Overvaluation of currency, 511 purchasing power parity and, 480–481 P Par value See Face value Paul, Ron, 376 Payment technology, 541 Payments system defined, 53 evolution of, 53–55 Payoff method, FDIC, 218 PCE (personal consumption expenditures) deflator, 20, 452–453, 551b Pecora hearings, 350b “Penny Benny” (Pension Benefit Guarantee Corporation), 302 Pension Benefit Guarantee Corporation (PBGC), 302 Pension funds, 41, 301–304 capital market securities and, 27 insurance companies managing, 294 primary assets and liabilities, 39t share of total financial intermediary assets (1970– 2016), 295t value of assets, 40t Pension plans defined-benefit, 301–302, 302 n.2 Z03_MISH4200_05_BSE_IDX.indd 27 private, 302 public, 302–304 vesting, 302 “Perfect storm,” Global Financial Crisis of 2007–2009 as, 531 Perfect substitutes, bonds, 127, 130, 131 Permanent life insurance, 294 Permanent supply shocks, 572– 575, 574f, 575 n.5 monetary policy response to, 597–598, 597f, 598f Perpetuity bonds See Consol bonds Perpetuity (consol) bonds, 73–74 Persistent output gap, 561–562, 562f Personal consumption expenditures (PCE) deflator, 20, 452–453, 551b Phelps, Edmund, Phillips curve analysis and, 587–589 Phillips, A W., 585 See also Phillips curve Phillips curve, 585–593 See also Short-run aggregate supply curve 1950–1969, 586f 1970–2016, 586f in 1960s, 585–586, 587b with adaptive expectations, 590–591 after 1960s, 589 expectations-augmented, 588–589 Friedman-Phelps analysis, 587–589 long-run, 588f modern, 589–591 rational expectations, 590 n.5 short-run, 588f theory, 464–465 Physical capital, bank balance sheet, 189f Pigou, A C., 534 n.2 Plain vanilla swaps See Interestrate swaps Planned investment spending (I), 550 Policy, monetary See Monetary policy Policy instrument, choosing, 460–462 central bank tools and, 461f criteria for, 462–463 Policy Targets Agreement, 445 Policy trilemma, 514–515, 514f Political business cycle, 377 Portfolio balance effect, 506 n.2 Portfolio choice theory, 88, 543 Portfolio of assets, 36 Portfolio theory, 86 money demand, 542–544 Portugal, sovereign debt crisis, 281b Positive supply shocks, 575, 576f Potential output, 442, 556 Pound, British Brexit and, 474, 493–494, 494f foreign exchange crisis (1992) and, 512–513, 512f PPP (theory of purchasing power parity), 477–478 Precautionary motive, money demand, 541 Predictability, policy instrument criterion, 463 Preferred habitat theory, 131– 134 compared with expectations theory, 132f Premiums option See Option premiums risk-based, 299 Present discounted value See Present value Present value, 64–67 defined, 64–65 President, U.S., Federal Reserve System and, 376–377 Price level See also Aggregate price level unanticipated, as monetary transmission mechanism, 630, 633–634 26/10/17 5:31 PM www.ebookslides.com I-28 Index Price level changes, liquidity preference framework, 106t, 107, 107f Price-level effect, 105, 106t, 109 Price stability, 383 exchange-rate targeting and, 520, 521 financial stability and, 454 mandates for, 443–444 as monetary policy goal, 439–441, 444 monetary transmission mechanisms and, 633–634 nominal anchor role in, 440 time-inconsistency problem in, 440–441 Price stickiness, 558, 624 Prices, 51–52, 51 n.2 residential housing, in Global Financial Crisis of 2007– 2009, 277, 278f, 279 sticky, 558, 624 Primary credit, 423, 423 n.5 Primary Dealer Credit Facility (PDCF), 428, 429b Primary dealers, open market operations, 391, 421 Primary markets, 25–26 See also Investment banks Prime rate, 28b Principal, 65 notional, interest-rate swaps and, 334 Principal–agent problem equity contracts, 175–176, 177 n.4 Global Financial Crisis of 2007–2009 and, 275–276 rogue traders and, 211b solutions, 181t tools for solving, 176–177 Printing money, 539 Private equity firms, and venture capital firms compared, 177 n.3 Private equity funds, 310–311 Private pension plans, 302 Private production, “lemons problem” and, 171 Z03_MISH4200_05_BSE_IDX.indd 28 Privatization, proposals for Social Security, 303b Producer Price Index (PPI), 551b Productivity, foreign exchange rates and, 482–483, 482 n.2, 483 n.3 Profits decline in, banks’ responses to, 249–250 financial innovation and, 239 on options and futures contracts, 328–331, 329f Property and casualty insurance See Casualty insurance companies Provisions, restrictive, in insurance management, 299 Prudential supervision See Financial supervision Public Company