Mishkin The Economics of Money, Banking, and Financial Markets, 7e Contents in Brief Part I: Introduction 1 Chapter 1: Why Study Money, Banking, and Financial Markets? 2 Chapter 2: An Overview of the Financial System 23 Chapter 3: What Is Money? 44 Part II: Financial Markets 59 Chapter 4: Understanding Interest Rates 61 Chapter 5: The Behavior of Interest Rates 85 Chapter 6: The Risk and Term Structure of Interest Rates 120 Chapter 7: The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis 141 Part III: Financial Institutions 167 Chapter 8: An Economic Analysis of Financial Structure 169 Chapter 9: Banking and the Management of Financial Institutions 201 Chapter 10: Banking Industry: Structure and Competition 229 Chapter 11: Economic Analysis of Banking Regulation 260 Chapter 12: Nonbank Finance 287 Chapter 13: Financial Derivatives 309 Part IV: Central Banking and the Conduct of Monetary Policy 333 Chapter 14: Structure of Central Banks and the Federal Reserve System 335 Chapter 15: Multiple Deposit Creation and the Money Supply Process 357 Chapter 16: Determinants of the Money Supply 374 Chapter 17: Tools of Monetary Policy 393 Chapter 18: Conduct of Monetary Policy: Goals and Targets 411 Part V: International Finance and Monetary Policy 433 Chapter 19: The Foreign Exchange Market 435 Chapter 20: The International Financial System 462 Chapter 21: Monetary Policy Strategy: The International Experience 487 Part VI: Monetary Theory 515 Chapter 22: The Demand for Money 517 Chapter 23: The Keynesian Framework and the ISLM Model 536 Chapter 24: Monetary and Fiscal Policy in the ISLM Model 561 Chapter 25: Aggregate Demand and Supply Analysis 582 Chapter 26: Transmission Mechanisms of Monetary Policy: The Evidence 603 Chapter 27: Money and Inflation 632 Chapter 28: Rational Expectations: Implications for Policy 658 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 1 of 16
Contents Part I: Introduction 1 Chapter 1: Why Study Money, Banking, and Financial Markets? 2 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: Defining the 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 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 Markets: An International Comparison 31 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 2 of 16
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 40 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 Box 2: E-Finance Why Are Scandinavians So Far Ahead of Americans in Using Electronic Payments? 50 E-Money 51 Measuring Money 51 The Federal Reserve s Monetary Aggregates 51 Box 3: E-Finance Are We Headed for a Cashless Society? 52 Following the Financial News The Monetary Aggregates 54 How Reliable Are the Money Data? 55 Summary, Key Terms, Questions and Problems, and Web Exercises 56 Part II: Financial Markets 59 Chapter 4: Understanding Interest Rates 61 Preview 61 Measuring Interest Rates 61 Present Value 61 Four Types of Credit Market Instruments 63 Yield to Maturity 64 Box 1: Global Negative T-Bill Rates? Japan Shows the Way 69 Other Measures of Interest Rates 69 Current Yield 70 Yield on a Discount Basis 71 Application Reading the Wall Street Journal: The Bond Page 72 Following the Financial News Bond Prices and Interest Rates 73 The Distinction Between Interest Rates and Returns 75 Maturity and the Volatility of Bond Returns: Interest-Rate Risk 78 Box 2 Helping Investors to Select Desired Interest-Rate Risk 79 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 3 of 16
Summary 79 The Distinction Between Real and Nominal Interest Rates 79 Box 3 With TIPS, Real Interest Rates Have Become Observable in the United States 82 Summary, Key Terms, Questions and Problems, and Web Exercises 82 Chapter 5: The Behavior of Interest Rates 85 Preview 85 Determinants of Asset Demand 85 Wealth 86 Expected Returns 86 Risk 87 Liquidity 87 Theory of Asset Demand 87 Supply and Demand in the Bond Market 87 Demand Curve 88 Supply Curve 90 Market Equilibrium 90 Supply and Demand Analysis 91 Loanable Funds Framework 91 Changes in Equilibrium Interest Rates 93 Shifts in the Demand for Bonds 93 Shifts in the Supply of Bonds 97 Application Changes in the Equilibrium Interest Rate Due to Expected