Economics of Money Banking and Financial Markets Fifth Canadian Edition Canadian 5th Edition Mishkin Solutions Manual
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Economics of Money Banking and Financial Markets Fifth Canadian Edition Canadian 5th Edition Mishkin Solutions Manual.
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Economics of Money Banking and Financial Markets Fifth Canadian Edition Canadian 5th Edition Mishkin Solutions Manual
Product details:
- ISBN-10 : 0321785703
- ISBN-13 : 978-0321785701
- Author:
The Economics of Money, Banking, and Financial Markets provides a unifying and analytic framework that uses basic economic principles to organize students’ thinking about the structure of financial markets, the foreign exchange markets, financial institution management, and the role of monetary policy in the economy.
Table contents:
part 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 8
Money and Inflation 10
Money and Interest Rates 11
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
Collecting and Graphing Data 15
Web Exercises 15
Concluding Remarks 16
Summary 17
Key Terms, Questions and Problems 18
Web Exercises and Web References 19
Appendix to Chapter 1
Defining Aggregate Output, Income, the Price Level,
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
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
Financial Markets Instruments 28
Money Maker Instruments 28
Following the Financial News Money Market Rates 30
Capital Market Instruments 31
Internationalization of Financial Markets 33
International Bond Market, Eurobonds, and Eurocurrencies 33
World Stock Markets 33
Following the Financial News Foreign Stock Market Indexes 34
Function of Financial Intermediaries 35
Transaction Costs 35
Box 1 Global: The Importance of Financial Intermediaries to Securities
Markets: An International Comparison 36
Risk Sharing 36
Asymmetric Information: Adverse Selection and Moral Hazard 37
Types of Financial Intermediaries 39
Depository Institutions 39
Contractual Savings Institutions 40
Investment Intermediaries 42
Regulation of the Financial System 42
Increasing Information Available to Investors 44
Ensuring the Soundness of Financial Intermediaries 44
Financial Regulation Abroad 45
Summary 46
Key Terms, Questions and Problems 47
Web Exercises and Web References 48
Chapter 3
What Is Money? 49
Preview 49
Meaning of Money 49
Functions of Money 50
Medium of Exchange 50
Unit of Account 51
Store of Value 52
Evolution of the Payments System 53
Commodity Money 53
Fiat Money 53
Checks 53
Electronic Payment 54
E-Money 54
Box 1 E-Finance: Why Are Scandinavians So Far Ahead of Americans in
Using Electronic Payments? 55
Box 2 E-Finance: Are We Headed for a Cashless Society? 56
Measuring Money 56
The Federal Reserve’s Monetary Aggregates 56
Following the Financial News The Monetary Aggregates 58
Box 3 Where Are All the U. S. Dollars? 59
How Reliable Are the Money Data? 59
Summary 61
Key Terms, Questions and Problems 62
Web Exercises and Web References 63
part II
Financial Markets 65
Chapter 4
Understanding Interest Rates 67
Preview 67
Measuring Interest Rates 67
Present Value 67
Application Simple Present Value 69
Application How Much Is That Jackpot Worth? 69
Four Types of Credit Market Instruments 70
Yield to Maturity 71
Application Yield to Maturity on a Simple Loan 71
Application Reading the Wall Street Journal: The Bond Page 72
Application Yeild to Maturity and the Yearly Payment on a Fixed-Payment Loan 73
Application Yeild to Maturity and the Bond Price for a Coupon Bond 74
Application Perpetuity 76
Box 1 Global: Negative T-Bill Rates? Japan Shows the Way 78
Yield on a Discount Basis 78
Application Reading the Wall Street Journal: The Bond Page 80
Following the Financial News Bond Prices and Interest Rates 81
The Distinction Between Interest Rates and Returns 82
Box 2 Helping Investors to Select Desired Interest-Rate Risk 85
Maturity and the Volatility of Bond Returns: Interest-Rate Risk 85
The Distinction Between Real and Nominal Interest Rates 87