Accounting Oversight Board (PCAOB), 228 Public interest view, bureaucratic behavior, 379 Public pension plans federal, 302–303 local, 304 state, 304 Purchase and assumption method, FDIC, 218–219 Purchases, government, 550, 553, 555t Purchasing Power of Money (Fisher), 532–533 Purchasing power parity (PPP) actual exchange rate and, 480–481 Big Mac Index and, 479–481, 480t evidence on, 478–479 exchange rates and, 479 predictive power of, 480 theory, 477–478 United States/United Kingdom (1973–2017), 478f Put option, 328 Q QE2 (Quantitative Easing 2), 430 QE3 (Quantitative Easing 3), 430 Quantitative easing (QE) asset purchases and, 428, 430, 615–616, 616 n.1 credit easing vs, 430–431 in Japan (2013), 617–619, 618f money supply (2007–2017) and, 407–408, 407 n.8 nonconventional monetary policy and, 427–429, 613– 618, 614f Quantitative Easing (QE2), 430 Quantitative Easing (QE3), 430 Quantity theory of money, 534–538 defined, 534 equation of exchange, 533 inflation and, 535–536 price level and, 535 velocity of money and, 533–534 Quotas, 479 R Random walk defined, 152 foreign exchange rates and, 153b stock prices, 152–153 Rate of capital gain, 77 Rate of inflation See Inflation rate Rate of return See Returns Ratings bonds, 119–122, 120t credit See Credit-rating agencies Rational expectations theory, 146–156, 590 n.5 See also Efficient market hypothesis defined, 147 formal statement, 148 implications, 149 rationale behind, 148–149 Reagan, Ronald, administration of, 376 Real business cycle theory, 572–575 Real estate loans bank balance sheet, 189f commercial, 249 Real exchange rate, 477 26/10/17 5:31 PM www.ebookslides.com Index I-29 Real GDP, 20 Real interest rates, 82f calculating, 81 defined, 80 easing of monetary policy and, 624 interest-rate transmission mechanism and, 624 long-term vs short-term, 624, 633 nominal interest rates distinguished, 80–81 Real money balances, 541 Real terms, defined, 80–81 Recessions of 1980, 623 of 1981–1982, 623 defined, global See Global Financial Crisis of 2007–2009 subprime mortgage crisis and See Subprime mortgage crisis (2007–2008) Recognition lag, 602 Redlining, 228 Refinancing operations, 434 Regulation See Financial regulation; specific topics and legislation Regulation B, 228 Regulation K, 263 Regulation Q, 44, 245, 247, 248–249 deposit rate ceilings, 628 Regulatory arbitrage, 223 Reinhart, Carmen, 454 Reinhart, Vincent, 454 Reinsurance, 296 Reinvestment risk, 79 n.6 Relative price levels, foreign exchange rates and, 481 Rents, reputational, 352 Repos See Repurchase agreements Repression, financial, 181 Repurchase agreements, 27t, 28–29, 421 Global Financial Crisis of 2007–2009 and, 279 reverse See Matched salepurchase transaction Z03_MISH4200_05_BSE_IDX.indd 29 Reputational rents, 352 Required reserve ratio (rr), 390, 402, 407 n.8, 411t defined, 191 federal funds rate and, 418 n.3 money multiplier and, 406 Required reserves, 390 as bank asset, 191 demand curve for reserves and, 414 federal funds rate and, 418, 418f Research, by investment banks, 346–347 Reserve Bank of New Zealand Act of 1989, 445 Reserve currency, 510 Reserve Primary Fund, 246b Reserve requirements, 191, 366f See also Required reserve ratio (rr) on checkable deposits, 426, 426 n.7 European Central Bank and, 435 federal funds rate and, 418, 418 n.3, 419f financial innovation and, 245 Reserves bank balance sheet and, 189f, 191 effects of federal funds rate, 418–419, 419f, 420f international, 502, 506, 510, 515 liquidity management and, 195–198 monetary base control and, 391–394 multiple deposit creation and, 395–401 open market operations and, 391–392 supply and demand in market for, 418–419, 419f, 420f T-accounts and, 192–194 Residential housing prices, and Global Financial Crisis of 2007–2009, 277, 278f, 279 Residential mortgages See Mortgages Residual claimants, 25, 141 Resolution authority, under Dodd-Frank bill, 285–286 future directions, 288 Restrictive covenants banks and credit risk management, 205 defined, 167 monitoring and enforcement, 179–180 Restrictive provisions, in insurance management, 299 Return on assets (ROA), 201 Return on equity (ROE), 201 Returns coupon-rate bonds, 78t defined, 75–76 distinguished from interest rates, 75–80, 78t to equity holders, trade-off between safety and, 201–202 expected, domestic and foreign assets compared, 489 n.1, 498–500 Revaluation of currency, 511 Reverse transactions, 434 Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, 221, 232t, 255 Rigidity, inflation targeting and, 449 Risk See also Credit risk; Interest-rate risk banks and banking, 203–209 defined, 36, 87 as determinant of asset demand, 87–88, 88t foreign exchange, 326–327 hedging, 317–318, 326–327 inflation hedges, 543 interest rates, 78–79 money demand and, 543, 544 sharing, 296 shifts in demand for bonds, 93, 94t, 95 systemic regulation, under Dodd-Frank bill, 286 Risk aversion, 88 26/10/17 5:31 PM www.ebookslides.com I-30 Index Risk-based premiums, 299 Risk management, assessment of, 226–227 Risk premium, 118 Risk sharing and indirect finance, 36 Risk structure of interest rates, 117–125 Risky assets, 222 Rogue traders, principal-agent problem and, 211b Rohatyn, Felix, 425b Roosevelt, Franklin Delano, 273–274 Rs (supply curve of reserves), 415 S S & P 500 See Standard and Poor’s (S&P) 500 index S&P 500 index, 416 Sales finance companies, 304 Samuelson, Paul, 455, 587b Sarbanes-Oxley Act of 2002, 32b, 228, 232t, 310, 352–353 evaluating, 357–359 Savings accounts, 49 Savings and loan associations (S&Ls), 39, 260 primary assets and liabilities of, 39t shares, 39 value of assets, 40t Savings deposits defined, 39 interest restrictions, 44 as monetary aggregate component, 57t, 58 Screening, banks and credit risk management, 204 See also Monitoring Seasonal credit, 252, 423 n.5 Seasoned issue, 305 Second Bank of the United States, 237, 364 Secondary credit, 423, 423 n.5 Secondary loan participation See Loan sales Secondary markets, 25–26, 306 See also Foreign exchange market; Z03_MISH4200_05_BSE_IDX.indd 30 NASDAQ; New York Stock Exchange (NYSE) Secondary reserves, 191 “Secular stagnation,” 102 Secured debt, 167 Securities See also Bonds; Investment banks; Underwriting securities as bank assets, 191 bank balance sheet, 189f, 191 behavioral finance, 157–158 brokers and dealers, 26, 306 defined, liquidity, 26 mortgage-backed See Mortgage-backed securities as source of external funding, 165f, 166 Securities Act of 1933, 42, 227, 231t Securities Amendments Act, 307 Securities and Exchange Commission (SEC), 42, 43t, 227 mutual funds and, 309 options markets and, 328 Securities brokers and dealers, 26, 305 Securities Exchange Act of 1934, 231t Securities markets access to, 166 operations, 305–307 Securitization, 249 defined, 243 shadow banking system and, 243–244 subprime mortgages, 275 Security First Network Bank, 242 Segmented markets theory, 130–131 Seignorage, 526 Self-correcting mechanism, 566 zero lower bound and, 612– 613, 613f Separation of functions, 356 Settlement price, 325 Shadow banking system, 239–250, 279–280 See also Financial innovation defined, 239 securitization and, 243–244 Shares See Credit unions; Mutual savings banks; Savings and loan associations (S&Ls); Stocks Shell operations, 262 Shilller, Robert, 157 Shocks, 557 See also Demand shocks; Supply shocks aggregate demand, 566–569 aggregate supply, 569–577 monetary policy response to, 594–602 Short position, 317 Short-run aggregate supply curve, 591–593, 591 n.7 deriving, 593 shifts in, 559–562, 560t, 561f, 562f Short-run equilibrium, 562– 566, 563f Short-run exchange rates, 483–485 demand curve for domestic assets, 483–484 equilibrium in foreign exchange market, 485f expected returns on domestic and foreign assets, 489 n.1, 498–500 interest parity condition and, 500–501 purchasing power parity (PPP) and, 479 supply curve for domestic assets, 483 Short sales, 158 Short-term debt instruments, 25 See also Commercial paper; Money markets; Repurchase agreements Short-term interest rates, expectations theory and, 129, 130 n.3 Simple deposits multiplier, 398–399, 398 n.6 Simple interest rate, 65, 69 Simple loans, 65, 68 yield to maturity, 68–69 26/10/17 5:31 PM www.ebookslides.com Index I-31 Simplified balance sheet, Federal Reserve System, 388–389 Small-denomination time deposits and bank balance sheet, 189f as monetary aggregate component, 57t, 58 Smart cards, 54 Social Security, 302–304 privatization proposals, 303b Socialization, of information production, 357 Société Générale, 211b Solow, Robert, 455, 587b Soros, George, 513 Sound currency, 521 dollarization and, 526 South Korea, government bailout in, 283b Sovereign debt crisis, European, 281b Sovereign wealth funds, 308, 308b Spain government bailout, 283b sovereign debt crisis, 281b Speculative attacks on currency, 512 on foreign currencies, 513 Speculative