Inflation or Business Cycle Expansions 99 Changes in Expected Inflation: The Fisher Effect 99 Business Cycle Expansion 100 Application Explaining Low Japanese Interest Rates 103 Application Reading the Wall Street Journal Credit Markets Column 103 Following the Financial News The Credit Markets Column 104 Supply and Demand in the Market for Money: The Liquidity Preference Framework 105 Changes in Equilibrium Interest Rates in the Liquidity Reference Framework 107 Shifts in the Demand for Money 107 Shifts in the Supply of Money 108 Application Changes in the Equilibrium Interest Rate Due to Changes in Income, the Price Level, or the Money Supply 108 Changes in Income 108 Changes in the Price Level 108 Changes in the Money Supply 109 Following the Financial News Forecasting Interest Rates 111 Application Money and Interest Rates 112 Does a Higher Rate of Growth of the Money Supply Lower Interest Rates? 114 Summary, Key Terms, Questions and Problems, and Web Exercises 117 Chapter 6: The Risk and Term Structure of Interest Rates 120 Preview 120 Risk Structure of Interest Rates 120 Default Risk 120 Application The Enron Bankruptcy and the Baa-Aaa Spread 127 Liquidity125 Income Tax Considerations 125 Summary 127 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 4 of 16
Application Effects of the Bush Tax Cut on Bond Interest Rates 127 Term Structure of Interest Rates 127 Following the Financial News Yield Curves 128 Expectations Theory 129 Segmented Markets Theory 132 Liquidity Premium and Preferred Habitat Theories 133 Evidence on the Term Structure 136 Summary 137 Application Interpreting Yield Curves, 1980 2003 137 Summary, Key Terms, Questions and Problems, and Web Exercises 138 Chapter 7: The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis 141 Preview 141 Computing the Price of Common Stock 141 The One-Period Valuation Model 142 The Generalized Dividend Valuation Model 143 The Gordon Growth Model 143 How the Market Sets Security Prices 144 Application Monetary Policy and Stock Prices 146 Application The September 11 Terrorist Attacks, the Enron Scandal, and the Stock Market 146 The Theory of Rational Expectations 147 Formal Statement of the Theory 148 Rationale Behind the Theory 149 Implications of the Theory 149 The Efficient Markets Hypothesis: Rational Expectations in Financial Markets 150 Rationale Behind the Hypothesis 151 Stronger Version of the Efficient Market Hypothesis 152 Evidence on the Efficient Market Hypothesis 153 Evidence in Favor of Market Efficiency 153 Application Should Foreign Exchange Rates Follow a Random Walk? 155 Evidence Against Market Efficiency 156 Overview of the Evidence on the Efficient Market Hypothesis 158 Application Practical Guide to Investing in the Stock Market 158 How Valuable Are Published Reports by Investment Advisers? 158 Following the Financial News Stock Prices 159 Box 1 Should You Hire an Ape as Your Investment Adviser? 160 Should You Be Skeptical of Hot Tips? 160 Do Stock Prices Always Rise When There Is Good News? 161 Efficient Markets Prescription for the Investor 161 Evidence on Rational Expectations in Other Markets 162 Application What Do the Black Monday Crash of 1987 and the Tech Crash of 2000 Tell Us About Rational Expectations and Efficient Markets? 163 Summary, Key Terms, Questions and Problems, and Web Exercises 164 Part III: Financial Institutions 167 Chapter 8: An Economic Analysis of Financial Structure 169 Preview 169 Basic Puzzles About Financial Structure Throughout the World 169 Transaction Costs 173 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 5 of 16
