chapter 1 (money & banking)

8/17/2019 Chapter 1 (Money & Banking)

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MGEC71: Chapter 1

Why Study Money, Banking,

and Financial Markets


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Why Study Money, Banking, and Financial Markets

1.1 Why Study Financial Markets

1.2 Why Study Banking & Financial Institutions

1.3 Why Study Money & Monetary Policy

1.4 Ho We Will Study Money! Banking! andFinancial Markets

Chapter 1 - ist o! "opics


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Why Study Financial Markets#

1. Financial "arkets channel #unds #ro"sa$ers to in$estors %#ro" those ho ha$e an ecess o#a$aila'le #unds to (eo(le ho ha$e a shortage)! there'y

(ro"oting econo"ic e##iciency

2. Financial "arkets are a key #actor in(roducing econo"ic groth

3. Financial "arkets a##ect (ersonal ealthand 'eha$iour o# 'usinesses


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Financial Securities - $ssets

* security %#inancial instru"ent) is aclai" on the issuer+s #uture inco"e or

assets

* #inancial asset is any #inancial clai"

that is su',ect to onershi(


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"he Bond Market % &nterest 'ates

* (ond is a de't security that(ro"ises (eriodic (ay"ents #or a

s(eci#ied ti"e %the 'ond "arket is

here interest rates are deter"ined)

*n interest rate is the cost o#

'orroing %or the (rice (aid on therental o# #unds)


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High interest rates could deter (urchases! orin$est"ent! and encourage sa$ings

/i##erent interest rates ha$e a tendency to

"o$e in unison %Figure 1-1)! (erha(s'ecause o# this correlation o# interest rates

econo"ists #re0uently lu"( interest rates

together and re#er to the+ interest rate

Shortter" interest rates tend to #luctuate

"ore and are loer on a$erage than others


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"he Stock Market

Co))on stock re(resents a share o# onershi( in a cor(oration

* stock is a security that is a clai" on

the earnings and assets o# thatcor(oration

5or(orations issue & sell stock to the(u'lic to raise #unds to #inance theiracti$ities


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"he Stock Market

7he stock "arket is also an i"(ortant #actor in'usiness in$est"ent decisions 'ecause the

(rice o# shares a##ects the a"ount o# #unds that

can 'e raised 'y selling nely issued stock to

#inance in$est"ent s(ending %daily $ote o#con#idence)

7he stock )arket is a (lace here (eo(le get

rich and (oor + 0uickly ith considera'le#luctuations in stock (rices! hich a##ect the si8e

o# (eo(le+s ealth %and their illingness to

s(end) 9 Figure 1-*


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1:

Stock Market Fluctuations +S%"S./


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Financial &nstitutions and Banking

Banks and other #inancial institutions are hat "ake#inancial "arkets ork

Financial &nter)ediaries institutions that channel #unds #ro" (eo(le ho ha$e sa$ed to (arties ho ish 'orro

%indirect !inance) Financial Crises 9 disru(tion o# the #inancial "arkets that

lead to decline in asset (rices %can cause signi#icant shortter" disru(tions in the real econo"y 9 non neutrality)

Banks institutions that acce(t de(osits and "ake loans %chartered 'anks! trust and "ortgage loan co"(anies! andcredit unions & caisses (o(ulaires)! these are the #inancialinter"ediaries that the a$erage (erson interacts ith "ost#re0uently


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Financial &nstitutions and Banking

0ther Financial &nter)ediaries insurance co"(anies!#inance co"(anies! (ension #unds! "utual #unds andin$est"ent 'anks

Financial &nnoation- in (articular! dra"atic

i"(ro$e"ents in in!or)ation technology ha$e led to ne "eans o# deli$ering #inancial ser$ices electronically %e#inance) and higher (ro#its result #ro" creati$e thinking

5hanges in 'ules % 'egulations also in#luence ho#inancial institutions 'eha$e and co"(ete ith each other!

ho e interact ith the"! ho (ro#ita'le they are! andho "uch 'ene#it their custo"ers gain %#ro" theirser$ices)

7hese! & other! innovations i"(act the $elocity o# "oney%MxV = PxY)


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Money and Monetary olicy

Money 9 anything that is generally acce(ted in(ay"ent #or goods and ser$ices or in the re(ay"ent o#de'ts

;$idence suggests that "oney (lays an i"(ortant role

in generating (usiness cycles %"o$e"ents inaggregate real out(ut & une"(loy"ent) 2 see !igs