Application Calculating Real Interest Rates 88
Box 3 With TIPS, Real Interest Rates Have Become Observable in the
United States 90
Summary 90
Key Terms, Questions and Problems 91
Web Exercise sand Web References 92
Chapter 5
The Behavior of Interest Rates 93
Preview 93
Determinants of Asset Demand 93
Wealth 94
Expected Returns 94
Risk 95
Liquidity 95
Theory of Asset Demand 95
Supply and Demand in the Bond Market 95
Demand Curve 96
Supply Curve 98
Market Equilibrium 98
Supply and Demand Analysis 99
Changes in Equilibrium Interest Rates 99
Shifts in the Demand for Bonds 100
Shifts in the Supply of Bonds 103
Application Changes in the Interest Rate Due to Expected Inflation: The Fisher
Effect
105
Application Changes in the Interest Rate Due to a Business Cycle Expansion 106
Application Explaining Low Japanese Interest Rates 109
Application Reading the Wall Street Journal “Credit Markets” Column 109
Following the Financial News The “Credit Markets” Column 110
Supply and Demand in the Market for Money: The Liquidity
Preference Framework 111
Changes in Equilibrium Interest Rates in the Liquidity Reference Framework 113
Shifts in the Demand for Money 113
Shifts in the Supply of Money 114
Application Changes in the Equilibrium Interest Rate Due to Changes
in Income, the Price Level, or the Money Supply 114
Changes in Income 114
Changes in the Price Level 114
Changes in the Money Supply 115
Application Money and Interest Rates 116
Does a Higher Rate of Growth of the Money Supply Lower Interest Rates? 118
Following the Financial News Forecasting Interest Rates 122
Summary 123
Key Terms, Questions and Problems 124
Web Exercises 125
Web References 126
Chapter 6
The Risk and Term Structure of Interest Rates 127
Preview 127
Risk Structure of Interest Rates 127
Default Risk 127
Application The Enron Bankruptcy and the Baa-Aaa Spread 131
Liquidity 131
Income Tax Considerations 132
Summary 133
Application Effects of the Bush Tax Cut on Bond Interest Rates 134
Term Structure of Interest Rates 134
Following the Financial News Yield Curves 136
Expectations Theory 136
Segmented Markets Theory 139
Liquidity Premium and Preferred Habitat Theories 140
Evidence on the Term Structure 143
Box 2 The Yield Curve as a Forecasting Tool for Inflation and the Business Cycle
144
Summary 144
Application Interpreting Yield Curves, 1980/2003 145
Summary 146
Key Terms, Questions and Problems 147
Web Exercises 148
Web References 149
Chapter 7
The Stock Market, the Theory of Rational Expectations,
and the Efficient Market Hypothesis 151
Preview 151
Computing the Price of Common Stock 151
The One-Period Valuation Model 152
The Generalized Dividend Valuation Model 153
The Gordon Growth Model 153
How the Market Sets Security Prices 154
Application Monetary Policy and Stock Prices 155
Application The September 11 Terrorist Attacks, the Enron Scandal,
and the Stock Market 156
The Theory of Rational Expectations 156
Formal Statement of the Theory 158
Rationale Behind the Theory 158
Implications of the Theory 159
The Efficient Markets Hypothesis: Rational Expectations in Financial Markets 160
Rationale Behind the Hypothesis 161
Stronger Version of the Efficient Market Hypothesis 162
Evidence on the Efficient Market Hypothesis 162
Evidence in Favor of Market Efficiency 162
Application Should Foreign Exchange Rates Follow a Random Walk? 165
Evidence Against Market Efficiency 165
Overview of the Evidence on the Efficient Market Hypothesis 168
Application Practical Guide to Investing in the Stock Market 168
How Valuable Are Published Reports by Investment Advisers? 168
Following the Financial News Stock Prices 169
Should You Be Skeptical of Hot Tips? 169
Box 1 Should You Hire an Ape as Your Investment Adviser? 170
Do Stock Prices Always Rise When There Is Good News? 170
Efficient Market Prescription for the Investor 171
Evidence on Rational Expectations in Other Markets 171
Application What Do the Black Monday Crash of 1987 and the Tech
Crash of 2000 Tell Us About Rational Expectations and Efficient Markets? 172