motive, money demand, 541 Spending government See Government purchases investment See Investment spending Spinning, 347 Spitzer, Eliott, 353 Spot exchange rate, 475, 475b Spot transactions, 475, 475b Stagflation, 571–572, 571f Standard and Poor’s (S&P) 500 index, 34b Standing lending facility, 423, 423 n.6 State banking and insurance commissions, 43t State banks, 238 examining bodies, 226 State-owned banks, 183 Z03_MISH4200_05_BSE_IDX.indd 31 Statistical discrepancy, financial account balance, 507 n.3 Sterilized foreign exchange intervention, 506 defined, 505 portfolio balance effect and, 506 n.2 Sticky prices, 558, 624 Stimulus packages under Bush administration, 283 under Obama administration, 283, 604b Stock exchange See Stock market Stock market, 3–4, 141–146 See also Over-the-counter (OTC) markets; Stock prices; World stock markets adverse selection and, 170 bubbles, 156 computing price of common stock, 141–144 crashes See Stock market declines and crashes investing in, practical guide to, 153–156 “lemons problem,” 170 setting prices, 144–146 Web references, 161 Stock market declines and crashes, 157, 273, 273f See also Financial crises “Black Monday,” 4, 424, 425b in Global Financial Crisis of 2007–2009, 146 in Great Depression, 273–275, 273f Great Depression and See Great Depression of October 2008, 63 Stock options, 327 Stock prices, 144–146 computing, 141–144 in Global Financial Crisis of 2007–2009, 280f in Great Depression, 273–274, 273f investment spending and, 627, 627 n.2 measured by Dow Jones Industrial Average, 5f monetary policy and, 146 reactions to announcements, 155 volatility, 4, 5f Stockholders, 141 Stocks See also Convertible bonds; Dividends; Overthe-counter (OTC) markets; Securities; Stock market as capital market instrument, 29t, 30 defined, 3, 23, 25, 30, 141 exchanges for, 26 generalized dividend valuation model, 143 Gordon growth model, 143–144 investing in See Investing and investments one-period valuation model, 142–143 prices of See Stock prices residual claimants, 141 as source of external funding, 164–165, 165f, 165 n.1 valuation, 142–143 Stocks of assets, 92 Store of value, money as, 52 Stored-value cards, 54 Strait Times Index, 34b Stress tests, 227 annual, under Dodd-Frank bill, 285 Strike price, 327 Structural unemployment, 441, 587 n.4 Structured credit products, 275 Structured investment vehicles (SIVs) See Financial derivatives Subprime mortgage crisis (2007–2008), 63 See also Global Financial Crisis of 2007–2009 consumer protection regulation and, 228 “lender of last resort” and, 220 monetary transmission mechanisms and, 632 24/10/17 5:58 PM www.ebookslides.com I-32 Index Subprime mortgages and Global Financial Crisis of 2007–2009, 275 market for, 244 Sumitomo Corporation, 211b Summers, Lawrence, 102 Super-NOW accounts, required reserves on, 426, 426 n.7 Superregional banks, 254 Supervisory oversight, 356 Supply See also Demand excess supply, 91 of money See Money supply shifts in supply of bonds, 96–102, 96t, 97f shifts in supply of money, 105, 106t shocks in See Supply shocks Supply and demand analysis See also Aggregate demand and supply analysis bond market, 92 of fixed exchange rate regime, 510–512 foreign exchange rate, 483–485 in market for reserves, 413–415 movements along curve, 92 response to business cycle expansion, 100–101, 100f shifts in curve, 92 Supply conditions, financial innovation and, 241–243 Supply curve defined, 90 for domestic assets, 483 for money, 105, 106t movements along, 92 reserves and, 415 shifts in, 96t, 97f Supply shocks, 557 Global Financial Crisis of 2007–2009 and, 280 n.4, 577, 578f negative, 570–572, 571f, 577, 578f permanent, 572–575, 574f, 575 n.5, 597–598, 597f, 598f positive, 575, 576f Z03_MISH4200_05_BSE_IDX.indd 32 temporary, 571f, 599–601, 599f–601f Supply side economic policy, economic growth and, 442 Surplus See Budget deficit or surplus Swap lines, 428, 429b Swaps credit, 337 credit default swaps, 296–297, 337–338 currency, 334 interest-rate See Interest-rate swaps Swaptions, 334 Sweden, government bailout in, 283b Sweep accounts, 247 Systemically important financial institutions (SIFIs), 286 higher capital requirements for, 287 too-big-to-fail problem and, 287 T T-accounts, 192–194 defined, 192 Federal Reserve System, 388–389 liquidity management in banks, 195–198 multiple deposit creation and, 395–397, 400 open market operations and, 391–393 Target financing rate, 434 