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Money and Monetary olicy

Every recession in the 2:th century has 'een(receded 'y a decline in the rate o# "oney

groth! indicating that changes in "oney are

also a dri$ing #orce 'ehind 'usiness cycle

#luctuations %but not e$ery decline in the rateo# "oney groth is #olloed 'y a recession)

7he 5anadian recession that started in late

2:: is sort o# an ece(tion %hile (receded'y such a dro( it started ith a #inancial

crisis in the =S)


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M* Money Supply Gro3th % Business Cycles +Can/


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Money and Business Cycles


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Money and &n!lation

7he aggregate price leel is thea$erage (rice o# goods and ser$ices in an econo"y

&n!lation * continual rise in the (rice le$el! a##ectsall econo"ic (layers & is generally regarded as an

i"(ortant (ro'le" o# concern to (oliticians &(olicy"akers

7he "oney su((ly and the (rice le$el generally"o$e closely together %4"M i"(lies the continuingincrease in the "oney su((ly "ight cause thecontinuing increase in the (rice le$el! Figure 1-5)

In#lation is alays and e$eryhere a "onetary(heno"enon+ %Milton Freid"an! Figure 1-6)


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Money and the rice eel


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Money Gro3th and &n!lation


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Money and &nterest 'ates

&nterest rates are the (rice %o$er ti"e)o# %'orroing) "oney

Prior to 16:! the rate o# "oney

groth and the interest rate on longter" 'onds ere closely tied %Fig 1-)

Since then! the relationshi( is less

clear 'ut still an i"(ortant deter"inanto# interest rates %es(ecially longter"rates 9 Fisher e0uation)


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Money Gro3th and &nterest 'ates


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Monetary and Fiscal olicy

Monetary policy is the "anage"ent o#the "oney su((ly and interest rates+Conducted (y the Bank o! Canada/

Fiscal policy is decisions a'outgo$ern"ent s(ending and taation Budget de#icit>sur(lus is the ecess o#

e(s>re$enue over re$enues>e(s #or a

(articular year *ny de!icit is usually #inanced solely 'y

'orroing %or sale o# go$ern"ent assets)


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Monetary and Fiscal olicy

/e#icits increase the national de(t and "ake it$ulnera'le to increases in orld interest rates

So"e 'elie$e the a'ility to issue (u'lic de't

allos the go$ern"ent to s"ooth taes and

in#lation o$er ti"e

arge (udget de!icits "ight lead to a !inancial

crisis and result in %)oneti8ation o# de't) a

higher rate o# "oney groth! a higher rate o#in#lation! and higher interest rates


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Fiscal olicy 2 Budgetary Balance


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Why Study &nternational Finance#

Increasing integration o# #inancial"arkets %continued & groing

glo(ali8ation)

5anadian co"(anies 'orro in #oreign"arkets and #oreign "arkets 'orro

#ro" 5anada

Banks and other #inancial institutionsincreasingly international 9 #oreign

e(osures


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Foreign E9change Market

7he #oreign echange "arket is here onecountry+s currency is echanged #or another

7he e9change rate is the (rice o# onecountry+s currency in ter"s o# another+s %i.e. itis the relati$e (rice o# to national currencies)

7hroughout this course! the echange rateis normally e(ressed as units o# #oreign

currency %(urchased) (er 5anadian dollar


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Foreign ;change Market


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"he &nternational Financial Syste)

@arger ca(ital #los 'eteen countries Areater i"(ortance o# #oreign #inancial

syste"s on do"estic econo"y.

Potentially larger role #or international

institutions %e.g. IMF! W7! BIS! etc.)


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3:

o3 We Study Money and Banking

;eelop an analytical !ra)e3ork that uses (asic

econo)ic concepts to organi8e our thinking

Si"(li#ied a((roach %(artial e0uili'riu" #ra"eork)

to the de"and #or assets %det o# asset (rices) Basic su((ly and de"and a((roach to understand

'eha$iour in %and structure o#) #inancial "arkets

Pro#it "ai"i8ation

7ransactions cost and asy""etric in#or"ation

a((roach to #inancial structure & 'ank "anage"ent

*ggregate su((ly and de"and analysis


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o3 We Study Money and Banking &&

earning "ools:1. 5ase studies

2. *((lications

3. S(ecialinterest 'oes4. Financial ?es 'oes

-. We' ;ercises and

chapter 1 (money & banking)

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