Behavioral Finance 173
Summary 174
Key Terms, Questions and Problems 175
Web Exercises 176
WebReferences 177
part III
Financial Institutions 179
Chapter 8
An Economic Analysis of Financial Structure 181
Preview 181
Basic Puzzles About Financial Structure Throughout the World 181
Transaction Costs 184
How Transaction Costs Influence Financial Structure 184
How Financial Intermediaries Reduce Transaction Costs 185
Asymmetric Information: Adverse Selection and Moral Hazard 186
The Lemons Problem: How Adverse Selection Influences Financial Structure 186
Lemons in the Stock and Bond Markets 187
Tools to Help Solve Adverse Selection Problems 188
Box 1 The Enron Implosion 189
How Moral Hazard Affects the Choice Between Debt and Equity Contracts 192
Moral Hazard in Equity Contracts: The Principal/Agent Problem 192
Tools to Help Solve the Principal/Agent Problem 193
How Moral Hazard Influences Financial Structure in Debt Markets 195
Tools to Help Solve Moral Hazard in Debt Contracts 195
Summary 197
Conflicts of Interest 198
Why Do We Care About Conflicts of Interest? 199
Why Do Conflicts of Interesst Arise? 199
Box 2 Conflicts of Interest The King, Queen, and the Jack of the Interest 200
What Has Been Done to Remedy Conflicts of Interest? 201
Box 3 Conflicts of Interest The Demise of Arthur Andersen 194
Application Financial Development and Economic Growth 203
Application Is China a Counter-Example to the Importance of Financial
Developement? 204
Financial Crises and Aggregate Economic Activity 205
Factors Causing Financial Crises 206
Application Financial Crises in the United States 208
Box 4 Case Study of a Financial Crisis: The Great Depression 210
Application Financial Crises in Emerging-Market Countries:
Mexico, 1994/1995; East Asia, 1997/1998; and Argentina, 2001/2002 211
Summary and Key Terms 215
Questions and Problems and Web Exercises 216
Web References 217
Chapter 9
Banking and the Management of Financial Institutions 219
Preview 219
The Bank Balance Sheet 219
Liabilities 219
Assets 222
Basic Banking 223
General Principles of Bank Management 226
Liquidity Management and the Role of Reserves 226
Asset Management 229
Liability Management 230
Capital Adequacy Management 231
Application Strategies for Managing Bank Capital 233
Application Did the Capital Crunch Cause a Credit Crunch in the
Early 1990s? 234
Managing Credit Risk 234
Screening and Monitoring 235
Long-Term Customer Relationships 236
Loan Commitments 237
Collateral and Compensating Balances 237
Credit Rationing 238
Managing Interest-Rate Risk 238
Gap and Duration Analysis 239
Application Strategies for Managing Interest-Rate Risk 240
Off-Balance-Sheet Activities 241
Loan Sales 241
Generation of Fee Income 241
Trading Activities and Risk Management Techniques 242
Box 1 Global: Barings, Daiwa, Sumitomo, and Allied Irish:
Rogue Traders and the Principal/Agent Problem 243
Summary and Key Terms 244
Questions and Problems 245
Web Exercises and Web References 246
Chapter 10
Banking Industry: Structure and Competition 247
Preview 247
Historical Development of the Banking System 247
Multiple Regulatory Agencies 249
Financial Innovation and the Evolution of the Banking Industry 250
Responses to Changes in Demand Conditions: Interest Rate Volatility 251
Responses to Changes in Supply Conditions: Information Technology 252
Box 1 E-Finance: Will “Clicks” Dominate “Bricks” in the Banking Industry? 254
Avoidance of Existing Regulations 255
Financial Innovation and the Decline of Traditional Banking 257
Structure of the U.S. Commercial Banking Industry 261
Restrictions on Branching 261
Response to Branching Restrictions 262
Bank Consolidation and Nationwide Banking 263
Box 2 E-Finance: Information Technology and Bank Consolidation 265
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 265
What Will the Structure of the U.S. Banking Industry Look Like in the Future? 266
Box 3 Global: Comparison of Banking Structure in the United States
and Abroad 266
Are Bank Consolidation and Nationwide Banking Good Things? 267