Tariffs, 479 TARP (Troubled Asset Relief Program), 283 Taxes and tax considerations aggregate demand curve and, 553, 555t fiscal policy and control of government spending and See Fiscal policy international banks as tax havens, 262 securities, buying and selling, 156 n.8 Taylor, John, 276b, 464, 625, 625 n.1 Taylor principle, 464 Taylor rule, 463–465 for federal funds rate, 466b “Teal book,” 373b Temporary supply shocks, 569–572 monetary policy response to, 599–601, 599f–601f Tennessee Valley Authority, 31 Term Asset-Backed Securities Loan Facility (TALF), 428, 429b Term Auction Facility (TAF), 428, 429b Term Securities Lending Facility (TSLF), 428, 429b Term structure of interest rates, 117, 134–135 Term (temporary) life insurance, 294 Terrorist attacks of September 11, 2001, 425b The Economist magazine, 479 Theory of bureaucratic behavior, 379 Federal Reserve communication/transparency and, 380b Theory of efficient capital markets, 149 Theory of purchasing power parity (PPP), 477–478 Theory of rational expectations See Rational expectations theory Thrift institutions (thrifts), 38, 259–261 Tightening of monetary policy, 373 transmission mechanisms and, 632 Time deposits See also Certificates of deposit (CDs) bank balance sheet and, 189f defined, 39 Time-inconsistency problem exchange-rate targeting and, 520, 522, 523 24/10/17 5:58 PM www.ebookslides.com Index I-33 inflation targeting and, 447–448 price stability and, 440–441 TIPS (Treasury Inflation Protection Securities), 543 Tobin, James, 542, 542 n.3, 625 Tobin’s q theory, 625, 626f, 627 Too-big-to-fail problem, government safety net and, 220–221, 287 Trade balance (on goods and services), 507 Trade barriers, foreign exchange rates and, 481–482, 490 Traders, rogue, 211b Trading Activities Manual, 227 Trading desk management, 421–423, 422b Traditional banking decline, 247–250 information technology and, 241–243 in other industrialized countries, 250 in U.S., 247–250, 248f Transaction costs, 34–35, 51, 52 defined, 34 of financial institutions, 167–168 reduction in, 168 Transactions motive, money demand, 541 Transition countries, financial development and economic growth in, 181–183 Transmission, mechanisms of monetary policy See Monetary transmission mechanisms Transparency Federal Reserve System and, 451 inflation targeting and, 447–448 Transparent communication Greenspan and, 375b theory of bureaucratic behavior and, 380b TRAPS (Trading Room Automated Processing System), 421 Z03_MISH4200_05_BSE_IDX.indd 33 Traveler’s checks, 56, 57, 57t Treasury bills See U.S Treasury bills Treasury Inflation Protection Securities (TIPS), 543 Troubled Asset Relief Program (TARP), 283 Trump, Donald, 287–288 Truth in Lending Act, 228 U Uncertainty central bank behavior and, 381, 381 n.5 Federal Reserve’s lack of transparency and, 451 Unconditional commitment, to future policy actions, 432 Underfunded defined-benefit plan, 302 Undervaluation of currency, 510f, 511 purchasing power parity and, 480–481 Underwriting securities, 26, 42, 305, 346–347 Unemployment See also Phillips curve; Short-run aggregate supply curve aggregate output and, 551b frictional, 441, 587 n.4 in Great Depression, 441 in “Great Inflation” (1965– 1982), 608–610, 609f inflation and, 551b, 608– 610, 609f Okun’s law, 591–592, 591 n.7, 592f, 592 n.8 structural, 441, 587 n.4 Volcker disinflation (1980– 1986), 567–569, 568f Web references, 584 Unemployment gap, 588, 591 Unemployment rate defined, natural rate, 441, 556, 587 Unexploited profit opportunities, 151–152 Unit of account, 51–52 United Kingdom Brexit and the British pound, 474, 493–494, 494f central bank of, 383–384 See also Bank of England exchange-rate targeting and, 521, 522 foreign exchange market for British pound (1992), 512–513, 512f Global Financial Crisis of 2007–2009 and, 579–580, 579f government bailout in, 283b inflation targeting in, 446f, 447 purchasing power parity between U.S and (1973– 2017), 478f United States banking industry in, 236– 264 central bank See Federal Reserve System (the Fed) financial crises in See Global Financial Crisis of 2007– 2009; Great Depression; Stock market declines and crashes purchasing power parity between United Kingdom and (1973–2017), 478f Universal banking, 258–259 Universal banks and banking, 348–349 Pecora hearings, 350b Universal life insurance, 294 Unsecured debt, 167 Unsterilized foreign exchange intervention, 505–506, 505f defined, 504 