The Economics of Money, Banking and Financial Markets

by Frederic S. Mishkin

• ISBN13: 9780321014405
• ISBN10: 0321014405
• Edition: 5th
• Format: Hardcover
• Copyright: 1997-08-01
• Publisher: Addison-Wesley

Table of Contents

Preface	xxvii	(9)
About the Author	xxxvi
PART I Introduction	1	(66)
CHAPTER 1 WHY STUDY MONEY, BANKING, AND FINANCIAL MARKETS?	3	(17)
Preview	3	(1)
Why Study Financial Markets?	3	(4)
The Bond Market and Interest Rates	4	(1)
The Stock Market	4	(2)
The Foreign Exchange Market	6	(1)
Why Study Banking and Financial Institutions?	7	(2)
Structure of the Financial System	7	(1)
Banks and Other Financial Institutions	8	(1)
Financial Innovation	8	(1)
Why Study Money and Monetary Policy?	9	(5)
Money and Business Cycles	9	(1)
Money and Inflation	10	(2)
Money and Interest Rates	12	(1)
Conduct of Monetary Policy	12	(1)
Budget Deficits and Monetary Policy	13	(1)
How We Will Study Money, Banking, and Financial Markets	14	(1)
Concluding Remarks	15	(1)
Summary, Key Terms, Questions and Problems	15	(2)
Appendix to Chapter 1: Defining Aggregate Output, Income, and the Price Level	17	(3)
CHAPTER 2 AN OVERVIEW OF THE FINANCIAL SYSTEM	20	(28)
Preview	20	(3)
Function of Financial Markets	21	(2)
Structure of Financial Markets	23	(2)
Debt and Equity Markets	23	(1)
Primary and Secondary Markets	23	(1)
Exchanges and Over-the-Counter Markets	24	(1)
Money and Capital Markets	25	(1)
Financial Market Instruments	25	(7)
Money Market Instruments	25	(2)
Following the Financial News Money Market Rates	27	(2)
Capital Market Instruments	29	(2)
BOX 1 Mortgage-Backed Securities	31	(1)
Internationalization of Financial Markets	32	(1)
International Bond Market and Eurobonds	32	(1)
World Stock Markets	32	(1)
Following the Financial News Foreign Stock Market Indexes	33	(1)
Function of Financial Intermediaries	33	(4)
BOX 2 The Importance of Financial Intermediaries to Securities Markets: An International Comparison	34	(1)
Transaction Costs	34	(1)
Asymmetric Information: Adverse Selection and Moral Hazard	35	(2)
Financial Intermediaries	37	(5)
Depository Institutions	37	(3)
Contractual Savings Institutions	40	(1)
Investment Intermediaries	41	(1)
Regulation of the Financial System	42	(3)
Increasing Information Available to Investors	42	(1)
Ensuring the Soundness of Financial Intermediaries	42	(3)
Improving Control of Monetary Policy	45	(1)
Financial Regulation Abroad	45	(1)
Summary, Key Terms, Questions and Problems	45	(3)
CHAPTER 3 WHAT IS MONEY?	48	(19)
Preview	48	(1)
Meaning of Money	48	(1)
Functions of Money	49	(3)
Medium of Exchange	49	(1)
Unit of Account	50	(1)
Store of Value	51	(1)
Evolution of the Payments System	52	(5)
BOX 1 Birth of a New European Currency: The Euro?	54	(1)
Electronic Money: A Coming Global Phenomenon	55	(1)
Are We Moving to a Cashless Society?	56	(1)
Measuring Money	57	(5)
Theoretical and Empirical Definitions of Money	57	(1)
The Federal Reserve's Monetary Aggregates	58	(3)
Following the Financial News The Monetary Aggregates	61	(1)
Money as a Weighted Aggregate	61	(1)
How Reliable Are the Money Data?	62	(1)
Summary, Key Terms, Questions and Problems	63	(6)
PART II Financial Markets	67	(126)
CHAPTER 4 UNDERSTANDING INTEREST RATES	69	(25)
Preview	69	(1)
Measuring Interest Rates	70	(9)
Present Value	71	(1)
Application The Cost of the S&L Bailout: Was It Really $500 Billion?	72	(1)
Yield to Maturity	72	(7)
Other Measures of Interest Rates	79	(5)
Current Yield	79	(1)
Yield on a Discount Basis	80	(1)
Application Reading the Wall Street Journal: The Bond Page	81	(1)
Following the Financial News Bond Prices and Interest Rates	82	(2)
The Distinction Between Interest Rates and Returns	84	(5)
Maturity and the Volatility of Bond Returns: Interest-Rate Risk	87	(1)
Summary	88	(1)
Application Should Retirees Invest in "Gilt-Edged" Long-Term Bonds?	88	(1)
The Distinction Between Real and Nominal Interest Rates	89	(3)
Summary, Key Terms, Questions and Problems	92	(2)
CHAPTER 5 PORTFOLIO CHOICE	94	(10)
Preview	94	(1)
Determinants of Asset Demand	94	(4)
Wealth	95	(1)
Expected Returns	96	(1)
Risk	96	(1)
Liquidity	97	(1)
Theory of Portfolio Choice	97	(1)