Separation of the Banking and Other Financial Service Industries 268
Erosion of Glass-Steagall 268
The Gramm-Leach-Bliley Financial Services Modernization Act of 1999:
Repeal of Glass-Steagall 268
Implications for Financial Consolidation 269
Separation of Banking and Other Financial Services Industries Throughout the World
269
Thrift Industry: Regulation and Structure 270
Savings and Loan Associations 270
Mutual Savings Banks 270
Credit Unions 271
International Banking 271
Eurodollar Market 272
Box 4 Global: Ironic Birth of the Eurodollar Market 273
Structure of U.S. Banking Overseas 273
Foreign Banks in the United States 273
Summary and Key Terms 275
Questions and Problems, and Web Exercises 276
Web References 277
Chapter 11
Economic Analysis of Banking Regulation 279
Preview 279
Asymmetric Information and Banking Regulation 279
Government Safety Net: Deposit Insurance and the FDIC 279
Box 1 Global: The Spread of Government Deposit Insurance Throughout
the World: Is This a Good Thing? 281
Restrictions on Asset Holdings and Bank Capital Requirements 283
Bank Supervision: Chartering and Examination 284
Box 2 Global: Basel 2: Is It Unworkable? 285
Assessment of Risk Management 286
Disclosure Requirements 287
Consumer Protection 288
Restrictions on Competition 288
Box 3 E-Finance: Electronic Banking: New Challenges for Bank Regulation 289
International Banking Regulation 291
Problems in Regulating International Banking 291
Summary 291
The 1980s U.S. Savings and Loan and Banking Crisis: Why? 293
Early Stages of the Crisis 293
Later Stages of the Crisis: Regulatory Forbearance 294
Competitive Equality in Banking Act of 1987 295
Political Economy of the Savings and Loan Crisis 295
The Principal/Agent Problem for Regulators and Politicians 296
FYI The Principal-Agent Problem in Action: Charles Keating and the Lincoln Savings
and Loan Scandal 297
Savings and Loan Bailout: The Financial Institutions Reform, Recovery, and
Enforcement Act of 1989
298
Federal Deposit Insurance Corporation Improvement Act of 1991 299
Banking Crises Throughout the World 300
Scandinavia 301
Latin America 302
Russia and Eastern Europe 302
Japan 303
China 304
East Asia 305
“Døjø Vu All Over Again” 305
Summary 305
Key Terms, Questions and Problems 306
Web Exercises and Web References 307
Part IV Central Banking and the Conduct of Monetary Policy 309
Chapter 12
Structure of Central Banks and the Federal Reserve System 311
Preview 311
Origins of the Federal Reserve Systems 311
Box1 Inside the Fed The political Genius of the Founders of the Federal Reserve
System 312
Structure of the Federal Reserve System 312
Federal Reserve Banks 313
Box2 Inside the Fed The special Role of the Federal Reserve Bank of New York 315
Member Banks 316
Board of Governors of the Federal Reserve System 316
Federal Open market Committee (FOMC) 317
Box3 Inside the Fed The Role of the Research Staff 318
The FOMC Meeting 319
Box4 Inside the Fed Green, Blue, and Beige: What Do These Colors Mean at the Fed?
320
Why the Chairman of the Board of Governors Really Runs the Show 320
How Independent is the Fed? 321
Structure and Independence of the European Central Bank 322
Differences Between the European System of Central Banks and the Federal Reserve
System 323
Governing Council 323
How Independent Is the ECB? 324
Structure and Independence of other Foreign Central Banks 325
Bank of Canada 325
Bank of England 325
Bank of Japan 326
The Trend Toward Greater Independence 326
Explaining Central Bank Behavior 326
Box5 Inside the Fed Federal Reserve Transparency 327
Should the Fed be Independent? 328
The Case for Independence 328
The Case Against Independence 329
Central Bank Independence and Macroeconomic Performance Throughout The World 330
Summary 330
Key Terms 331
Questions and Problems 331
Web Exercises and Web References 332
Chapter 13
Multiple Deposit Creation and the Money Supply Process 333
Preview 333
Four Players in the Money Supply Process 333
The Fed’s Balance Sheet 334
Liabilities 334
Control of the Monetary Base 335
Federal Reserve Open Market Operations 336
