Why Study Money, Banking, and Financial Markets?

markets such as bond, stock and foreign exchange markets work
To

examine how financial institutions such as banks and insurance companies work
To examine the role of money in the economy

money important?
Why is inflation a problem?
How do banks make “money”

(profits)?
Why are banks important?
How does the government regulate banks and why?
Financial Markets and financial instruments
What is monetary policy?
How does the Fed conduct monetary policy?
How are interest rates determined?

payment for goods and services.

Money, or the money supply,

includes:
currency and coins in circulation,
checking accounts in depository institutions, and
other items, such as Certificates of Deposit (CDs), when measured more broadly.

for the trend or long-run behavior of the money supply.
Banks

and non-bank public also play important roles in determining the aggregate money supply.
In the United States, the central bank is the Federal Reserve System (the Fed).
The Fed conducts monetary policy.
Monetary Policy refers to the management of money supply and interest rates.

rapidly than the output of goods and services, inflation occurs.

Why is Inflation a problem?
Deflation is a continuing decline in prices and is more damaging to a nation's economic health than inflation.
Why is deflation a problem?
Inflation targeting occurs when a central bank announces an explicit inflation range it pledges to maintain and enforces policies consistent with that goal.

role in generating business cycles
Recessions (unemployment) and booms (inflation) affect

all of us
Monetary Theory ties changes in the money supply to changes in aggregate economic activity and the price level

exchange (ForEx) market
Markets in which funds are transferred from

people who have an excess of available funds to people who have a shortage of funds

a claim on the issuer’s future income or assets
A bond

is a debt security that promises to make payments periodically for a specified period of time
Bondholders are lenders; stockholders are owners.
An interest rate (or yield) is the cost of borrowing or the price paid for the rental of funds and are determined by market forces of supply and demand.

tend to move together.
Sometimes we ignore the differences among interest

rates and focus on the interest rate level.
The interest rate level is determined in the bond market or loanable funds market.
There are intimate relationships among different interest rates.

a corporation
A share of stock is a claim on the

earnings and assets of the corporation
A company’s stock share price reflects the opinion of the market about the company's economic value, which ultimately depends on its future profitability.
Major indexes reflect changing sentiment about the nation's economic prospects.
Dow-Jones Industrials Average (DJIA)
Standard and Poor's 500 Average (S&P 500)

are converted from one currency into another
The foreign exchange rate

is the price of one currency in terms of another currency
The foreign exchange market determines the foreign exchange rate

of one nation’s currency relative to another nation’s currency.

Depreciation

is the opposite.

Appreciation causes:
higher prices to foreign buyers of exports,
lower prices to domestic consumers of imports, and
a trade deficit (or a reduction in the trade surplus).

Depreciation causes:
lower prices to foreign buyers of exports,
higher prices to domestic consumers of imports, and
a trade surplus (or a reduction in the trade deficit.)

who have saved and make loans to other people
Banks—institutions that

accept deposits and make loans
Other Financial Institutions—insurance companies, finance companies, pension funds, mutual funds and investment banks
Financial Innovation—in particular, the advent of the information age and e-finance

to 1980, the rate of money growth and the interest

rate on long-term Treasure bonds were closely tied
Since then, the relationship is less clear but still an important determinant of interest rates

money supply and interest rates
Conducted in the U.S. by the

Federal Reserve Bank (Fed)
Fiscal policy is 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