Economics 330Money and Banking

(Fall 2006)

Prof. Menzie ChinnTAs: Chikako Baba,

Deokwoo Nam

Outline

• Administrative issues• The current macro context• Some basic concepts and

definitions

Administrative Issues

• Course website: http://www.ssc.wisc.edu/~mchinn/web330_f06.html

• OH: MW 2:30-3:30, 7418 Soc Sci• Textbook: Mishkin, Economics of Money,

Banking and Financial Markets 8/e (7/e okay)

• Grading: 20% PS, 40% 2xMTs, 40% Final

Administrative Issues

• Dates:- MT1 on Wed. 10/11- MT2 on Wed. 11/8- Final on Fri. 12/22

• Make-ups: None. Points are re-allocated if you have a legitimate excuse. No late assignments accepted (have to be handed in)

• If you know you can’t make the final exam, don’t take the course.

Macro Context

• The slowdown and potential recession

• Housing price deflation• Associated energy shocks• Government budget deficit• Current account and trade deficits

The slowdown: GDP

-.02

.00

.02

.04

.06

.08

1999 2000 2001 2002 2003 2004 2005 2006

(G D P 00/G D P 00(-1 ))^4-1 DBFCST

R e a l G D Pg ro w th(S AAR )

D eutscheB ankf'c a s t (9 /1 )

Annualized growth = [(X(t)/X(t-1))4 – 1] when data is quarterly

The Slowdown: Employm’t

125000

130000

135000

140000

145000

1999 2000 2001 2002 2003 2004 2005 2006

Nonfarmpayrollemploym't('000s)

Civilian employm't('000s)

The Slowdown: Employmen’t

-.08

-.04

.00

.04

.08

.12

2000 2001 2002 2003 2004 2005 2006

(P A Y E M S /P A Y E M S (-1 ))^1 2 -1(C E 1 6 O V /C E 1 6 O V(-1 ))^1 2 -1

H u rric a n eK a tr in a

Annualized growth = [(X(t)/X(t-1))12 – 1] when data is monthly

The Slowdown: Hours

98

99

100

101

102

103

104

105

106

33.2

33.4

33.6

33.8

34.0

34.2

34.4

34.6

34.8

1999 2000 2001 2002 2003 2004 2005 2006

AW HI AWHNONAG

AggregateHours W orked[left scale]

AverageW eeklyHours[right scale]

The Slowdown: Yield Curve

-3

-2

-1

0

1

2

3

4

5

1970 1975 1980 1985 1990 1995 2000 2005

/S ep. 5-0 .21%

10 year-3 monthspread

The Slowdown: Housing

http://www.ofheo.gov/media/pdf/2q06hpi.pdf

Petroleum Prices

St. Louis Fed, 9/5/06

0

10

20

30

40

50

60

70

80

1970 1975 1980 1985 1990 1995 2000 2005

Real O ilPrice W T I(CPI=1 '82-'84) \

NominalOil PriceW T I

Energy Futures

St. Louis Fed, NET 9/5/06

Gasoline

http://www.eia.doe.gov/oil_gas/petroleum/data_publications/wrgp/mogas_home_page.html

Macro Implications: Framework

Negative Supply Shock

GDP

-.08

-.04

.00

.04

.08

.12

80 82 84 86 88 90 92 94 96 98 00 02 04 06

quarter-on-quarterGDP growth(SAAR)

\ year-on-year GDP growth (SAAR)

Appendix: Definitions

Growth Rates and the Inflation Rate

1

1

Growth Rate 100t t

t

x xx

−

−

−= ×

$9.5 trillion $9 trillionGDP Growth Rate 100 5.6%$9 trillion

−= × =

113 111Inflation Rate 100 1.8%111−

= × =

Inflation: CPI and core CPI

.00

.02

.04

.06

.08

.10

.12

.14

.16

80 82 84 86 88 90 92 94 96 98 00 02 04 06

year-on-yearcore CPIinflation

year-on-yearCPI inflation

Interest Rates

0

4

8

12

16

20

80 82 84 86 88 90 92 94 96 98 00 02 04 06

10 yearbond yield

3 monthT-bill yield

Term Structure

http://www.bloomberg.com/markets/rates/index.html

The rest of the world

-.07

-.06

-.05

-.04

-.03

-.02

-.01

.00

.01

.02

80 82 84 86 88 90 92 94 96 98 00 02 04

Current Accountto G D P ratio

N et assetincome to GDP

N et Exportsto GDP ratio

The Dollar

3.4

3.6

3.8

4.0

4.2

4.4

4.6

4.8

5.0

80 82 84 86 88 90 92 94 96 98 00 02 04 06

Log real valueof the dollar

Log nominal valueof the dollar

Chapter 1

Why Study Money, Banking, and Financial Markets?

Why Study Financial Markets?1.Channel funds from savers to investors, thereby

promoting economic efficiency2.Affect personal wealth and behavior of business

firmsWhy Study Banking and Financial

Institutions?1.Financial Intermediation

Helps get funds from savers to investors2.Banks and Money Supply

Crucial role in creation of money3.Financial Innovation

Why Study Money and Monetary Policy?1. Influence on business cycles, inflation, and interest

rates

Bond Market

Stock Market

Money and Business Cycles

Money and the Price Level

Money Growth and Inflation

Money Growth and Interest Rates

Fiscal Policy

-.07

-.06

-.05

-.04

-.03

-.02

-.01

.00

.01

1980 1985 1990 1995 2000 2005 2010 2015

Actua l Federa lBudget Balanceto G D P ratio(fisca l yrs)

C BO Baseline

Extend ingEG T R R A& JG T RRA

CBO Debt Projections

Source: CBO (Aug. 2006)

.25

.30

.35

.40

.45

.50

1980 1985 1990 1995 2000 2005 2010 2015

Debt to GDPRatio (Actualand Projected) CBO

Baseline

Extend EGTRRAand JGTRRA,reform AMT

34

How We Study Money and Banking

Basic Analytic Framework1. Simplified approach to the demand for assets2. Concept of equilibrium3. Basic supply and demand approach to understand

behavior in financial markets4. Search for profits5. Transactions cost and asymmetric information

approach to financial structure6. Aggregate supply and demand analysis

Appendix: DefinitionsAggregate OutputAggregate IncomeDistinction Between Nominal and RealNominal = values measured using current pricesReal = quantities, measured with constant pricesAggregate Price Level

nominal GDPGDP Deflator = real GDP

$10 trillion GDP Deflator = = 1.11$9 trillionConsumer Price Index (CPI) price of “basket” of goods and

services