effect on monetary base, 505 n.1 URLs, 15 U.S Congress, Federal Reserve System independence and, 375–378 26/10/17 5:31 PM www.ebookslides.com I-34 Index U.S dollar adoption as second currency, 526 foreign exchange market and, 473 Global Financial Crisis of 2007–2009 and, 492–493, 492f unsterilized purchase, 505f value, 492–493 U.S economy central bank in See Federal Reserve System current account deficit (balance of payments), 506–508 monetary policy and health of See Monetary policy U.S financial system See Financial system U.S government bonds bond market, 26 yield curves for, 136f U.S government intervention, in Global Financial Crisis of 2007–2009, 283–284 AIG insurance, 282, 428, 429b U.S government securities, as capital market instruments, 29t, 31 U.S Treasury deposits at Federal Reserve, 393–394 monetary liability (monetary base) of, 389–390 U.S Treasury bill rate, 28b changes in, stock market crash of 2008, 63 U.S Treasury bills, 27t, 28–29 U.S Treasury bonds, 378, 378 n.4 corporate bonds compared with, 123 n.1 financial futures market in, 324–325 income tax considerations, 123 interest rates discussed in the media, 30b interest rates on, 124f Z03_MISH4200_05_BSE_IDX.indd 34 U.S Treasury securities, Federal Reserve purchase in Global Financial Crisis of 2007– 2009, 430 V Valuation of stocks, 142–143 Value-at-risk (VaR) calculations, 227 Variable life insurance, 294 Vault cash, as bank asset, 191 Velocity of money, 532–534, 545 defined, 533 determinants, 533–534 Venture capital firms, 177 private equity firms compared with, 177 n.3 Venture capital funds, 310–311 Vesting, pension plans, 302 Virtual bank, 242 Volcker, Paul, 363, 374, 376 n.2, 567, 568f Volcker Rule, 286 future directions, 288 W Wall Street Journal See Following the Financial News Wealth defined, 49–50, 87 as determinant of asset demand, 87, 88t as monetary transmission mechanism, effects of, 626f, 627–628 money demand and, 543, 544 shifts in demand for bonds, 93, 94t Web references aggregate demand and supply analysis, 584 banking and management of financial institutions, 216 banking industry, 267 business cycles, 637 central banks, 387 conflicts of interest, 361 efficient market hypothesis, 161 Federal Reserve System, 387, 412 financial crises, 292 financial derivatives, 343 financial regulation, 235 financial system, 48 foreign exchange market, 497 Great Depression, 292 gross domestic product, 622 interest rates, 85, 116, 140 international financial system, 530 Keynes, John Maynard, 549 “lemons problem,” 187 monetary policy, 438, 471 monetary policy theory, 622 monetary transmission mechanisms, 637 money, 62 money, banking, and financial markets, 18 money supply process, 412 nonbank finance, 316 stock market, 161 unemployment, 584 Zimbabwean hyperinflation, 549 Wells Fargo, 242 Whole life insurance, 294 World Bank, 509 deposit insurance research, 219b World stock markets, 33 See also Financial Times Stock Exchange (FTSE) 100Share Index indexes, 34b World Trade Center, terrorist attacks of September 11, 2001, 425b World Trade Organization (WTO), 509 World Wide Web See Internet; Web references Worldwide government bailouts, in global financial crisis, 283b Writer (seller) of option, 327 26/10/17 5:31 PM www.ebookslides.com Index I-35 Y Yellen, Janet, 374 Fed chair style, 374b–375b inflation targeting policy, 452 Yield curves, 133–135, 134f, 135b defined, 125 interpreting, 135–137 U.S government bonds, 136f Yield to maturity, 68–75 See also Interest rates Z03_MISH4200_05_BSE_IDX.indd 35 coupon bonds, 71–74, 72t curve on See Yield curves defined, 64, 68 discount bonds, 74–75 fixed-payment loans, 69–70 simple loans, 68–69 Z Zero-coupon bonds See Discount bonds Zero lower bound deriving aggregate demand curves with, 610, 611f, 612 monetary policy at, 610–619 self-correcting mechanism and, 612–613, 613f Zero-lower-bound problem, 428, 454, 455 Zimbabwean hyperinflation, 540 Web references, 549 24/10/17 5:58 PM www.ebookslides.com This page intentionally left blank A01_MISH4182_11_GE_FM.indd 10/06/15 11:46 am www.ebookslides.com GUIDE TO COMMONLY USED SYMBOLS Symbol Term Δ change in a variable π inflation rate e expected inflation π T inflation target π AD aggregate demand curve AS aggregate supply curve d demand for bonds B s supply of bonds B BR borrowed reserves c currency ratio C yearly coupon payment C currency C consumption expenditure D demand curve D checkable deposits DL discount