Shifts from Deposits into Currency 339
Discount Loans 340
Other Factors That Affect the Monetary base 341
Overview of the Fed’s Ability to Control the Monetary Base 341
Multiple Deposit Creation: A Simple Model 341
Deposit Creation: The Single Bank 41
Deposit Creation: The Banking System 343
Deriving the Formula for Multiple Deposit Creation 345
Critique of the Simple Model 347
Summary 347
Key Terms and Questions and Problems 348
Web Exercises and Web References 349
Chapter 14
Determinants of the Money Supply 351
Preview 351
The Money Supply Model and the Money Multiplier 352
Deriving the Money Multiplier 352
Intuition Behind the Money Multiplier 354
Factors that Determine the Money Multiplier 355
Changes in the Required Reserve Ratio r 355
FYI The Declining Importance of Reserve Requirements 356
Changes in the Currency Ratio c 357
Changes in the Excess Reserves Ratio e 357
Additional Factors That Determine the Money Supply 359
Changes in the Nonborrowed Monetary Base MBn 360
Changes in the Discount Loans DL from the Fed 360
Overview of the Money Supply Process 360
Application Explaining Movements in the Money Supply, 1980/2005 362
Application The Great Depression Bank Panics, 1930/1933 364
Summary, Key Terms, Questions and Problems 368
Web Exercises and References 369
Appendix to Chapter 14
The M2 Money Multiplier 370
Factors that Determine the M2 Money Multiplier 371
Response to Changes in t and mm 371
Chapter 15
Tools of Monetary Policy 373
Preview 373
The Market for Reserves and the Federal Funds Rate 373
Supply and Demand in the Market for Reserves 374
How Changes in the Tools of Monetary Policy Affect the Federal Funds Rate 375
Open Market Operations 378
A Day at the Trading Desk 378
Advantages of Open Market Operations 380
Discount Policy 380
Operation of the Discount Window 381
Lender of Last Resort 381
Advantages and Disadvantages of Discount Policy 383
Reserve Requirements 383
Box 1 Inside the Fed: Using Discount Policy 384
Disadvantages of Reserve Requirements 385
Application Why Have Reserve Requirements Been Declining Worldwide? 385
Application The Channel/Corridor System for Setting Interest Rates in
Other Countries 386
Monetary Policy Tools of the European Central Bank 388
Open Market Operations 388
Reserve Requirements 389
Summary 389
Key Terms and Questions and Problems 390
Web Exercises and Web References 391
Chapter 16
What Should Central Banks Do? Monetary Policy Goals, Strategy, and Tactics 393
Preview 393
The Price Stability Goal and the Nominal Anchor 393
The Role of a Nominal Anchor 394
The Time-Inconsistency Problem 394
Other Goals of Monetary Policy 395
High Employment 395
Economic Growth 396
Stability of Financial Markets 396
Interest-Rate Stability 396
Stability in Foreign Exchange Markets 396
Should Price Stability be the Primary Goal of Monetary Policy? 397
Hierarchical Versus Dual Mandates 397
Price Stability as the Primary, Long-Run Goal of Monetary Policy 398
Monetary Targeting 398
Monetary Targeting in the United States, Japan, and Germany 398
Box1 Global: The European Central Bank’s Monetary Policy Strategy 401
Advantages of Monetary Targeting 402
Disadvantages of Monetary Targeting 402
Inflation Targeting 402
Inflation Targeting in New Zealand, Canada, and the United Kingdom 403
Advantages of Inflation Targeting 405
Disadvantages of Inflation Targeting 406
Monetary Policy with an Implicit Nominal Anchor 408
Advantages of the Fed’s Approach 409
Disadvantages of the Fed’s Approach 409
Box2 Inside the Fed The New Fed Chairman and Inflation Targeting 410
Tactics: Choosing the Policy Instrument 412
The Taylor Rule, NAIRU, and the Phillips Curve 414
Box3 Inside the Fed Fed Watchers 416
Summary 417
Key Terms, Questions and Problems 418
Web Exercises and Web References 419
Appendix to Chapter16
Fed Policy Procedures: Historical Perspective 420
The Early Years: Discount Policy as the Primary Tool 420
Discovery of Open Market Operations 421
The Great Depression 421
Box4 Inside the Fed Bank Panics of 1930-1933: Why Did the Fed Let Them Happen?
