Mishking/Serletis

The Economics
of Money, Banking,
and Financial Markets
Fifth Canadian Edition

Chapter 1

WHY STUDY MONEY,

BANKING, AND FINANCIAL
MARKETS?
Copyright 2014 Pearson Canada Inc.

Why Study Financial Markets?

Financial markets are markets in which
funds are transferred from people and who
have an excess of available funds to people
who have a shortage

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The Bond Market and Interest Rates

A security (financial instrument) is a claim
on the issuers future income or assets
A bond is a debt security that promises to
make payments periodically for a specified
period of time
An interest rate is the cost of borrowing or
the price paid for the rental of funds

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Interest Rates on Selected Bonds

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The Stock Market

Common stock represents a share of
ownership in a corporation
A share of stock is a claim on the residual
earnings and assets of the corporation

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Stock Prices

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Why Study Financial Institutions

and Banking?
Banks and other financial institutions are
what make financial markets work
They play a crucial role in the economy
The financial system is complex and heavily
regulated by the government

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Financial Intermediaries
Institutions that accept deposits and make
loans:
chartered banks, trust and mortgage loan
companies, and credit unions and caisses
populaires

Other Financial Institutions: insurance

companies, finance companies, pension
funds, mutual funds and investment banks

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Financial Innovation
The development of new financial products
and services
can be an important force for good by making
the financial system more efficient

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Financial Crises
Financial crises are major disruptions in
financial markets that are characterized by
sharp declines in asset prices and the
failures of many financial and nonfinancial
firms

Copyright 2014 Pearson Canada Inc.

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Why Study Money and Monetary

Policy?
Evidence suggests that money plays an
important role in generating business cycles
Recessions (unemployment) and expansions
affect all of us
Monetary Theory ties changes in the money
supply to changes in aggregate economic
activity and the price level

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Money Growth and the Business

Cycle

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Price Level and the Money Supply

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Average Inflation Rate Versus

Average Rate of Money Growth for
Selected Countries, 2000-2010

Source: Based on International Financial Statistics. www.imfstatistics.org/imf.

Copyright 2014 Pearson Canada Inc.

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Money and Interest Rates

Interest rates are the price of money
Prior to 1980, the rate of money growth and
the interest rate on long-term bonds were
closely tied
Since then, the relationship is less clear but
still an important determinant of interest
rates

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Money Growth and Interest Rates

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Monetary Policy
Monetary policy is the management of the
money supply and interest rates
conducted by the Bank of Canada (the Bank)

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Fiscal Policy
Fiscal policy deals with government
spending
and taxation
budget deficit is the excess of expenditures over
revenues for a particular year
budget surplus is the excess of revenues over
expenditures for a particular year
any deficit must be financed by borrowing

Copyright 2014 Pearson Canada Inc.

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Government Budget Surplus or

Deficit

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The International Financial System

The international financial system has a
growing impact on domestic economies:
exchange rate policies are an important
determinant of how monetary policy is conducted
capital controls have an effect on domestic
financial systems
what role international financial institutions such
as the International Monetary Fund play?

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How We Will Study Money, Banking,

and Financial Markets
A simplified approach to the demand for
assets
The concept of equilibrium
Basic supply and demand to explain
behavior in financial markets
The search for profits
An approach to financial structure based on
transaction costs and asymmetric
information
Aggregate supply and demand analysis
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Bank of Canada Website

Copyright 2014 Pearson Canada Inc.

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