loans e excess reserves ratio exchange (spot) rate Et par (fixed) exchange rate Epar e (E t+1 - Et)/Et expected appreciation of domestic currency EM equity multiplier ER excess reserves f for financial frictions G government purchases i interest rate (yield to maturity) discount rate id D interest rate on domestic assets i F interest rate on foreign assets i interest rate paid on reserves ior I planned investment spending IS IS curve m money multiplier Z04_MISH4200_05_BSE_BEP.indd Symbol Term M money supply d M demand for money s M supply of money M1 M1 monetary aggregate M2 M2 monetary aggregate MB monetary base (high-powered money) MBn nonborrowed monetary base MP monetary policy curve mpc marginal propensity to consume NBR nonborrowed reserves NX net exports P price level Ps stock prices Pt price of a security at time t ρ price shock r real interest rate rr required reserve ratio for checkable deposits R reserves R return e R expected return D R expected return on domestic deposits F expected return on foreign deposits R ROA return on assets ROE return on equity RR required reserves S supply curve T taxes V velocity of money Y aggregate output (national income) ad Y aggregate demand P Y potential (natural rate level of) output 24/10/17 5:56 PM www.ebookslides.com APPLYING THEORY TO THE REAL WORLD: APPLICATIONS AND BOXES Applications Will Bitcoin Become the Money of the Future?, p 55 Simple Present Value, p 66 How Much Is That Jackpot Worth?, p 66 Yield to Maturity on a Simple Loan, p 68 Yield to Maturity and the Yearly Payment on a FixedPayment Loan, p 70 Yield to Maturity and the Bond Price for a Coupon Bond, p 71 Yield to Maturity on a Perpetuity, p 73 Yield to Maturity on a Discount Bond, p 74 Calculating Real Interest Rates, p 82 Changes in the Interest Rate Due to a Change in Expected Inflation: The Fisher Effect, p 98 Changes in the Interest Rate Due to a Business Cycle Expansion, p 100 Explaining Current Low Interest Rates in Europe, Japan, and the United States: Low Inflation and Secular Stagnation, p 101 Changes in the Equilibrium Interest Rate Due to Changes in Income, the Price Level, or the Money Supply, p 106 Does a Higher Rate of Growth of the Money Supply Lower Interest Rates?, p 110 The Global Financial Crisis and the Baa-Treasury Spread, p 122 Effects of the Obama Tax Increase on Bond Interest Rates, p 124 Interpreting Yield Curves, 1980–2014, p 135 Monetary Policy and Stock Prices, p 146 The Global Financial Crisis and the Stock Market, p 146 Practical Guide to Investing in the Stock Market, p 153 What Do Stock Market Crashes Tell Us About the Efficient Market Hypothesis and the Efficiency of Financial Markets?, p 157 Financial Development and Economic Growth, p 182 Is China a Counterexample to the Importance of Financial Development?, p 183 Strategies for Managing Bank Capital, p 202 How a Capital Crunch Caused a Credit Crunch During the Global Financial Crisis, p 203 Strategies for Managing Interest-Rate Risk, p 209 The Mother of All Financial Crises: The Great Depression, p 273 Insurance Management, p 298 Z04_MISH4200_05_BSE_BEP.indd Hedging with Interest-Rate Forward Contracts, p 318 Hedging with Financial Futures, p 321 Hedging Foreign Exchange Risk, p 326 Hedging with Futures Options, p 331 Hedging with Interest-Rate Swaps, p 335 Lessons from the Global Financial Crisis: When Are Financial Derivatives Likely to Be a Worldwide Time Bomb?, p 338 Evaluating Sarbanes-Oxley, the Global Legal Settlement, and the Dodd-Frank Bill, p 357 Quantitative Easing and the Money Supply 2007–2017, p 407 How the Federal Reserve’s Operating Procedures Limit Fluctuations in the Federal Funds Rate, p 419 Burgernomics: Big Macs and PPP, p 479 Effects of Changes in Interest Rates on the Equilibrium Exchange Rate, p 490 The Global Financial Crisis and the Dollar, p 492 Brexit and the British Pound, p 492 The Foreign Exchange Crisis of September 1992, p 512 How Did China Accumulate $4 Trillion of International Reserves?, p 515 Testing the Quantity Theory of Money, p 536 The Zimbabwean Hyperinflation, p 540 The Volcker Disinflation, 1980–1986, p 567 Negative Demand Shocks, 2001–2004, p 569 Negative Supply Shocks, 1973–1975 and 1978–1980, p 572 Positive Supply Shocks, 1995–1999, p 575 Negative Supply and Demand Shocks and the 2007–2009 Financial Crisis, p 577 The United Kingdom and the 2007–2009 Financial Crisis, p 579 China and the 2007–2009 Financial