pa974-001 monetary policy and financial regulation in ...mchinn/pa974_lec1_f10.pdf · monetary...

PA974-001Monetary Policy and

Financial Regulation in aFinancial Regulation in a Globalized Economyy

Instructor: Menzie ChinnFall 2010

Administrative IssuesAdministrative Issues• Course website:Course website:

http://www.ssc.wisc.edu/~mchinn/web974_f10.html

• OH: MW 4-5, 7418 Soc Sci• Textbook: Mishkin, The Economics of

Money, Banking and Financial Marketsy g(9/e)

• Additional Readings: from WWW, Econbrowser, CBO, IMF

• NYT, FT, WSJ, Economist

Administrative IssuesAdministrative Issues

• Grading: 30% PS 80% Final Paper• Grading: 30% PS, 80% Final Paper• Make-ups: None. Points are re-allocated if

h l iti t N l tyou have a legitimate excuse. No late assignments accepted (must be handed in during lecture)lecture)

Risk

Libor-3 mo. T-bill (TED) spread( ) p

Lending

Monetary Policy (I)y y ( )

Monetary Policy (II)

Source: Econbrowser, 8/11/2010, using data thru 8/4

Asset Prices: Rational or Not

Source: Calculated Risk, 7/27/2010

Function of Financial MarketsFunction of Financial Markets

Perform the essential f nction of channeling• Perform the essential function of channeling funds from economic players that have saved surplus funds to those that have asaved surplus funds to those that have a shortage of funds

• Promotes economic efficiency by producing• Promotes economic efficiency by producing an efficient allocation of capital, which increases productionincreases production

• Directly improve the well-being of consumers by allowing them to time purchases better

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by allowing them to time purchases better

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Structure of Financial MarketsStructure of Financial Markets

• Debt and Equity Marketsq y

• Primary and Secondary Markets– Investment Banks underwrite securities in primary markets– Brokers and dealers work in secondary markets

• Exchanges and Over-the-Counter (OTC) Markets

• Money and Capital Markets– Money markets deal in short-term debt instruments

C it l k t d l i l t d bt d– Capital markets deal in longer-term debt and equity instruments

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Internationalization of Financial Markets

• Foreign Bonds sold in a foreign country and• Foreign Bonds—sold in a foreign country and denominated in that country’s currency

• Eurobond—bond denominated in a currency• Eurobond—bond denominated in a currency other than that of the country in which it is sold

• Eurocurrencies—foreign currencies depositedEurocurrencies foreign currencies deposited in banks outside the home country– Eurodollars—U.S. dollars deposited in foreign p g

banks outside the U.S. or in foreign branches of U.S. banks

World Stock MarketsCopyright © 2007 Pearson Addison-Wesley All rights

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• World Stock Markets

Function of Financial Intermediaries: Indirect Finance

• Lower transaction costs– Economies of scale– Liquidity services

Reduce Risk• Reduce Risk– Risk Sharing (Asset Transformation)– Diversification

• Asymmetric Information– Adverse Selection (before the transaction)—more likely to select

risky borrowery– Moral Hazard (after the transaction)—less likely borrower will

repay loan

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Regulation of the Financial System

• To increase the information available to investors:– Reduce adverse selection and moral hazard problems– Reduce insider trading

• To ensure the soundness of financial intermediaries:– Restrictions on entry– DisclosureDisclosure– Restrictions on Assets and Activities– Deposit Insurance

Limits on Competition– Limits on Competition– Restrictions on Interest Rates

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Copyright © 2007 Pearson Addison-Wesley All rights

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