How Transaction Costs Influence Financial Structure 173 How Financial Intermediaries Reduce Transaction Costs 173 Asymmetric Information: Adverse Selection and Moral Hazard 174 The Lemons Problem: How Adverse Selection Influences Financial Structure 175 Lemons in the Stock and Bond Markets 175 Tools to Help Solve Adverse Selection Problems 176 Box 1 The Enron Implosion and the Arthur Andersen Conviction 178 How Moral Hazard Affects the Choice Between Debt and Equity Contracts 180 Moral Hazard in Equity Contracts: The Principal Agent Problem 181 Tools to Help Solve the Principal Agent Problem 182 Box 2: E-Finance Venture Capitalists and High-Tech Sector 183 How Moral Hazard Influences Financial Structure in Debt Markets 184 Tools to Help Solve Moral Hazard in Debt Contracts 184 Summary 186 Application: Financial Development and Economic Growth 187 Financial Crises and Aggregate Economic Activity 189 Factors Causing Financial Crises 189 Application: Financial Crises in the United States 191 Box 3 Case Study of a Financial Crisis 194 Application Financial Crises in Emerging-Market Countries: Mexico, 1994 1995; East Asia, 1997 1998; and Argentina, 2001 2002 194 Summary, Key Terms, Questions and Problems, and Web Exercises 199 Chapter 9: Banking and the Management of Financial Institutions 201 Preview 201 The Bank Balance Sheet 201 Liabilities 201 Assets 204 Basic Banking 205 General Principles of Bank Management 208 Liquidity Management and the Role of Reserves 208 Asset Management 211 Liability Management 212 Capital Adequacy Management 213 Application Strategies for Managing Bank Capital 215 Application Did the Capital Crunch Cause a Credit Crunch in the Early 1990s? 216 Managing Credit Risk 217 Screening and Monitoring 217 Long-Term Customer Relationships 218 Loan Commitments 219 Collateral and Compensating Balances 219 Credit Rationing 220 Managing Interest-Rate Risk 220 Gap and Duration Analysis 221 Application: Strategies for Managing Interest-Rate Risk 222 Off-Balance-Sheet Activities 223 Loan Sales 223 Generation of Fee Income 223 Trading Activities and Risk Management Techniques 224 Box 1: Global Barings, Daiwa, Sumitomo, and Allied Irish 225 Summary, Key Terms, Questions and Problems, and Web Exercises 226 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 6 of 16
Chapter 10: Banking Industry: Structure and Competition 229 Preview 229 Historical Development of the Banking System 229 Multiple Regulatory Agencies 231 Financial Innovation 232 Responses to Changes in Demand Conditions: Interest Rate Volatility 233 Responses to Changes in Supply Conditions: Information Technology 234 Box 1: E-Finance Will Clicks Dominate Bricks in the Banking Industry? 236 Avoidance of Existing Regulations 237 Financial Innovation and the Decline of Traditional Banking 239 Structure of the U.S. Commercial Banking Industry 243 Restrictions on Branching 244 Response to Branching Restrictions 245 Bank Consolidation and Nationwide Banking 245 Box 2: E-Finance Information Technology and Bank Consolidation 247 The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 248 What Will the Structure of the U.S. Banking Industry Look Like in the Future? 248 Box 3: Global Comparison of Banking Structure in the United States and Abroad 249 Are Bank Consolidation and Nationwide Banking Good Things? 249 Separation of the Banking and Other Financial Service Industries 250 Erosion of Glass-Steagall 250 The Gramm-Leach-Bliley Financial Services Modernization Act of 1999: Repeal of Glass-Steagall 251 Implications for Financial Consolidation 251 Separation of Banking and Other Financial Services Industries Throughout the World 251 Thrift Industry: Regulation and Structure 252 Savings and Loan Associations 252 Mutual Savings Banks 253 Credit Unions 253 International Banking 253 Eurodollar Market 254 Box 4: Global Ironic Birth of the Eurodollar Market 255 Structure of U.S. Banking Overseas 255 Foreign Banks in the United States 256 Summary, Key Terms, Questions and Problems, and Web Exercises 257 Chapter 11: Economic Analysis of Banking Regulation 260 Preview 260 Asymmetric Information and Banking Regulation 260 Government Safety Net: Deposit Insurance and the FDIC 260 Box 1: Global The Spread of Government Deposit Insurance Throughout the World: Is This a Good Thing? 262 Restrictions on Asset Holdings and Bank Capital Requirements 264 Bank Supervision: Chartering and Examination 265 Box 2: Global Basel 2: Is It Spinning Out of Control? 262 Assessment of Risk Management 267 Disclosure Requirements 268 Consumer Protection 269 Restrictions on Competition 269 Box 3: E-Finance Electronic Banking: New Challenges for Bank Regulation 270 International Banking Regulation 272 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 7 of 16