Benefits of Diversification	98	(2)
Systematic Risk	100	(1)
Risk Premiums: Capital Asset Pricing Model and Arbitrage Pricing Theory	101	(1)
Summary, Key Terms, Questions and Problems	102	(2)
CHAPTER 6 THE BEHAVIOR OF INTEREST RATES	104	(39)
Preview	104	(1)
Loanable Funds Framework: Supply and Demand in the Bond Market	104	(5)
Demand Curve	105	(1)
Supply Curve	106	(1)
Market Equilibrium	107	(1)
Supply and Demand Analysis	108	(1)
Changes in Equilibrium Interest Rates	109	(13)
Shifts in the Demand for Bonds	110	(3)
Shifts in the Supply of Bonds	113	(2)
Application Changes in the Equilibrium Interest Rate Due to Expected Inflation or Business Cycle Expansions	115	(4)
Application Reading the Wall Street Journal: The "Credit Markets" Column	119	(1)
Following the Financial News The "Credit Markets" Column	120	(1)
Application Have Low Savings Rates in the United States Led to Higher Interest Rates?	121	(1)
Liquidity Preference Framework: Supply and Demand in the Market for Money	122	(2)
Changes in Equilibrium Interest Rates	124	(11)
Shifts in the Demand for Money	124	(1)
Shifts in the Supply of Money	125	(1)
Application Changes in the Equilibrium Interest Rate Due to Changes in Income, the Price Level, or the Money Supply	125	(3)
Application Money and Interest Rates	128	(4)
Following the Financial News Forecasting Interest Rates	132	(3)
Summary, Key Terms, Questions and Problems	135	(2)
Appendix to Chapter 6: Applying the Asset Market Approach to a Commodity Market: The Case of Gold	137	(6)
Application Changes in the Equilibrium Price of Gold Due to a Rise in Expected Inflation	140	(1)
Following the Financial News The "Commodities" Column	141	(1)
Application Reading the Wall Street Journal: The "Commodities" Column	142	(1)
CHAPTER 7 THE RISK AND TERM STRUCTURE OF INTEREST RATES	143	(22)
Preview	143	(1)
Risk Structure of Interest Rates	143	(8)
Default Risk	144	(3)
Application The Stock Market Crash of 1987 and the Junk Bond-Treasury Spread	147	(1)
Application What If Treasury Securities Were No Longer Default-Free?	148	(1)
Liquidity	148	(1)
Income Tax Considerations	149	(1)
Summary	150	(1)
Application Effects of the Clinton Tax Increase on Bond Interest Rates	150	(1)
Term Structure of Interest Rates	151	(12)
Following the Financial News Yield Curves	153	(1)
Expectations Hypothesis	153	(4)
Segmented Markets Theory	157	(1)
Preferred Habitat and Liquidity Premium Theories	158	(2)
Recent Evidence on the Term Structure	160	(1)
Summary	160	(1)
Application Interpreting Yield Curves, 1980-1997	161	(2)
Summary, Key Terms, Questions and Problems	163	(2)
CHAPTER 8 THE FOREIGN EXCHANGE MARKET	165	(28)
Preview	165	(1)
Foreign Exchange Market	165	(4)
What Are Foreign Exchange Rates?	167	(1)
Why Are Exchange Rates Important?	167	(1)
Following the Financial News Foreign Exchange Rates	168	(1)
How Is Foreign Exchange Traded?	169	(1)
Exchange Rates in the Long Run	169	(5)
Law of One Price	170	(1)
Theory of Purchasing Power Parity	170	(1)
Why the Theory of Purchasing Power Parity Cannot Fully Explain Exchange Rates	171	(1)
Factors That Affect Exchange Rates in the Long Run	172	(2)
Exchange Rates in the Short Run	174	(5)
Comparing Expected Returns on Domestic and Foreign Deposits	174	(2)
Interest Parity Condition	176	(1)
Equilibrium in the Foreign Exchange Market	177	(2)
Explaining Changes in Exchange Rates	179	(12)
Shifts in the Expected-Return Schedule for Foreign Deposits	179	(2)
Shifts in the Expected-Return Schedule for Domestic Deposits	181	(1)
Application Changes in the Equilibrium Exchange Rate: Two Examples	182	(5)
Application Why Are Exchange Rates So Volatile?	187	(1)
Application The Dollar and Interest Rates, 1973-1996	187	(1)
BOX 1 Forecasting Exchange Rates	188	(1)
Application Reading the Wall Street Journal: The "Foreign Exchange" Column	189	(1)
Following the Financial News The "Foreign Exchange" Column	190	(1)
Summary, Key Terms, Questions and Problems	191	(4)
PART III Financial Institutions	193	(194)
CHAPTER 9 AN ECONOMIC ANALYSIS OF FINANCIAL STRUCTURE	195	(31)
Preview	195	(1)
Basic Puzzles About Financial Structure Throughout the World	195	(4)
Transaction Costs	199	(2)
How Transaction Costs Influence Financial Structure	199	(1)
How Financial Intermediaries Reduce Transaction Costs	200	(1)
Asymmetric Information: Adverse Selection and Moral Hazard	201	(1)
The Lemons Problem: How Adverse Selection Influences Financial Structure	201	(6)
Lemons in the Stock and Bond Markets	202	(1)
Tools to Help Solve Adverse Selection Problems	203	(4)
How Moral Hazard Affects the Choice Between Debt and Equity Contracts	207	(3)
Moral Hazard in Equity Contracts: The Principal-Agent Problem	207	(1)
Tools to Help Solve the Principal-Agent Problem	208	(1)
BOX 1 "Hollywood Accounting": Has Forrest Gump Been a Loser?	209	(1)
How Moral Hazard Influences Financial Structure in Debt Markets	210	(5)
Tools to Help Solve Moral Hazard in Debt Contracts	211	(2)
Summary	213	(1)
Application Financial Development and Economic Growth	213	(2)
Financial Crises and Aggregate Economic Activity	215	(8)
Factors Causing Financial Crises	215	(2)
Application Financial Crises in the United States	217	(2)
Application Financial Crises in Developing Countries: The Case of Mexico, 1994-1995	219	(1)
BOX 2 Case Study of a Financial Crisis: The Great Depression	220	(3)
Summary, Key Terms, Questions and Problems	223	(3)
CHAPTER 10 THE BANKING FIRM AND THE MANAGEMENT OF FINANCIAL INSTITUTIONS	226	(38)
Preview	226	(1)
The Bank Balance Sheet	226	(5)
Liabilities	227	(2)
Assets	229	(1)
BOX 1 Understanding Loan Loss Reserves	230	(1)
Basic Operation of a Bank	231	(3)
General Principles of Bank Management	234	(10)
Liquidity Management and the Role of Reserves	235	(3)
Asset Management	238	(1)
Liability Management	239	(1)
Capital Adequacy Management	240	(3)
Application Strategies for Managing Bank Capital	243	(1)
Application Did the Capital Crunch Cause a Credit Crunch in the Early 1990s?	243	(1)
Managing Credit Risk	244	(5)
Screening and Monitoring	245	(1)
Long-Term Customer Relationship	246	(1)
Loan Commitments	247	(1)
Collateral and Compensating Balances	247	(1)
BOX 2 Japanese and German Banking Arrangements: A Better Way to Deal with Asymmetric Information?	248	(1)
Credit Rationing	249	(1)
Managing Interest-Rate Risk	249	(3)
Gap and Duration Analysis	250	(1)
Application Strategies for Managing Interest-Rate Risk	251	(1)
Off-Balance-Sheet Activities	252	(3)
Loan Sales	252	(1)
Generation of Free Income	252	(1)
Trading Activities and Risk Management Techniques	253	(1)
BOX 3 Barings, Daiwa, and Sumitomo: Rogue Traders and the Principal-Agent Problem	254	(1)
Financial Innovation	255	(6)
Responses to Changes in Demand Conditions	256	(1)
Responses to Changes in Supply Conditions	257	(2)
Avoidance of Existing Regulations	259	(2)
Summary, Key Terms, Questions and Problems	261	(3)
CHAPTER 11 BANKING INDUSTRY: STRUCTURE AND COMPETITION	264	(32)
Preview	264	(1)
Historical Development of the Banking System	264	(3)
Multiple Regulatory Agencies	267	(1)
Structure of the U.S. Commercial Banking Industry	267	(4)
Restrictions on Branching	268	(1)
Response to Branching Restrictions	269	(2)
Nationwide Banking and Bank Consolidation	271	(4)
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994	272	(1)
What Will the Structure of the U.S. Banking Industry Look Like in the Future?	273	(1)
BOX 1 Comparison of Banking Structure in the United States and Abroad	274	(1)
Are Bank Consolidation and Nationwide Banking Good Things?	274	(1)
Separation of the Banking and Securities Industries	275	(3)
Repeal of the Glass-Steagall Act	278	(1)
Separation of the Banking and Securities Industries in Other Countries	278	(1)
Thrift Industry: Regulation and Structure	278	(2)
Savings and Loan Associations	278	(1)
Mutual Savings Banks	279	(1)
Credit Unions	279	(1)
International Banking	280	(4)
Eurodollar Market	281	(1)
BOX 2 Ironic Birth of the Eurodollar Market	282	(1)
Structure of U.S. Banking Overseas	282	(1)
Foreign Banks in the United States	283	(1)
Financial Innovation and the Decline of Traditional Banking	284	(10)
Behind the Decline: Four Financial Innovations	284	(4)
Decline of Traditional Banking	288	(1)
Reasons for the Decline	288	(4)
Banks' Responses	292	(1)
Decline of Traditional Banking in Other Industrialized Countries	293	(1)
Summary, Key Terms, Questions and Problems	294	(2)
CHAPTER 12 ECONOMIC ANALYSIS OF BANKING REGULATION	296	(36)
Preview	296	(1)
Asymmetric Information and Bank Regulation	296	(12)
Government Safety Net: Deposit Insurance and the FDIC	297	(3)
BOX 1 A Tale of Two Bank Collapses: Bank of New England and Freedom National Bank	300	(1)
Restrictions on Asset Holdings and Bank Capital Requirements	301	(1)
Bank Supervision: Chartering and Examination	302	(1)
BOX 2 The Basel Accord on Risk-Based Capital Requirements	303	(1)
A New Trend in Bank Supervision: Assessment of Risk Management	304	(1)
Disclosure Requirements	305	(1)
BOX 3 New Zealand's Disclosure-Based Experiment in Bank Regulation	306	(1)
BOX 4 The Community Reinvestment Act: A Political Hot Button	307	(1)
Consumer Protection	307	(1)
Restrictions on Competition	307	(1)
Separation of the Banking and Securities Industries: The Glass-Steagall Act	308	(1)
International Banking Regulation	308	(4)
Problems in Regulating International Banking	310	(1)
Summary	310	(1)
BOX 5 The BCCI Scandal	311	(1)
The 1980s U.S. Banking Crisis: Why?	312	(3)
Early Stages of the Crisis	312	(2)
Later Stages of the Crisis: Regulatory Forbearance	314	(1)
Competitive Equality in Banking Act of 1987	315	(1)
Political Economy of the Savings and Loan Crisis	315	(3)
Principal-Agent Problem for Regulators and Politicians	316	(1)
Application Principal-Agent Problem in Action: Charles Keating and the Lincoln Savings and Loan Scandal	317	(1)
Savings and Loan Bailout: Financial Institutions Reform, Recovery, and Enforcement Act of 1989	318	(1)
Federal Deposit Insurance Corporation Improvement Act of 1991	319	(7)
BOX 6 The SAIF Fix and the Future of the S&L Industry	321	(1)
Application Evaluating FDICIA and Other Proposed Reforms of the Banking Regulatory System	322	(4)
Banking Crises Throughout the World	326	(3)
Scandinavia	326	(2)
Latin America	328	(1)
Eastern Europe	328	(1)
Japan	328	(1)
"Deja Vu All Over Again"	329	(1)
Summary, Key Terms, Questions and Problems	329	(3)
CHAPTER 13 NONBANK FINANCIAL INSTITUTIONS	332	(22)
Preview	332	(1)
Insurance Companies	332	(9)
Life Insurance Companies	333	(1)
Property and Casualty Insurance Companies	334	(1)
The Competitive Threat from the Banking Industry	335	(1)
BOX 1 The Woes of Lloyd's of London	336	(1)
BOX 2 Are Independent Insurance Agents Going the Way of the Milkman?	337	(1)
Application Insurance Management	337	(4)
Pension Funds	341	(2)
Private Pension Plans	342	(1)
Public Pension Plans	342	(1)
BOX 3 Will Social Security Be Privatized?	343	(1)
Finance Companies	343	(2)
Mutual Funds	345	(1)
Money Market Mutual Funds	346	(1)
Government Financial Intermediation	346	(2)
Federal Credit Agencies	346	(1)
Government Loan Guarantees: Another Crisis Waiting to Happen?	347	(1)
BOX 4 The Downside of Government Downsizing	348	(1)
Securities Market Institutions	348	(4)
Investment Banks	348	(1)
BOX 5 America Is Number One--at Least in Investment Banking	349	(1)
Following the Financial News New Securities Issues	350	(1)
Securities Brokers and Dealers	350	(1)
Organized Exchanges	351	(1)
Summary, Key Terms, Questions and Problems	352	(2)
CHAPTER 14 FINANCIAL DERIVATIVES	354	(33)
Preview	354	(1)
Forward Markets	354	(2)
Interest-Rate Forward Contracts	354	(1)
Application Hedging with Interest-Rate Forward Contracts	355	(1)
Pros and Cons of Forward Contracts	355	(1)
Financial Futures Markets	356	(9)
Financial Futures Contracts	356	(1)
Following the Financial News Financial Futures	357	(2)
Application Hedging with Financial Futures	359	(1)
Organization of Trading in Financial Futures Markets	359	(1)
The Globalization of Financial Futures Markets	360	(1)
Explaining the Success of Futures Markets	360	(3)
BOX 1 The Hunt Brothers and the Silver Crash	363	(1)
Some Problems with Financial Futures Markets	364	(1)
Stock Index Futures	365	(2)
BOX 2 Program Trading and Portfolio Insurance: Were They to Blame for the Stock Market Crash of 1987?	366	(1)
Stock Index Futures Contracts	366	(1)
Options	367	(8)
Following the Financial News Futures Options	368	(1)
Option Contracts	368	(1)
Profits and Losses on Option and Futures Contracts	369	(3)
Application Hedging with Futures Options	372	(1)
Factors Affecting the Prices of Option Premiums	373	(2)
Summary	375	(1)
Interest-Rate Swaps	375	(9)
Interest-Rate Swap Contracts	375	(1)
Application Hedging with Interest-Rate Swaps	376	(1)
Advantages of Interest-Rate Swaps	377	(1)
Disadvantages of Interest-Rate Swaps	377	(1)
Financial Intermediaries in Interest-Rate Swaps	378	(1)
Application Hedging Foreign Exchange Risk	379	(3)
Application Are Financial Derivatives a Worldwide Time Bomb?	382	(1)
BOX 3 The Orange County Bankruptcy	383	(1)
Summary, Key Terms, Questions and Problems	384	(3)
PART IV Central Banking and the Conduct of Monetary Policy	387	(140)
CHAPTER 15 STRUCTURE OF CENTRAL BANKS AND THE FEDERAL RESERVE SYSTEM	389	(25)
Preview	389	(1)
Origins of the Federal Reserve System	389	(1)
Formal Structure of the Federal Reserve System	390	(9)
BOX 1 INSIDE THE FED The Political Genius of the Founders of the Federal Reserve System	391	(1)
Federal Reserve Banks	391	(3)
BOX 2 INSIDE THE FED Special Role of the Federal Reserve Bank of New York	394	(1)
Member Banks	394	(1)
Board of Governors of the Federal Reserve System	395	(1)
Federal Open Market Committee (FOMC)	396	(1)
BOX 3 INSIDE THE FED Role of the Research Staff	397	(1)
The FOMC Meeting	398	(1)
BOX 4 INSIDE THE FED Green, Blue, and Beige	399	(1)
Informal Structure of the Federal Reserve System	399	(4)
BOX 5 INSIDE THE FED Decoding the FOMC Derivative	400	(2)
BOX 6 INSIDE THE FED Role of Member Banks in the Federal Reserve System	402	(1)
How Independent Is the Fed?	403	(2)
Structure and Independence of Foreign Central Banks	405	(2)
Bank of England	405	(1)
Deutsche Bundesbank	406	(1)
Bank of Canada	406	(1)
Bank of Japan	406	(1)
The Trend Toward Greater Independence	407	(1)
Explaining Central Bank Behavior	407	(1)
Should the Fed Be Independent?	408	(4)
The Case for Independence	408	(1)
BOX 7 INSIDE THE FED Games the Fed Plays	409	(1)
The Case Against Independence	410	(1)
Central Bank Independence and Macroeconomic Performance in Seventeen Countries	411	(1)
Summary, Key Terms, Questions and Problems	412	(2)
CHAPTER 16 MULTIPLE DEPOSIT CREATION AND THE MONEY SUPPLY PROCESS	414	(21)
Preview	414	(1)
Four Players in the Money Supply Process	414	(1)
The Fed's Balance Sheet and the Monetary Base	415	(3)
Assets	415	(1)
Liabilities	415	(2)
Monetary Base	417	(1)
Control of the Monetary Base	418	(7)
Federal Reserve Open Market Operations	418	(5)
BOX 1 Foreign Exchange Rate Intervention and the Monetary Base	423	(1)
Shifts from Deposits into Currency	423	(1)
Discount Loans	424	(1)
Overview of the Fed's Ability to Control the Monetary Base	425	(1)
Multiple Deposit Creation: A Simple Model	425	(8)
Deposit Creation: The Single Bank	425	(2)
Deposit Creation: The Banking System	427	(3)
Multiple Deposit Contraction	430	(1)
Deriving the Formula for Multiple Deposit Creation	431	(2)
Critique of the Simple Model	433	(1)
Summary, Key Terms, Questions and Problems	433	(2)
CHAPTER 17 DETERMINANTS OF THE MONEY SUPPLY	435	(23)
Preview	435	(1)
The Money Supply Model and the Money Multiplier	436	(3)
Deriving the Money Multiplier	436	(2)
Intuition Behind the Money Multiplier	438	(1)
Factors That Determine the Money Multiplier	439	(5)
Changes in the Required Reserve Ratio r(D)	439	(1)
Changes in the Currency Ratio {C/D}	440	(1)
Changes in the Excess Reserves Ratio {ER/D}	441	(3)
Additional Factors That Determine the Money Supply	444	(1)
Changes in the Nonborrowed Monetary Base MB(n)	444	(1)
Changes in Discount Loans DL from the Fed	444	(1)
Market Interest Rates and the Discount Rate	445	(1)
Overview of the Money Supply Process	445	(8)
Application Explaining Movements in the Money Supply, 1980-1996	447	(2)
Application The Great Depression Bank Panics, 1930-1933	449	(4)
Summary, Key Terms, Questions and Problems	453	(2)
Appendix to Chapter 17: The M2 Money Multiplier	455	(3)
CHAPTER 18 TOOLS OF MONETARY POLICY	458	(16)
Preview	458	(1)
Open Market Operations	458	(3)
A Day at the Trading Desk	459	(2)