422
Reserve Requirements as a Policy Tool 422
War Finance and the Pegging of Interest Rates: 1942/1951 423
Targeting Money Market Conditions: The 1950s and 1960s 423
Targeting Monetary Aggregates: The 1970s 424
New Fed Operating Procedures: October 1979/October 1982 425
De-Emphasis of Monetary Aggregates: October 1982/Early 1990s 426
Federal Funds Targeting Again: Early 1990s and Beyond 427
International Considerations 428
Box5 Global International Policy Coordination: The Plaza Agreement and the Louvre
Accord 428
Part V
International Finance and Monetary Policy 429
Chapter 17
The Foreign Exchange Market 431
Preview 431
Foreign Exchange Market 431
What Are Foreign Exchange Rates? 432
Box1 Following the Financial News Foreign Exchange Rates 433
Why Are Exchange Rates Important? 433
How Is Foreign Exchange Traded? 433
Exchange Rates in the Long Run 434
Law of One Price 434
Theory of Purchasing Power Parity 434
Why the Theory of Purchasing Power Parity Cannot Fully Explain Exchange Rates 436
Factors That Affect Rates in the Long Run 437
Exchange Rates in the Short Run 438
Comparing Expected Returns on Domestic and Foreign Deposits 439
Interest Parity Condition 441
Demand Curve for Domestic Assets 442
Supply Curve for Domestic Assets 443
Equilibrium in the Foreign Exchange Market 443
Explaining Changes in Exchange Rates 444
Shifts in the Expected-Return Schedule for Foreign Deposits 444
Application Changes in the Equilibrium Exchange Rate: Two Examples 447
Changes in Interest Rates 447
Changes in the Money Supply 449
Exchange Rate Overshooting 450
Application Why Are Exchange Rates So Volatile? 451
Application The Dollar and Interest Rates, 1973/2005 452
Application The Euro’s First Four Years 453
Application Reading the Wall Street Journal: The “Currency Trading” Column 453
Box 2 Following the Financial News The “Currency Trading” Column 454
Summary and Key Terms 455
Questions and Problems, and Web Exercises 456
Web References 457
Chapter 18
The International Financial System 459
Preview 459
Intervention in the Foreign Exchange Market 459
Foreign Exchange Intervention and the Money Supply 459
Box 1 Inside the Fed: A Day at the Federal Reserve Bank of New York’s
Foreign Exchange Desk 460
Unsterilized Intervention 462
Sterilized Intervention 463
Balance of Payments 464
Box1 Global Why the Large U. S. Current Account Deficit Worries Economists 465
Exchange Rate Regimes in the International Financial System 465
Gold Standard 466
Bretton Woods System 466
Box 2 Global: The Euro’s Challenge to the Dollar 467
How the Fixed Rate Regime Works 467
Application How Did China Accumulate Nearly $1 Trillion of International Reserves?
470
Managed Float 471
European Monetary System(EMS) 472
Application Recent Foreign Exchange Crises of September 1992 472
Application Recent Foreign Exchange Crises in Emerging Market Countries: Mexico
1994, East Asia
1997, Brazil 1999, and Argentina 2002 474
Capital Controls 475
Controls on Capital Outflows 475
Controls on Capital Inflows 476
The Role of the IMF 477
How Should the IMF Operate? 478
International Considerations and Monetary Policy 479
Should the IMF Be an International Lender of Last Resort? 480
Direct Effects of the Foreign Exchange Market on the Money Supply 479
Balance-of-Payments Considerations 480
Exchange Rate Considerations 480
To Peg or Not to Peg: Exchange-Rate Targeting as an alternative Monetary Policy
Strategy 481
Advantages of Exchange-Rate Targeting 481
Disadvantages of Exchange-Rate Targeting 482
When is Exchange-Rate Targeting Desirable for Industrialized Countries 484
When is Exchange-Rate Targeting Desiravle for Emerging Market Countries? 484
Currency Boards 485
Dollarization 485
Box3 Global Argentina’s Currency Board 486
Summary 487
Key Terms, Questions and Problems 488
Web Exercises and Web References 489
Part VI
Chapter 19
Monetary Theory 491
The Demand for Money 493
Preview 493
Quantity Theory of Money 493
Velocity of Money and Equation of Exchange 494
Quantity Theory 495
Quantity Theory of Money Demand 495
Is Velocity a Constant? 496
Keynes’s Liquidity Preference Theory 497
Transactions Motive 497
Precautionary Motive 498