Problems in Regulating International Banking 272 Summary 272 The 1980s U.S. Banking Crisis: Why? 273 Early Stages of the Crisis 274 Later Stages of the Crisis: Regulatory Forbearance 275 Competitive Equality in Banking Act of 1987 276 Political Economy of the Savings and Loan Crisis 276 The Principal Agent Problem for Regulators and Politicians 277 Savings and Loan Bailout: The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 278 Federal Deposit Insurance Corporation Improvement Act of 1991 279 Banking Crises Throughout the World 280 Scandinavia 280 Latin America 281 Russia and Eastern Europe 282 Japan 282 East Asia 284 Déjà Vu All Over Again 284 Summary, Key Terms, Questions and Problems, and Web Exercises 284 Chapter 12: Nonbank Finance 287 Preview 287 Insurance 287 Life Insurance 287 Property and Casualty Insurance 288 The Competitive Threat from the Banking Industry 290 Application Insurance Management 290 Pension Funds 294 Private Pension Plans 295 Public Pension Plans 295 Box 1 Should Social Security Be Privatized? 296 Finance Companies 296 Mutual Funds 297 Box 2: E-Finance Mutual Funds and the Internet 298 Money Market Mutual Funds 299 Hedge Funds 299 Box 3 The Long-Term Capital Management Debacle 300 Government Financial Intermediation 301 Federal Credit Agencies 301 Box 4 Are Fannie Mae and Freddie Mac Getting Too Big for Their Britches? 302 Securities Market Operations 302 Investment Banking 303 Following the Financial News New Securities Issues 304 Securities Brokers and Dealers 304 Organized Exchanges 305 Box 5 The Return of the Financial Supermarket? 305 Box 6: E-Finance The Internet Comes to Wall Street 306 Summary, Key Terms, Questions and Problems, and Web Exercises 306 Chapter 13: Financial Derivatives 309 Preview 309 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 8 of 16
Hedging 309 Interest-Rate Forward Contracts 310 Application Hedging with Interest-Rate Forward Contracts 310 Pros and Cons of Forward Contracts 311 Financial Futures Contracts and Markets 311 Following the Financial News Financial Futures 312 Application Hedging with Financial Futures 314 Organization of Trading in Financial Futures Markets 315 The Globalization of Financial Futures Markets 317 Explaining the Success of Futures Markets 317 Application Hedging Foreign Exchange Risk 319 Options 320 Following the Financial News Futures Options 321 Option Contracts 322 Profits and Losses on Option and Futures Contracts 322 Application Hedging with Futures Options 325 Factors Affecting the Prices of Option Premiums 326 Summary 327 Interest-Rate Swaps 328 Interest-Rate Swap Contracts 328 Application Hedging with Interest-Rate Swaps 329 Advantages of Interest-Rate Swaps 329 Disadvantages of Interest-Rate Swaps 330 Financial Intermediaries in Interest-Rate Swaps 330 Summary, Key Terms, Questions and Problems, and Web Exercises 330 Part IV: Central Banking and the Conduct of Monetary Policy 333 Chapter 14: Structure of Central Banks and the Federal Reserve System 335 Preview 335 Origins of the Federal Reserve System 335 Box 1: Inside the Fed The Political Genius of the Founders of the Federal Reserve System 336 Formal Structure of the Federal Reserve System 336 Federal Reserve Banks 337 Box 2: Inside the Fed The Special Role of the Federal Reserve Bank of New York 339 Member Banks 340 Board of Governors of the Federal Reserve System 340 Federal Open Market Committee (FOMC) 341 Box 3: Inside the Fed The Role of the Research Staff 342 The FOMC Meeting 343 Box 4: Inside the Fed Green, Blue, and Beige 344 Informal Structure of the Federal Reserve System 344 Box 5: Inside the Fed The Role of Member Banks in the Federal Reserve System 346 How Independent Is the Fed? 346 Structure and Independence of Foreign Central Banks 349 Bank of Canada 349 Bank of England 349 Bank of Japan 350 European Central Bank 350 The Trend Toward Greater Independence 351 Explaining Central Bank Behavior 351 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 9 of 16
