economics_of_money_banking__financial_markets
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Seventh Edition
The Addison-Wesley Series in Economics
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Introduction to Economic Reasoning
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Industry Structure, Strategy, and Public Policy
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Macroeconomics
Frederic S. Mishkin
Columbia University
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Library of Congress Cataloguing-in-Publication Data
Mishkin, Frederic S.
The economics of money, banking, and financial markets / Frederic S. Mishkin.—7th ed. p. cm. — (The Addison-Wesley series in economics)
Supplemented by a subscription to a companion web site. Includes bibliographical references and index.
ISBN 0-321-12235-6
1. Finance. 2. Money. 3. Banks and banking. I. Title. II. Series. HG173.M632 2004
332—dc21
2003041912
Copyright © 2004 by Frederic S. Mishkin. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.
1 2 3 4 5 6 7 8 9 10—DOW—06050403
To Sally
CONTENTS IN BRIEF
P A R T |
I |
Introduction 1 |
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1 |
. . . . . . . . . . . . . . . . .Why Study Money, Banking, and Financial Markets? |
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2 |
An Overview of the Financial System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . |
.23 |
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3 |
What Is Money? . . . |
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . |
.44 |
P A R T |
I I |
Financial Markets |
59 |
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4 |
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Understanding Interest Rates |
.61 |
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5 |
The Behavior of Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . |
.85 |
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6 |
The Risk and Term Structure of Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . |
120 |
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7 |
The Stock Market, the Theory of Rational Expectations, |
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and the Efficient Market Hypothesis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . |
141 |
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P A R T |
I I I |
Financial Institutions 167 |
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8 |
. . . . . . . . . . . . . . . . . . . . . . . .An Economic Analysis of Financial Structure |
169 |
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9 |
Banking and the Management of Financial Institutions . . . . . . . . . . . . . . . . . |
201 |
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10 |
Banking Industry: Structure and Competition . . . . . . . . . . . . . . . . . . . . . . . . |
229 |
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11 |
Economic Analysis of Banking Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . |
260 |
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12 |
Nonbank Finance . . . |
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . |
287 |
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13 |
Financial Derivatives |
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . |
309 |
P A R T |
I V |
Central Banking and the Conduct of |
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Monetary Policy |
333 |
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14 Structure of Central Banks and the Federal Reserve System . . . . . . . . . . . . .335
15 Multiple Deposit Creation and the Money Supply Process . . . . . . . . . . . . . .357
16 Determinants of the Money Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .374
17 Tools of Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .393
18 Conduct of Monetary Policy: Goals and Targets . . . . . . . . . . . . . . . . . . . . . .411
P A R T V |
International Finance and Monetary Policy |
433 |
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19 |
. . . . . . . . . . . . . . . . . . . . . .The Foreign Exchange Market |
. . . . . . . . . . . . . .435 |
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20 |
The International Financial System . . . . . . . . . . . . . . . . . . |
. . . . . . . . . . . . . .462 |
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21 |
Monetary Policy Strategy: The International Experience . . |
. . . . . . . . . . . . . .487 |
vii
viii Contents in Brief
P A R T V I |
Monetary Theory 515 |
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22 |
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .The Demand for Money |
.517 |
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23 |
The Keynesian Framework and the ISLM Model . . . . . . . . . . . . . . . . . . . . . . |
536 |
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24 |
Monetary and Fiscal Policy in the ISLM Model . . . . . . . . . . . . . . . . . . . . . . . |
561 |
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25 |
Aggregate Demand and Supply Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . |
582 |
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26 |
Transmission Mechanisms of Monetary Policy: The Evidence . . . . . . . . . . . . |
603 |
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27 |
Money and Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . |
632 |
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28 |
Rational Expectations: Implications for Policy . . . . . . . . . . . . . . . . . . . . . . . . |
658 |
CONTENTS
P A R T I |
Introduction 1 |
CHAPTER 1
WHY STUDY MONEY, BANKING, AND FINANCIAL MARKETS? . . . . . . . . . . . . . . . . .3
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Why Study Financial Markets? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
The Bond Market and Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
The Stock Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5
The Foreign Exchange Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5
Why Study Banking and Financial Institutions? . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7
Structure of the Financial System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7
Banks and Other Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8
Financial Innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8
Why Study Money and Monetary Policy? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8
Money and Business Cycles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9
Money and Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10
Money and Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12
Conduct of Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12
Fiscal Policy and Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12
How We Will Study Money, Banking, and Financial Markets . . . . . . . . . . . . . . . . . .13
Exploring the Web . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14
Concluding Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17 Summary, Key Terms, Questions and Problems, and Web Exercises . . . . . . . . . . . . .17
Appendix to Chapter 1 |
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Defining Aggregate Output, Income, the Price Level, |
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and the Inflation Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . |
20 |
Aggregate Output and Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20 Real Versus Nominal Magnitudes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20 Aggregate Price Level . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21 Growth Rates and the Inflation Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .22
ix
xContents
CHAPTER 2
AN OVERVIEW OF THE FINANCIAL SYSTEM . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23
Function of Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23
Structure of Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25
Debt and Equity Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25
Primary and Secondary Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26
Exchanges and Over-the-Counter Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27
Money and Capital Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27
Internationalization of Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28
International Bond Market, Eurobonds, and Eurocurrencies . . . . . . . . . . . . . . . . . . . . . . . .28
World Stock Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29
Function of Financial Intermediaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . |
.29 |
Transaction Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . |
.29 |
Following the Financial News Foreign Stock Market Indexes . . . . . . . . . . . . . . . . |
30 |
Box 1 Global: The Importance of Financial Intermediaries to Securities |
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Markets: An International Comparison . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . |
31 |
Risk Sharing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . |
31 |
Asymmetric Information: Adverse Selection and Moral Hazard . . . . . . . . . . . . . . . . . . . . . |
32 |
Financial Intermediaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34
Depository Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34
Contractual Savings Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35
Investment Intermediaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37
Regulation of the Financial System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37
Increasing Information Available to Investors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .39
Ensuring the Soundness of Financial Intermediaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .39
Financial Regulation Abroad . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40
Summary, Key Terms, Questions and Problems, and Web Exercises . . . . . . . . . . . . .41
CHAPTER 3
WHAT IS MONEY? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .44
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .44
Meaning of Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .44
Functions of Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45
Medium of Exchange . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45
Unit of Account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46
Store of Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47
Evolution of the Payments System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48
Commodity Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48
Fiat Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48
Checks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48
Box 1 Global: Birth of the Euro: Will It Benefit Europe? . . . . . . . . . . . . . . . . . . . . .49
Electronic Payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .50