Asset Markets Let’s take a closer look at this market. Money Market Financial MarketBond Market Equities Market

Money Market What is money? Without it, modern economies could not function

Historical Development of Money No Money: Barter Economy (goods for goods) Money as a medium of Exchange: GoodsMoney Goods Lydian Coin (Western Turkey), B.C. How did all start? (shells, barley, peppercorns, gold, and silver) – Precious metals, (Metals objects were introduced as money around 5000 B.C. By 700 BC, the Lydians became the first in the Western world to make coins.) –

History of money – Precious metals, (Metals objects were introduced as money around 5000 B.C. By 700 BC, the Lydians became the first in the Western world to make coins.) – Paper money (fully) backed by gold, – Paper money fractionally backed by gold, – Fiat money, Chinese note (size of a sheet of notebook paper)

Properties of a Good Medium of Exchange 1.Acceptable 2.Standardized quality (diamonds, clear or not) 3.Durable (fish, strawberry, do they last) 1.Valuable relative to its weight (cement) 2.Divisible (diamonds, pay for bread)

The Functions of Money 1) Medium of Exchange 2) Unit of account 3) Store of Value New York Note, ) Standard of deferred payments Precious metals are easily divisible into standardized coins and do not lose value when made into smaller units : COINS

Initial stages of development of money Coins, “Bank Notes” start of Paper money, – Fully backed by gold. – Fractionally backed by gold, Fiat Money What is the supply? (more efficient)

Why is money important? Using standardized coins or paper bills made it easier to determine prices of goods and services, the amount of money in the system also plays an important role in setting prices. Inflation or deflation

Money Supply Delegated to Central Banks

Money Supply Today Money supply (M1) Currency (in circulation) + demand deposits (TL and Foreign Currency) 229,091,917,800 TL Money supply (M2) M1 + Time deposits (TL and Foreign Currency) 930,652,330,000 TL

M1 and M2 in Turkey

US Money Supply

Can the Central Bank change MS? YES!!! HOW? – With some tools known as monetary policy tools. (Tools are instruments that a policy maker can change in order to influence the workings of an economy)

Monetary Policy Tools 1.Discount Rate, 2.Reserve Requirement ratio, 3.Open Market Operations. How do they work? Need to look at how banking system work and money changes hands…

Commercial Banks Banks are profit seeking institutions. – They accept deposits, – They give loans Public Banks (Ziraat, Halk …) and Private banks (IsBank, Akbank, Garanti …)

Commercial Banks Balance Sheets AssetsLiabilities ReservesDeposits LoansShort and long term borrowing Building and EquipmentOther Liabilities Other Assets Total Liabilities Stock holders equities Total AssetsTotal liabilities + stock holders’ equities

Rules that commercial banks follow: Hold the required reserve ratio determined by Central Bank. If required reserve ratio (rr) is 15%, then in equilibrium (Reserves/ Deposits)*100 ratio=15 %. e.g. If Total Deposits are 2000 billion TL, then reserves need to be 300 billion TL. (Reserves/ Deposits)*100 ratio=(300/2000)*100=15 %

A new deposit comes into Bank One Change AssetsChange Liabilities Reserves +1000Deposits Loans Total Assets +1000Total Liabilities +1000

Bank One uses this new deposits in giving out new loans (Reserves/deposits)*100= 15 %. Result: Creates a new loan equal to 850. Change AssetsChange Liabilities Reserves + 150Deposits Loans Total Assets +1000Total Liabilities +1000

The new loan comes back to Bank Two Change AssetsChange Liabilities Reserves +850Deposits +850 Loans Total Assets +850Total Liabilities +850 Change AssetsChange Liabilities Reserves (850*0.15)Deposits +850 Loans (850*0.85) Total Assets +850Total Liabilities +850 New loans of TL are created by Bank Two

This will repeat ∞ times Total change in the deposits: (0.85*1000)+(0.85*1000) 2 +(0.85*1000) 3 +… (0.85*1000) ∞ Total change = Change in total deposits=

Money supply Money market Tools to increase the MS 1)Discount rate increase, 2)Reserve requirement ratio decrease, 3)Open Market Operations (Buy bonds) I Q of money

Money demand Money market Types of Money demand 1)Transaction demand, 2)Speculative demand, 3)Precautionary demand, MD= L(Y, i) or MD= 5*Y – 3*i I Q of money

Money demand Money market If Y increases, then MD curve shifts to the right MD= L(Y, i) or MD= 5*Y – 3*i I Q of money

Money market equilibrium Money marketMS=MD Money supply MS= 1000 Money demand MD= L(Y, i) or MD= 5*Y – 3*I (For a given Y level you will be able to determine equilibrium interest rate) I Q of money

Money market equilibrium Money marketMS=MD Money supply MS= 1000 Money demand MD= L(Y, i) or MD= 5*Y – 3*I (For a given Y level you will be able to determine equilibrium interest rate) I Q of money

Central Bank Balance sheet AssetsLiabilities FX and Gold ReservesCurrency in Circulation GovernmentRequired Reserves Open Market OperationsFree Reserves OtherCapital

Central Bank (TCMB) Balance Sheet

Central Bank

Determination of output Equilibrium in 1. GOODS and SERVICES Market and 2.MONEY Market (Demand side of the economy)

Goods and Money Markets

What is in the model? GOODS MARKET The AE d = Y equality Other variables: C d, I d, G d, NX d, T, YD, IS Curve MONEY MARKET MD=MS equality Other variables: Y, i LM Curve

IS – LM model Money Market Goods market i Y i Y IS LM

IS curve

IS-LM equilibrium Equilibrium in both markets i Y IS LM

IS-LM equilibrium Expansionary Monetary Policy i Y IS LM

IS-LM equilibrium Expansionary Fiscal Policy: i Y IS LM

Mathematical model of the IS-LM See class notes and homework assignment