Box 6: Inside the Fed Federal Reserve Transparency 352 Should the Fed Be Independent? 352 The Case for Independence 352 The Case Against Independence 354 Central Bank Independence and Macroeconomic Performance Throughout the World 354 Summary, Key Terms, Questions and Problems, and Web Exercises 355 Chapter 15: Multiple Deposit Creation and the Money Supply Process 357 Preview 357 Four Players in the Money Supply Process 357 The Fed s Balance Sheet 358 Liabilities 358 Assets 359 Control of the Monetary Base 359 Federal Reserve Open Market Operations 359 Shifts from Deposits into Currency 363 Box 1: Global Foreign Exchange Rate Intervention and the Monetary Base 363 Discount Loans 364 Other Factors That Affect the Monetary Base 365 Overview of the Fed s Ability to Control the Monetary Base 365 Multiple Deposit Creation: A Simple Model 365 Deposit Creation: The Single Bank 366 Deposit Creation: The Banking System 367 Deriving the Formula for Multiple Deposit Creation 370 Critique of the Simple Model 371 Summary, Key Terms, Questions and Problems, and Web Exercises 372 Chapter 16: Determinants of the Money Supply 374 Preview 374 The Money Supply Model and the Money Multiplier 375 Deriving the Money Multiplier 375 Intuition Behind the Money Multiplier 377 Factors that Determine the Money Multiplier 378 Changes in the Required Reserve Ratio r 378 Changes in the Currency Ratio c 379 Changes in the Excess Reserves Ratio e 379 Additional Factors That Determine the Money Supply 381 Changes in the Nonborrowed Monetary Base MB n 382 Changes in the Discount Loans DL from the Fed 382 Overview of the Money Supply Process 383 Application Explaining Movements in the Money Supply, 1980 2002 384 Application The Great Depression Bank Panics, 1930 1933 387 Summary, Key Terms, Questions and Problems, and Web Exercises 390 Chapter 17: Tools of Monetary Policy 393 Preview 393 The Market for Reserves and the Federal Funds Rate 393 Supply and Demand in the Market for Reserves 394 How Changes in the Tools of Monetary Policy Affect the Federal Funds Rate 395 Open Market Operations 398 A Day at the Trading Desk 398 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 10 of 16
Advantages of Open Market Operations 400 Discount Policy 400 Operation of the Discount Window 401 Lender of Last Resort 402 Advantages and Disadvantages of Discount Policy 403 Reserve Requirements 403 Box 1: Inside the Fed Discounting to Prevent a Financial Panic 404 Advantages and Disadvantages of Reserve Requirement Changes 405 Application Why Have Reserve Requirements Been Declining Worldwide? 406 Application The Channel/Corridor System for Setting Interest Rates 406 Summary, Key Terms, Questions and Problems, and Web Exercises 408 Chapter 18: Conduct of Monetary Policy: Goals and Targets 411 Preview 411 Goals of Monetary Policy 411 High Employment 411 Economic Growth 412 Price Stability 412 Box 1: Global The Growing European Commitment to Price Stability 413 Interest-Rate Stability 413 Stability of Financial Markets 413 Stability in Foreign Exchange Markets 414 Conflict Among Goals 414 Central Bank Strategy: Use of Targets 414 Choosing the Targets 416 Criteria for Choosing Intermediate Targets 418 Criteria for Choosing Operating Targets 419 Fed Policy Procedures: Historical Perspective 419 The Early Years: Discount Policy as the Primary Tool 420 Discovery of Open Market Operations 420 The Great Depression 421 Box 2: Inside the Fed Bank Panics of 1930 1933: Why Did the Fed Let Them Happen? 421 Reserve Requirements as a Policy Tool 422 War Finance and the Pegging of Interest Rates: 1942 1951 422 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 427 Box 3: Global International Policy Coordination 428 The Taylor Rule, NAIRU, and the Philips Curve 428 Box 4 Fed Watching 430 Summary, Key Terms, Questions and Problems, and Web Exercises 431 Part V: International Finance and Monetary Policy 433 Chapter 19: The Foreign Exchange Market 435 Preview 435 Foreign Exchange Market 435 What Are Foreign Exchange Rates? 436 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 11 of 16
