Chapter 1: Money, Banking, and Financial Markets An Overview

The role that money, banks, financial markets and the central bank play in a nations economy.

1. Money or the money supply ( = money aggregates )

What determines the money supply?
Central Bank is known as the Federal Reserve System (the FED) a nations monetary authority or agency
charged with conducting monetary policy and other duties. < >

Recession or very sluggish economic activity and rising unemployment

Stimulate economic activity through "Easier money" increase the availability of credit
Result in falling interest rates and Fed
A rising money supply
; / Money Supply
Development that boost aggregate expenditures for
goods and service

Suffers from excessive growth of expenditures and unacceptably high levels of inflation

Restrain aggregate spending Fed

It pushes up short-term interest rates ; / Money Supply
Reduce credit availability to contract the money supply

Inflation
is a persistent or continuing increase in a nations general price level
When a nations money supply increase (excessive growth of aggregate expenditures) for a
sustained period at a substantially more rapid rate than the countrys capacity to expand output of
goods and services

Deflation
is a persistent or continuing decline in a nations general price level
several financial distress as indicated by high rates of farm, home, and business foreclosures
Stagnant or falling output, high unemployment, and
banks and businesses failed <>, the stock market crashed < >
Experience inflation than deflation < > [Inflation > Deflation]

Fear of deflation is due in part of the belief that monetary policy is more effective in fighting inflation than
in combating deflation.

Inflation targeting ( )
Monetary policy strategy in which a central bank specifics an explicit range within which it pledges to
maintain the rate of inflation

2. Banks and Other Financial Intermediaries

Serve as "middlemen"

3. Interest Rates
Cost of borrowing (or the return from lending), expressed as a [percent per year.]
Real Interest Rate- Interest rate after adjusting nominal interest rate for expected inflation.
The Federal Reserve

Can alter short-term interest rates by influencing the availability of loans through banks.
Very limited ability to directly influence long-term interest rates.

Prime loan rate ( )

is a key interest rate posted by large banks as a benchmark for setting bank lending rates

4. Government Budget Deficits (or Surpluses)

( )
TAX < Spending TAX > Spending
Stimulate economic Restrain
# Budget deficit is the federal government expenditures exceed tax revenues <
>
# National debt is the cumulative sum of past budget deficits less past surpluses
# Budget deficit associate with severe inflation < >
# Large deficits lead to rapid money growth, make inflation < >
* Key Financial Markets * <>
Bond
Total Asset = Total Liability + Total Equity
Stock
*<Bondholders are lenders, whereas stockholders are owners.>

1. Stock market ( ) <!!>

Stock = Share = Equity = claims of ownership in individual corporations held by stockholders are traded.
Fluctuations in a companys stock price reflect the markets opinion of the corporations changing
prospects.
Stock prices can be volatile
Major indexes of stock price, such as the Dow-Jone Industrials Average and the Standard &
Poors 500 Average (S&P500), reflect changing sentiment about the nations economic
prospects.
2. Bond market ( ) <>
Bond is a debt instrument an IOU issued by a corporation, government, or government agency.
*<IOU; I Owe U = = >
Contractual agreement that the issuer (seller, borrower) will make a stream of interest payments
(bond buyer = inventory, lender) on specified future dates and return the principal at maturity.
In the bond market, interest rates (or yield) are determined by the market forces of supply and
demand.
3. Foreign Exchange market (FOREX market) ()
Market in which various national currencies such as are traded for one another.
Foreign Exchange Rate- Price at which one countrys currency exchanges for foreign currency.
3.1 Fixed Exchange Rates
Which exchange rates are pegged or held constant by direct government intervention
3.2 Floating Exchange Rates
Which exchange rates are allowed to change continuously in response to the market forces of
supply and demand with occasional government intervention.


3.2.1 Appreciation- an increase in value of one nations currency relative to another currency.
Cause:-

Higher prices to foreign buyers of exports Export < Import

Lower prices to domestic consumers of imports, and

A trade deficit (or a reduction in the trade surplus)

3.2.2 Depreciation- a decrease in value of one nations currency relative to another currency.
Cause:-

Lower prices to foreign buyers of exports Export > Import

Higher prices to domestic consumers of imports, and

A trade surplus (or a reduction in the trade deficit)