Advantages of Open Market Operations	461	(1)
Discount Policy	461	(8)
Operation of the Discount Window	461	(1)
BOX 1 INSIDE THE FED Why has Adjustment Credit Borrowing Shrunk to Such Low Levels in the 1990s?	462	(2)
Lender of Last Resort	464	(1)
BOX 2 INSIDE THE FED Discounting to Troubled Banks: Franklin National and Continental Illinois	464	(2)
BOX 3 INSIDE THE FED Discounting to Prevent a Financial Panic: The Black Monday Stock Market Crash of 1987	466	(1)
Announcement Effect	467	(1)
Advantages and Disadvantages of Discount Policy	467	(1)
Application Evaluating Proposed Reforms of Discount Policy	467	(2)
Reserve Requirements	469	(3)
Advantages and Disadvantages of Reserve Requirement Changes	469	(1)
Application Evaluating Proposed Reforms of Reserve Requirements	470	(1)
Application Why Have Reserve Requirements Been Declining Worldwide?	471	(1)
Summary, Key Terms, Questions and Problems	472	(2)
CHAPTER 19 CONDUCT OF MONETARY POLICY: GOALS AND TARGETS	474	(28)
Preview	474	(1)
Goals of Monetary Policy	474	(4)
High Employment	474	(1)
Economic Growth	475	(1)
Price Stability	476	(1)
Interest-Rate Stability	476	(1)
Stability of Financial Markets	476	(1)
BOX 1 The Growing European Commitment to Price Stability	477	(1)
Stability in Foreign Exchange Markets	477	(1)
Conflict Among Goals	477	(2)
Central Bank Strategy: Use of Targets	478	(2)
Choosing the Targets	480	(3)
Criteria for Choosing Intermediate Targets	481	(2)
Criteria for Choosing Operating Targets	483	(1)
Fed Policy Procedures: Historical Perspective	483	(11)
The Early Years: Discount Policy as the Primary Tool	484	(1)
Discovery of Open Market Operations	484	(1)
The Great Depression	485	(1)
Reserve Requirements as a Policy Tool	485	(1)
BOX 2 INSIDE THE FED Bank Panics of 1930-1933: Why Did the Fed Let Them Happen?	486	(1)
War Finance and the Pegging of Interest Rates: 1942-1951	487	(1)
Targeting Money Market Conditions: The 1950s and 1960s	487	(2)
Targeting Monetary Aggregates: The 1970s	489	(1)
New Fed Operating Procedures: October 1979-October 1982	490	(2)
Deemphasis of Monetary Aggregates: October 1982-Early 1990s	492	(1)
Federal Funds Targeting Again: Early 1990s and Beyond	493	(1)
International Considerations	493	(1)
BOX 3 International Policy Coordination: The Plaza Agreement and the Louvre Accord	494	(1)
Monetary Targeting in Other Countries	494	(4)
United Kingdom	495	(1)
Canada	495	(1)
Germany	496	(1)
Japan	496	(1)
Lessons from Monetary Targeting Experiences	497	(1)
The New International Trend in Monetary Policy Strategy	498	(2)
Inflation Targeting	498	(1)
New Zealand	498	(1)
Canada	499	(1)
United Kingdom	499	(1)
Lessons from Inflation Targeting Experiences	499	(1)
Summary, Key Terms, Questions and Problems	500	(2)
CHAPTER 20 THE INTERNATIONAL FINANCIAL SYSTEM	502	(25)
Preview	502	(1)
Intervention in the Foreign Exchange Market	502	(5)
Foreign Exchange Intervention and the Money Supply	502	(2)
BOX 1 INSIDE THE FED A Day at the Federal Reserve Bank of New York's Foreign Exchange Desk	504	(1)
Unsterilized Intervention	505	(1)
Sterilized Intervention	506	(1)
Balance of Payments	507	(4)
Current Account	508	(1)
Following the Financial News The Balance of Payments	509	(1)
Capital Account	510	(1)
Official Reserve Transactions Balance	510	(1)
Methods of Financing the Balance of Payments	511	(1)
Evolution of the International Financial System	511	(10)
Gold Standard	511	(1)
Bretton Woods System and the IMF	512	(4)
Box 2 Argentina's Currency Board	516	(1)
Managed Float	517	(1)
European Monetary System (EMS)	518	(1)
Application September 1992 Foreign Exchange Crisis	519	(1)
Application Mexican Peso Crisis of December 1994	520	(1)
International Considerations and Monetary Policy	521	(2)
Direct Effects of the Foreign Exchange Market on the Money Supply	522	(1)
Balance-of-Payments Considerations	522	(1)
Exchange Rate Considerations	523	(1)
Summary, Key Terms, Questions and Problems	523	(4)
PART V Monetary Policy	527
CHAPTER 21 THE DEMAND FOR MONEY	529	(26)
Preview	529	(1)
Quantity Theory of Money	529	(3)
Velocity of Money and Equation of Exchange	530	(1)
Quantity Theory	531	(1)
Quantity Theory of Money Demand	531	(1)
