1. Money / Banking / Finance
Money = TRUST
Banking (& Finance) = TRUST
When Trust Evaporates … PANIC
1994 Tequila Crisis
1997 Asian Contagion
2001 Enron
"Enron proves how meaningless financial statements have become. Until someone makes sure that financial statements have meaning, we will never get this problem behind us."
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2. The Drop in East Asian Currencies, January 1997 to April 1998
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3. Topics in Money and Banking
Finance affects national and international economies.
We’ll study
Financial markets: buy and sell financial assets, e.g., stocks, bonds, foreign exchange
Financial institutions: banks, insurance companies, mutual funds, pawn shops
Money  Prices, Interest Rates, Activity
Monetary Policy
Five main topics are important in making financial decisions.
1. The financial system and the economy are connected in the United States and around the world.
2. Financial markets, which are markets for buying and selling bonds, stocks, foreign exchange, and other financial instruments, are an important part of the financial system.
3. Financial institutions, such as banks or insurance companies, serve as go-betweens for savers and borrowers.
4. Money influences economic activity, prices, and interest rates.
5. The economic approach helps interpret today’s information and helps predict future events.
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4. Services Provided by Financial Markets and Institutions
Risk sharing
Liquidity
Information
The financial system provides three key financial services: risk sharing, liquidity, and information.
1. Risk sharing gives savers and borrowers ways to reduce the uncertainty.
2. Liquidity is a measure of how easily an asset can be converted to cash.
3. The financial system gathers and communicates information about borrowers’ circumstances.
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5. Financial Institutions
Financial Markets
Transfers funds from savers to borrowers
International capital market growing rapidly
Asset prices communicate information
Financial Institutions
Intermediaries between borrowers and savers
Important source of loans
1. Financial markets such as stock or bond markets provide a means for transferring funds from savers and borrowers.
2. The international capital market has grown rapidly during the past 20 years.
3. Financial markets communicate important information through prices of financial assets.
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6. Figure 1.1 Sources of Funds for Nonfinancial Businesses
Most external funds raised by nonfinancial businesses are loans from financial institutions (mainly banks), with far less reliance on funds raised through bond and stock issues in financial markets. Data are averaged for
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7. Figure 2.1 Money and Exchange
1. Money makes exchange more efficient and allows for specialization.
2. The type of exchange known as barter, where goods and services are exchanged directly for other goods and services is inefficient because it incurs high transactions costs.
3. Voluntary trade may be sidestepped by using government allocation to distribute goods and services, but this is unlikely to be successful because it ignores market forces.
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8. Functions of Money Medium of exchange Unit of account Store of value
Standard of deferred payment
Store of value
Why would anyone outside an insane asylum hold his wealth in the form of money???
Money has four key functions that make it the most efficient means of trade:
1. Money acts as a medium of exchange, which is anything that is generally accepted as payment for goods and services or in the settlement of debts.
2. Money is a unit of account, which is a way of measuring value in the economy in terms of money.
3. Money is a store of value, in that it is an asset or a thing of value that can be owned and is, therefore, a component of wealth.
4. Money offers a standard of deferred payment in credit transactions.
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9. Criteria for Medium of Exchange
Acceptable to most traders
Standardized quality
Durable
Valuable relative to its weight
Divisible
There are five criteria a good must meet to be suitable as a medium of exchange:
1. The good must be acceptable to most traders.
2. It should be of standardized quality.
3. It should be durable.
4. It should be valuable relative to its weight.
5. It should be divisible.
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10. Figure 2.2 Measuring Monetary Aggregates
1. The narrowest definition of the money supply is M1, which includes currency, traveler's checks, and checking account deposits.
2. M2 includes the assets in M1 plus short-term investment accounts.
3. M3 includes the assets in M1 and M2 plus such less liquid assets as large- denomination time deposits, institutional money market mutual fund balances, term repurchase agreements, and Eurodollars.
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11. Selecting Monetary Aggregates
M2 currently considered best.
Correlates with prices and output
Aggregates move broadly together over long time periods.
But note a recent relative decline in M1.
Sweeps and other financial innovations.
1. In the 1980s and 1990s economists and policymakers have considered M2 the best measure of the money supply.
2. The monetary aggregates move broadly together over long periods of time, although there have been significant differences in their movements during certain periods.
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12. Figure 2.3 Growth Rates of Monetary Aggregates
Monetary aggregates move together broadly over long periods of time. However, their growth rates diverge during some periods.
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