Money and Banking Lecture 1

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Money and BankingLecture 1

• Selcuk Caner
• Bilkent University

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Course Outline

• Overview and Financial Environment
• Macroeconomy and the Monetary System
• Interest Rate Determination
• Exchange Rate Determination
• Demand and Supply for Money
• Banking System
• Monetary Policy

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Some Rules

• I expect participation in class
• You may not talk to each other in class!
• You would be ejected out of class if you do not
  comply with the above rule

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More Rules

• University rule Attendance is mandatory!
• I enforce this rule!
• Random roll calls to verify the names in the
  attendance list.
• If your name is on the list but you are not
  present in the class, you will face disciplinary
  action.

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More Rules (continued)

• Bilkent University has no tolerance for cheating
• Any student involved in cheating in an exam is
  expelled one semester from the university.
• According to Public Law 4207, smoking is banned
  in all closed public areas. Smoking in all
  University buildings are banned. I strongly
  enforce this Law. Anybody seen smoking in a
  university building will face disciplinary
  action.

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Exams and Grading

• Mid-term exam with a weight of 30.
• Final exam 40.
• Projects 30.
• Mid-term exam will cover material preceding it.
  Final is all comprehensive.

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Recommendations

• Start studying immediately
• Read chapters carefully, including boxes and
  applications
• Try exercises and questions at the end of each
  chapter
• On-line multiple-choice quizes
• Join the tutorials

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Introduction

• Why studying financial economics?
• Four broad themes
• Principles of financial intermediation
• Financial markets and interest rates
• Banking and regulation
• Monetary policy

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What effects will.

• The introduction of the Euro
• Ben Bernackes appointment as Fed Chairman
• Deregulation of the SL industry
• Hyperinflation in Ecuador
• Dollarization of the currency

have on the economy??
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Topics for Today Ch 1-3

• Introduction of the Financial System
• FS FM FI RG
• Definitions and terminology
• Principles of Financial Intermediation
• Matching savers and borrowers with different
  financial priorities
• Transforming the flows of funds and dealing with
  market imperfections
• The Functions and Role of Money

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Definitions Chapter 1
Aggregate Output Gross Domestic Product (GDP)
Value of all final goods and services produced in
domestic economy during year Aggregate
Income Total income of factors of production
(land, capital, labor) during year Distinction
Between Nominal and Real Nominal values
measured using current prices Real quantities,
measured with constant prices Aggregate Price
Level nominal GDP GDP Deflator real
GDP 10 trillion GDP
Deflator 1.11
9 trillion Consumer Price Index (CPI)
price of basket of goods and services Monetary
vs. Fiscal Policy
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Growth Rates and the Inflation Rate
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The Financial System Ch 2

• Financial Markets (FM)
• Debt and Equity Markets
• Primary and Secondary Markets
• Money and Capital Markets
• Financial Institutions (FI)
• Commercial Banks
• Non-bank Financial Institutions
• Regulators (RG)
• Various regulatory and supervisory bodies

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Financial Intermediation

• The transfer of funds from savers to borrowers
• Borrowers issue securities (liabilities) and
  savers buy securities (assets)
• Intermediation can be direct (through FMs) or
  indirect (through FIs)
• Efficient allocation is key!

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The Financial System
liabilities
securities
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Two Examples
How does financial intermediation and asset
transformation work? First Example Corporate
bonds issued on the primary bond market and
traded on the secondary market Second Example
Banks taking deposits from the public and making
loans to the corporate sector
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Market Imperfections

• Information Problems
• Adverse Selection
• Before transaction occurs
• Potential borrowers most likely to produce
  adverse outcomes are ones most likely to seek
  loans and be selected
• Moral Hazard
• After transaction occurs
• Hazard that borrower has incentives to engage in
  undesirable (immoral) activities making it more
  likely that wont pay loan back

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Functions of Financial Intermediaries

• Address the Market Imperfections
• - screening and monitoring techniques
• Transaction costs
• - economies of scale
• - liquidity services
• Risk Sharing
• - Asset Transformation
• - Diversification

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Two Main Reasons for Regulation

• 1. Increase information to investors
• A. Decreases adverse selection and moral hazard
  problems
• B. SEC forces corporations to disclose
  information
• Ensuring the soundness of financial
  intermediaries
• A. Prevents financial panics
• B. Chartering, reporting requirements,
  restrictions on assets and activities, deposit
  insurance, and anti-competitive measures

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Money Ch 3

• Economists Meaning of Money
• 1. Anything that is generally accepted in payment
  for goods and services
• 2. Not the same as wealth or income
• The three functions of money
• Medium of exchange
• unit of account
• store of value

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Money (cont)

• Measuring money
• Narrow and broad monetary aggregates
• M1 Currency, travelers checks, deposits
• M2 M1deposits with check-writing features
• M3 M2larger time deposits, mutual fund shares,
  etc

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Growth Rate of Money Supply
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Broader Issues

• Financial innovations
• Money, economic activity and inflation
• Remember MV PT
• The challenge of monetary policy

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Money Supply and the Price Level
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