Crisis, p 580 The Great Inflation, p 608 Nonconventional Monetary Policy and Quantitative Easing, p 613 Abenomics and the Shift in Japanese Monetary Policy in 2013, p 617 The Great Recession, p 632 Applying the Monetary Policy Lessons to Japan’s Two Lost Decades, p 634 Following the Financial News Boxes Money Market Rates, p 28 Capital Market Interest Rates, p 30 26/10/17 4:11 PM www.ebookslides.com Foreign Stock Market Indexes, p 34 The Monetary Aggregates, p 57 Yield Curves, p 125 Foreign Exchange Rates, p 475 Aggregate Output, Unemployment, and Inflation, p 551 Global Boxes Are U.S Capital Markets Losing Their Edge?, p 32 The Importance of Financial Intermediaries Relative to Securities Markets: An International Comparison, p 35 Negative Interest Rates? Japan First, Then the United States, Then Europe, p 76 Should Foreign Exchange Rates Follow a Random Walk?, p 153 Barings, Daiwa, Sumitomo, Société Générale, and JP Morgan Chase: Rogue Traders and the Principal– Agent Problem, p 211 The Spread of Government Deposit Insurance Throughout the World: Is This a Good Thing?, p 219 Where Is the Basel Accord Heading After the Global Financial Crisis?, p 224 International Financial Regulation, p 230 Comparison of Banking Structure in the United States and Abroad, p 256 Ironic Birth of the Eurodollar Market, p 262 The European Sovereign Debt Crisis, p 281 Worldwide Government Bailouts During the 2007–2009 Financial Crisis, p 283 The European Central Bank’s Monetary Policy Strategy, p 453 Should We Worry About the Large U.S Current Account Deficit?, p 508 Will the Euro Survive?, p 516 Argentina’s Currency Board, p 525 Inside the Fed Boxes Was the Fed to Blame for the Housing Price Bubble?, p 278 The Political Genius of the Founders of the Federal Reserve System, p 365 The Special Role of the Federal Reserve Bank of New York, p 368 The Role of the Research Staff, p 371 The FOMC Meeting, p 372 Green, Blue, Teal, and Beige: What Do These Colors Mean at the Fed?, p 373 Z04_MISH4200_05_BSE_BEP.indd Styles of Federal Reserve Chairs: Bernanke and Yellen Versus Greenspan, p 374 The Evolution of the Fed’s Communication Strategy, p 380 A Day at the Trading Desk, p 422 Using Discount Policy to Prevent a Financial Panic, p 425 Fed Lending Facilities During the Global Financial Crisis, p 429 Ben Bernanke’s Advocacy of Inflation Targeting, p 453 The Fed’s Use of the Taylor Rule, p 466 Fed Watchers, p 466 A Day at the Federal Reserve Bank of New York’s Foreign Exchange Desk, p 503 FYI Boxes Are We Headed for a Cashless Society?, p 55 Where Are All the U.S Dollars?, p 58 Conflicts of Interest at Credit-Rating Agencies and the Global Financial Crisis, p 121 The Yield Curve as a Forecasting Tool for Inflation and the Business Cycle, p 135 Should You Hire an Ape as Your Investment Adviser?, p 155 The Enron Implosion, p 172 The Tyranny of Collateral, p 182 Bruce Bent and the Money Market Mutual Fund Panic of 2008, p 246 The Global Financial Crisis and the Demise of Large, Free-Standing Investment Banks, p 259 Collateralized Debt Obligations (CDOs), p 276 The AIG Blowup, p 297 The Global Financial Crisis and the Monoline Insurers, p 298 Should Social Security Be Privatized?, p 303 Sovereign Wealth Funds: Are They a Danger?, p 308 The Global Financial Crisis and the Bailout of Fannie Mae and Freddie Mac, p 312 The Collapse of Arthur Andersen, p 348 Why Do Issuers of Securities Pay to Have Their Securities Rated?, p 349 Banksters, p 350 What Does Autonomous Mean?, p 553 The Phillips Curve Tradeoff and Macroeconomic Policy in the 1960s, p 587 The Activist/Nonactivist Debate Over the Obama Fiscal Stimulus Package, p 604 Consumers’ Balance Sheets and the Great Depression, p 630 24/10/17 5:56 PM www.ebookslides.com This page intentionally left blank A01_MISH4182_11_GE_FM.indd 10/06/15 11:46 am ... Managerial Economics Klein Mathematical Methods for Economics Krugman/Obstfeld/Melitz International Economics: Theory & Policy* Laidler The Demand for Money The Economics of Money, Banking, and Financial. .. comprehensive discussion of monetary theory and monetary policy, The Economics of Money, Banking, and Financial Markets, Twelfth Edition, contains all of the chapters on monetary theory Professors who want... Monetary Theory 531 CHAP T ER 22 Quantity Theory, Inflation, and the Demand for Money? ?? 532 Quantity Theory of Money 532 Velocity of Money and Equation of Exchange 532 From the