Following the Financial News Foreign Exchange Rates 437 Why Are Exchange Rates Important? 438 How Is Foreign Exchange Traded? 438 Exchange Rates in the Long Run 439 Law of One Price 439 Theory of Purchasing Power Parity 439 Why the Theory of Purchasing Power Parity Cannot Fully Explain Exchange Rates 440 Factors That Affect Rates in the Long Run 441 Exchange Rates in the Short Run 443 Comparing Expected Returns on Domestic and Foreign Deposits 443 Interest Parity Condition 445 Equilibrium in the Foreign Exchange Market 446 Explaining Changes in Exchange Rates 448 Shifts in the Expected-Return Schedule for Foreign Deposits 448 Shifts in the Expected-Return Schedule for Domestic Deposits 450 Application Changes in the Equilibrium Exchange Rate: Two Examples 452 Application Why Are Exchange Rates So Volatile? 455 Application The Dollar and Interest Rates, 1973 2002 455 Application The Euro s First Four Years 457 Application Reading the Wall Street Journal: The Currency Trading Column 457 Following the Financial News The Currency Trading Column 458 Summary, Key Terms, Questions and Problems, and Web Exercises 459 Chapter 20: The International Financial System 462 Preview 462 Intervention in the Foreign Exchange Market 462 Foreign Exchange Intervention and the Money Supply 462 Box 1: Inside the Fed A Day at the Federal Reserve Bank of New York s Foreign Exchange Desk 463 Unsterilized Intervention 465 Sterilized Intervention 466 Balance of Payments 467 Evolution of the International Financial System 468 Gold Standard 469 Bretton Woods System 469 Box 2: Global The Euro s Challenge to the Dollar 471 Managed Float 473 European Monetary System (EMS) 474 Application The Foreign Exchange Crisis of September 1992 475 Application Recent Foreign Exchange Crises in Emerging Market Countries: Mexico 1994, East Asia 1997, Brazil 1999, and Argentina 2002 477 Capital Controls 478 Controls on Capital Outflows 478 Controls on Capital Inflows 479 The Role of the IMF 479 Should the IMF Be an International Lender of Last Resort? 480 International Considerations and Monetary Policy 482 Direct Effects of the Foreign Exchange Market on the Money Supply 482 Balance-of-Payments Considerations 483 Exchange Rate Considerations 483 Summary, Key Terms, Questions and Problems, and Web Exercises 484 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 12 of 16
Chapter 21: Monetary Policy Strategy: The International Experience 487 Preview 487 The Role of a Nominal Anchor 487 The Time-Consistency Problem 488 Exchange-Rate Targeting 489 Advantages of Exchange-Rate Targeting 489 Disadvantages of Exchange-Rate Targeting 490 When Is Exchange-Rate Targeting Desirable for Industrialized Countries? 492 When Is Exchange-Rate Targeting Desirable for Emerging Market Countries? 492 Currency Boards 492 Dollarization 492 Box 1: Global Argentina s Currency Board 494 Monetary Targeting 496 Monetary Targeting in Canada, the United Kingdom, Japan, Germany, and Switzerland 496 Box 2: Global The European Central Bank s Monetary Policy Strategy 498 Advantages of Monetary Targeting 500 Disadvantages of Monetary Targeting 501 Inflation Targeting 501 Inflation Targeting in New Zealand, Canada, and the United Kingdom 501 Advantages of Inflation Targeting 504 Disadvantages of Inflation Targeting 506 Nominal GPD Targeting 508 Monetary Policy with an Implicit Nominal Anchor 509 Advantages of the Fed s Approach 510 Disadvantages of the Fed s Approach 510 Summary, Key Terms, Questions and Problems, and Web Exercises 512 Part VI: Monetary Theory 515 Chapter 22: The Demand for Money 517 Preview 517 Quantity Theory of Money 517 Velocity of Money and Equation of Exchange 518 Quantity Theory 519 Quantity Theory of Money Demand 519 Is Velocity a Constant? 520 Keynes s Liquidity Preference Theory 521 Transactions Motive 521 Precautionary Motive 522 Speculative Motive 522 Putting the Three Motives Together 523 Further Developments in the Keynesian Approach 524 Transactions Demand 524 Precautionary Demand 527 Speculative Demand 527 Friedman s Modern Quantity Theory of Money 528 Distinguishing Between the Friedman and Keynesian Theories 530 Empirical Evidence on the Demand for Money 532 Interest Rates and Money Demand 533 Stability of Money Demand 533 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 13 of 16