Speculative 498
Putting the Three Motives Together 499
Further Developments in the Keynesian Approach 501
Transactions Demand 501
Precautionary Demand 503
Speculative Demand 504
Friedman’s Modern Quantity Theory of Money 505
Distinguishing Between The Friedman and Keynesian Theories 507
Empirical Evidence on the Demand for Money 509
Interest Rates and Money Demand 509
Stability of Money Demand 510
Summary 510
Key Terms, Questions and Problems 511
Web Exercises and Web References 512
Chapter 20
The ISLM Model 513
Preview 513
Determination of Aggregate Output 513
Consumer Expenditure and the Consumption Function 514
Investment Spending 526
Box1 FYI Meaning of the Word Investment 517
Equilibrium and the Keynesian Gross Diagram 517
Expenditure Multiplier 519
Application The Collapse of Investment Spending and the Great Depression 521
Government’s Role 522
Role of International Trade 524
Summary of the Determinants of Aggregate Output 525
The ISLM Model 528
Equilibrium in the Goods Market: The IS Curve 528
Equilibrium in the Market for Money: The LM Curve 531
ISLM Approach to Aggregate output and Interest Rates 533
Summary and Key Terms 535
Questions and Problems and Web Exercises 536
Web References 537
Chapter 21
Monetary and Fiscal Policy in the ISLM Model 539
Preview 539
Factors That Cause The IS Curve to Shift 539
Factors That Cause The LM Curve to Shift 542
Changes in Equilibrium Level of the Interest Rate and Aggregate Output 544
Response to a Change in Monetary Policy 544
Response to a Change in Fiscal Policy 545
Effectiveness of Monetary Versus Fiscal Policy 546
Monetary Policy Versus Fiscal Policy: The Case of Complete Crowding Out 546
Application Targeting Money Supply Versus Interest Rates 549
ISLM Model in the Long Run 552
ISLM Model and the Aggregate Demand Curve 554
Deriving the Aggregate Demand Curve 555
Factors That Cause the Aggregate demand Curve to Shift 556
Summary and Key Terms 558
Questions and Problems, and Web Exercises 559
Web References 560
Chapter 22
Aggregate Demand and Supply Analysis 561
Preview 561
Aggregate Demand 561
Quantity Theory of Money Approach to Aggregate Demand 56
Deriving Aggregate Demand from the Behavior of It’s Component Parts 564
Aggregate Supply 565
Long-Run Aggregate Supply Curve 567
Short-Run Aggregate Supply Curve 567
Shifts in the Short-Run Aggregate Supply Curve 568
Factors that Shift the Short-Run Aggregate Supply Curve 569
Equilibrium in Aggregate Supply and Demand Analysis 570
Equilibrium in the Short Run 570
Equilibrium in the long Run 571
Changes in Equilibrium Caused by Aggregate Demand Shocks 574
Changes in Equilibrium Caused by Aggregate Supply Shocks 575
Shifts in the Long-Run Aggregate Supply Curve: Real Business Cycle Theory and
Hysteresis 575
Conclusions 577
Application Explaining Past Business Cycle Episodes 577
Vietnam War Buildup, 1964-1970 577
Negative Supply Shocks, 1973/1975 and 1978/1980 578
Favorable Supply Shocks, 1995/1999 579
Negative Demand Shocks, 2001/2004 579
Summary and Key Terms 580
Questions and Problems 581
Web Exercises and Web References 582
Chapter 23
Transmission Mechanisms of Monetary Policy: The Evidence 583
Preview 583
Framework for Evaluation Empirical Evidence 583
Structural Model Evidence 584
Reduced-Form Evidence 584
Advantages and Disadvantages of Structural Model Evidence 585
Advantages and Disadvantages of Reduced-Form Evidence 585
Box1 FYI Perils of Reverse Causation: A Russian Folk Tale 586
Conclusion 586
Box2 FYI Perils of Ignoring an Outside Driving Factor: How to Lose a Presidential
Election 587
Application The Debate on the Importance of Monetary Policy to Economic
Fluctuations 587
Early Keynesian Evidence on the Importance of Money 587
Objections to Early Keynesian Evidence 588
Early Monetarist Evidence on the Importance of Money 591
Overview of the Monetarist Evidence 595
Box3 FYI Real Business Cycle Theory and the Debate on Money and Economic Activity
596
Transmission Mechanisms of Monetary Policy 596
Traditional Interest-Rate Channels 597
Other Asset Price Channels 598
Credit view 601
Box4 FYI Consumers’ Balance Sheets and the Great Depression 604
