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					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

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       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
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      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
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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
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       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

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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
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        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
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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
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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 MBn                                   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
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       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
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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

				
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