Summary, Key Terms, Questions and Problems, and Web Exercises 533 Chapter 23: The Keynesian Framework and the ISLM Model 536 Preview 536 Determination of Aggregate Output 536 Consumer Expenditure and the Consumption Function 538 Investment Spending 539 Box 1 Meaning of the Word Investment 540 Equilibrium and the Keynesian Cross Diagram 540 Expenditure Multiplier 542 Application The Collapse of Investment Spending and the Great Depression 545 Government s Role 545 Role of International Trade 548 Summary of the Determinants of Aggregate Output 548 The ISLM Model 551 Equilibrium in the Goods Market: The IS Curve 552 Equilibrium in the Market for Money: The LM Curve 555 ISLM Approach to Aggregate Output and Interest Rates 557 Summary, Key Terms, Questions and Problems, and Web Exercises 558 Chapter 24: Monetary and Fiscal Policy in the ISLM Model 561 Preview 561 Factors that Cause the IS Curve to Shift 561 Factors that Cause the LM Curve to Shift 564 Changes in Equilibrium Level of the Interest Rate and Aggregate Output 566 Response to a Change in Monetary Policy 566 Response to a Change in Fiscal Policy 567 Effectiveness of Monetary Versus Fiscal Policy 568 Monetary Policy Versus Fiscal Policy: The Case of Complete Crowding Out 568 Application Targeting Money Supply Versus Interest Rates 571 ISLM Model in the Long Run 575 ISLM Model and the Aggregate Demand Curve 577 Deriving the Aggregate Demand Curve 577 Factors That Cause the Aggregate Demand Curve to Shift 578 Summary, Key Terms, Questions and Problems, and Web Exercises 580 Chapter 25: Aggregate Demand and Supply Analysis 582 Preview 582 Aggregate Demand 582 Monetarist View of Aggregate Demand 582 Following the Financial News Aggregate Output, Unemployment, and the Price Level 583 Keynesian View of Aggregate Demand 585 The Crowding-Out Debate 586 Aggregate Supply 587 Shifts in the Aggregate Supply Curve 588 Equilibrium in Aggregate Supply and Demand Analysis 588 Equilibrium in the Short Run 589 Equilibrium in the Long Run 589 Shifts in Aggregate Demand 592 Shifts in Aggregate Supply 594 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 14 of 16
Shifts in the Long-Run Aggregate Supply Curve: Real Business Cycle Theory and Hysteresis 596 Conclusions 597 Application Explaining Past Business Cycle Episodes 598 Vietnam War Buildup, 1964 1970 598 Negative Supply Shocks, 1973 1975 and 1978 1980 598 Favorable Supply Shocks, 1995 1999 599 Summary, Key Terms, Questions and Problems, and Web Exercises 600 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 Box 1 Perils of Reverse Causation 606 Box 2 Perils of Ignoring and Outside Driving Factor 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 Box 3 Real Business Cycle Theory and the Debate on Money and Economic Activity 616 Transmission Mechanisms of Monetary Policy 616 Traditional Interest-Rate Channels 617 Other Asset Price Channels 618 Credit View 621 Box 4 Consumers Balance Sheets and the Great Depression 624 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 Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 15 of 16
Budget Deficits and Inflation 543 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 Box 1 Perils of Accommodating Policy 654 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: Rational Expectations: Implications for Policy 658 Preview 658 The Lucas Critique of Policy Evaluation 659 Econometric Policy Evaluation 659 Example: The Term Structure of Interest Rates 659 New Classical Macroeconomic Model 660 Effects of Unanticipated and Anticipated Policy 661 Box 1 Proof of the Policy Ineffectiveness Proposition 663 Can an Expansionary Policy Lead to a Decline in Aggregate Output? 663 Implications for Policymakers 664 New Keynesian Model 665 Effects of Unanticipated and Anticipated Policy 666 Implications for Policymakers 666 Comparison of the Two New Models with the Traditional Model 666 Short-Run Output and Price Responses 668 Stabilization Policy 670 Anti-inflation Policies 671 Credibility in Fighting Inflation 673 Box 2: Global Ending the Bolivian Hyperinflation 674 Application Credibility and the Reagan Budget Deficits 675 Impact of the Rational Expectations Revolution 676 Summary, Key Terms, Questions and Problems 677 Glossary Answers to Selected Questions and Problems Credits Index Mishkin The Economics of Money, Banking, and Financial Markets, 7e TOC/ Page 16 of 16