Why Are Credit Channels Likely to be Important 605
Application Corporate Scandals and the Slow Recovery from the March 2001 Recession
605
Lessons for Monetary Policy 606
Application Applying the Monetary Policy Lessons to Japan 607
Summary 608
Key Terms and Questions and Problems 609
Web Exercises 610
Web References 611
Chapter 24
Money and Inflation 613
Preview 613
Money and Inflation: Evidence 613
German Huperinflation, 1921/1923 614
Recent Episodes of Raid Inflation 614
Meaning of Inflation 615
Views of Inflation 616
How money Growth Produces Inflation 616
Can Other Factors Besides Money Growth Produce a Sustained Inflation? 617
Summary 619
Origins of Inflationary Monetary Policy 620
High Employment Targets and Inflation 620
Budget Deficits and Inflation 623
Application Explaining the Rise in U. S. Inflation, 1960/1980 627
Activist/NonActivist Policy Debate 630
Responses to High Unemployment 630
Activist and Nonactivist Positions 632
Expectations and the Activist/Nonactivist Debate 632
Activist Versus Nonactivist: Conclusions 634
Application Importance of Credibility to Volcker’s Victory over Inflation 634
Summary and Key Terms 635
Questions and Problems and Web Exercises 636
Web References 637
Chapter 25
Rational Expectations: Implications for Policy 639
Preview 639
The Lucas Critique of Policy Evaluation 640
Econometric Policy Evaluation 640
Example: The Term Structure of Interest Rates 640
New Classical Macroeconomic Model 641
Effects of Unanticipated and Anticipated Policy 642
Can an Expansionary Policy Lead to a Decline in Aggregate Output? 644
Implications for Policymakers 645
New Keynesian Model 646
Effects of Unanticipated and Anticipated Policy 647
Implications for Policymakers 647
Comparison of the Two New Models with the Traditional Model 649
Short-Run Output and Price Responses 649
Stabilization Policy 652
Anti-inflation Policies 652
Credibility in Fighting Inflation 655
Successful Anti-inflation Program 656
Application Credibility and the Reagan Budget Deficits 656
Impact of the Rational Expectations Revolution 656
Summary 658
Key Terms, Questions and Problems 659
Web Exercises and Web References 660
Chapter 26
Transmission Mechanisms of Monetary Policy: The Evidence 603
Preview 603
Framework for Evaluating Empirical Evidence 603
Structural Model Evidence 604
Reduced-Form Evidence 604
Advantages and Disadvantages of Structural Model Evidence 605
Advantages and Disadvantages of Reduced-Form Evidence 606
Presidential Election 607
Conclusions 607
Early Keynesian Evidence on the Importance of Money 607
Objections to Early Keynesian Evidence 608
Early Monetarist Evidence on the Importance of Money 611
Timing Evidence 611
Statistical Evidence 613
Historical Evidence 615
Overview of the Monetarist Evidence 615
Economic Activity 616
Transmission Mechanisms of Monetary Policy 616
Traditional Interest-Rate Channels 617
Other Asset Price Channels 618
Credit View 621
Why Are Credit Channels Likely to Be Important? 625
Application Corporate Scandals and the Slow Recovery from the
March 2001 Recession 625
Lessons for Monetary Policy 626
Application Applying the Monetary Policy Lessons to Japan 628
Summary, Key Terms, Questions and Problems, and Web Exercises 629
Chapter 27
Money and Inflation 632
Preview 632
Money and Inflation: Evidence 632
German Hyperinflation, 1921/1923 633
Recent Episodes of Rapid Inflation 633
Meaning of Inflation 634
Views of Inflation 635
Monetarist View 635
Keynesian View 636
Summary 638
Origins of Inflationary Monetary Policy 638
High Employment Targets and Inflation 639
Budget Deficits and Inflation 643
Application Explaining the Rise in U.S. Inflation, 1960/1980 646
Activist/Nonactivist Policy Debate 650
Responses to High Unemployment 650
Activist and Nonactivist Positions 651
Expectations and the Activist/Nonactivist Debate 652
Rules Versus Discretion: Conclusions 654
Application Importance of Credibility to Volcker’s Victory over Inflation 655
Summary, Key Terms, Questions and Problems, and Web Exercises 655
Chapter 28
Glossary G-1
Answers to Selected Questions and Problems A-1
Credits C-1
Index I-1
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