Cambridge Approach to Money Demand	532	(1)
Is Velocity a Constant?	533	(2)
Keynes's Liquidity Preference Theory	535	(4)
Transactions Motive	535	(1)
Precautionary Motive	535	(1)
Speculative Motive	535	(1)
Putting the Three Motives Together	536	(3)
Further Developments in the Keynesian Approach	539	(5)
Transactions Demand	539	(3)
Precautionary Demand	542	(1)
Speculative Demand	542	(2)
Friedman's Modern Quantity Theory of Money	544	(1)
Distinguishing Between the Friedman and Keynesian Theories	545	(3)
Empirical Evidence on the Demand for Money	548	(5)
Interest Rates and Money Demand	548	(2)
Stability of Money Demand	550	(3)
Summary, Key Terms, Questions and Problems	553	(2)
CHAPTER 22 THE KEYNESIAN FRAMEWORK AND THE ISLM MODEL	555	(25)
Preview	555	(1)
Determination of Aggregate Output	555	(16)
Consumer Expenditure and the Consumption Function	557	(1)
Investment Spending	558	(1)
BOX 1 Meaning of the Word Investment	559	(1)
Equilibrium and the Keynesian Cross Diagram	560	(1)
Expenditure Multiplier	561	(3)
Application The Collapse of Investment Spending and the Great Depression	564	(1)
Government's Role	564	(3)
Role of International Trade	567	(1)
Summary of the Determinants of Aggregate Output	567	(4)
The ISLM Model	571	(6)
Equilibrium in the Goods Market: The IS Curve	571	(4)
Equilibrium in the Market for Money: The LM Curve	575	(2)
ISLM Approach to Aggregate Output and Interest Rates	577	(1)
Summary, Key Terms, Questions and Problems	578	(2)
CHAPTER 23 MONETARY AND FISCAL POLICY IN THE ISLM MODEL	580	(23)
Preview	580	(1)
Factors That Cause the IS Curve to Shift	581	(2)
Factors That Cause the LM Curve to Shift	583	(2)
Changes in Equilibrium Level of the Interest Rate and Aggregate Output	585	(5)
Response to a Change in Monetary Policy	585	(1)
Response to a Change in Fiscal Policy	586	(2)
Application The Vietnam War Buildup and the Rise in Interest Rates, 1965-1966	588	(2)
Effectiveness of Monetary Versus Fiscal Policy	590	(6)
Monetary Policy Versus Fiscal Policy: The Case of Complete Crowding Out	590	(2)
Application Targeting Money Supply Versus Interest Rates	592	(4)
ISLM Model in the Long Run	596	(2)
ISLM Model and the Aggregate Demand Curve	598	(5)
Deriving the Aggregate Demand Curve	598	(1)
Factors That Cause the Aggregate Demand Curve to Shift	599	(2)
Summary, Key Terms, Questions and Problems	601	(2)
CHAPTER 24 AGGREGATE DEMAND AND SUPPLY ANALYSIS	603	(26)
Preview	603	(1)
Aggregate Demand	603	(5)
Following the Financial News Aggregate Output, Unemployment, and the Price Level	604	(1)
Monetarist View of Aggregate Demand	604	(1)
Keynesian View of Aggregate Demand	606	(1)
The Crowding-Out Debate	607	(1)
Aggregate Supply	608	(2)
Shifts in the Aggregate Supply Curve	609	(1)
Equilibrium in Aggregate Supply and Demand Analysis	610	(13)
Equilibrium in the Short Run	610	(1)
Equilibrium in the Long Run	611	(3)
Shifts in Aggregate Demand	614	(2)
Shifts in Aggregate Supply	616	(1)
Shifts in the Long-Run Aggregate Supply Curve: Real Business Cycle Theory and Hysteresis	617	(3)
Conclusions	620	(1)
Application Explaining Past Business Cycle Episodes	620	(2)
Application Predicting Future Economic Activity	622	(1)
Summary, Key Terms, Questions and Problems	623	(2)
Appendix to Chapter 24: Aggregate Supply and the Phillips Curve: Historical Perspective	625	(4)
CHAPTER 25 TRANSMISSION MECHANISMS OF MONETARY POLICY: THE EVIDENCE	629	(30)
Preview	629	(1)
Framework for Evaluating Empirical Evidence	630	(4)
Structural Model Evidence	630	(1)
Reduced-Form Evidence	631	(1)
Advantages and Disadvantages of Structural Model Evidence	631	(1)
Advantages and Disadvantages of Reduced-Form Evidence	632	(1)
BOX 1 Perils of Reverse Causation: A Russian Folk Tale	633	(1)
Conclusions	633	(1)
BOX 2 Perils of Ignoring an Outside Driving Factor: How to Lose a Presidential Election	634	(1)
Early Keynesian Evidence on the Importance of Money	634	(3)
Objections to Early Keynesian Evidence	635	(2)
Early Monetarist Evidence on the Importance of Money	637	(6)
Timing Evidence	638	(3)
Statistical Evidence	641	(1)
Historical Evidence	642	(1)
Overview of the Monetarist Evidence	643	(1)
Transmission Mechanisms of Monetary Policy	643	(11)
BOX 3 Real Business Cycle Theory and the Debate on Money and Economic Activity	644	(1)
Traditional Interest-Rate Channels	644	(3)
Other Asset Price Channels	647	(2)
Credit View	649	(3)
BOX 4 Consumers' Balance Sheets and the Great Depression	652	(1)
Why Are Credit Channels Likely to Be Important?	653	(1)
Application Credit Crunch and Slow Recovery from the 1990-1991 Recession	653	(1)
Lessons for Monetary Policy	654	(2)
Summary, Key Terms, Questions and Problems	656	(3)
CHAPTER 26 MONEY AND INFLATION	659	(27)
Preview	659	(1)
Money and Inflation: Evidence	659	(4)
German Hyperinflation, 1921-1923	660	(1)
BOX 1 Inflation and Money Growth Rates in Latin America, 1986-1996	661	(1)
Recent Episodes of Rapid Inflation	662	(1)
Meaning of Inflation	663	(1)
Views of Inflation	663	(4)
Monetarist View	663	(1)
Keynesian View	664	(3)
Summary	667	(1)
Origins of Inflationary Monetary Policy	667	(12)
High Employment Targets and Inflation	668	(3)
Budget Deficits and Inflation	671	(4)
Application Explaining the Rise in U.S. Inflation, 1960-1980	675	(4)
Activist/Nonactivist Policy Debate	679	(5)
Responses to High Unemployment	679	(1)
Activist and Nonactivist Positions	680	(1)
Expectations and the Activist/Nonactivist Debate	681	(2)
BOX 2 Perils of Accommodating Policy: The Terrorism Dilemma	683	(1)
Rules Versus Discretion: Conclusions	683	(1)
Application Importance of Credibility to Volcker's Victory over Inflation	684	(1)
Summary, Key Terms, Questions and Problems	684	(2)
CHAPTER 27 THEORY OF RATIONAL EXPECTATIONS AND EFFICIENT CAPITAL MARKETS	686	(24)
Preview	686	(1)
Role of Expectations in Economic Activity	687	(2)
Theory of Rational Expectations	689	(3)
Formal Statement of the Theory	691	(1)
Rationale Behind the Theory	691	(1)
Implications of the Theory	692	(1)
Efficient Markets Theory: Rational Expectations in Financial Markets	692	(3)
Rationale Behind the Theory	694	(1)
Stronger Version of Efficient Markets Theory	695	(1)
Evidence on Efficient Markets Theory	695	(10)
Evidence in Favor of Market Efficiency	696	(1)
BOX 1 An Exception That Proves the Rule: Ivan Boesky	697	(2)
Application Should Foreign Exchange Rates Follow a Random Walk?	699	(1)
Evidence Against Market Efficiency	699	(2)
Overview of the Evidence on Efficient Markets Theory	701	(1)
Application Practical Guide to Investing in the Stock Market	702	(1)
Following the Financial News Stock Prices	703	(1)
BOX 2 Should You Hire an Ape as Your Investment Adviser?	704	(1)
Evidence on Rational Expectations in Other Markets	705	(3)
Application What Does the Stock Market Crash of 1987 Tell Us About Rational Expectations and Efficient Markets?	707	(1)
Summary, Key Terms, Questions and Problems	708	(2)
CHAPTER 28 RATIONAL EXPECTATIONS: IMPLICATIONS FOR POLICY	710
Preview	710	(1)
The Lucas Critique of Policy Evaluation	711	(2)
Econometric Policy Evaluation	711	(1)
Example: The Term Structure of Interest Rates	712	(1)
New Classical Macroeconomic Model	713	(4)
Effects of Unanticipated and Anticipated Policy	713	(2)
BOX 1 Proof of the Policy Ineffectiveness Proposition	715	(1)
Can an Expansionary Policy Lead to a Decline in Aggregate Output?	716	(1)
Implications for Policymakers	717	(1)
New Keynesian Model	717	(3)
Effects of Unanticipated and Anticipated Policy	718	(2)
Implications for Policymakers	720	(1)
Comparison of the Two New Models with the Traditional Model	720	(9)
Short-Run Output and Price Responses	721	(1)
Stabilization Policy	722	(2)
Anti-inflation Policies	724	(3)
Credibility in Fighting Inflation	727	(1)
BOX 2 Ending the Bolivian Hyperinflation: Case Study of a Successful Anti-inflation Program	728	(1)
Application Credibility and the Reagan Budget Deficits	728	(1)
Impact of the Rational Expectations Revolutions	729	(2)
Summary, Key Terms, Questions and Problems	731
MATHEMATICAL APPENDIX TO CHAPTER 21: A Mathematical Treatment of the Baumol-Tobin and Tobin Mean Variance Models	MA-1
MATHEMATICAL APPENDIX TO CHAPTER 23: Algebra of the ISLM Model	MA-7
GLOSSARY	G-1
ANSWERS TO SELECTED QUESTIONS AND PROBLEMS	A-1
CREDITS	C-1
INDEX	I-1