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Seventh Edition
Abel/BernankeMacroeconomicsBade/ParkinFoundations of MicroeconomicsBade/ParkinFoundations of MacroeconomicsBierman/Fernand...
Frederic S. MishkinColumbia University
Editor in Chief: Denise ClintonAcquisitions Editor: Victoria WarneckExecutive Development Manager: Sylvia MalloryDevelopme...
To Sally
Introduction 11 Why Study Money, Banking, and Financial Markets? . . . . . . . . . . . . . . . . . . . .32 An Overview of ...
Monetary Theory 51522 The Demand for Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....
Introduction 1CHAPTER 1WHY STUDY MONEY, BANKING, AND FINANCIAL MARKETS? . . . . . . . . . . . . . . . . .3Preview . . . . ...
CHAPTER 2AN OVERVIEW OF THE FINANCIAL SYSTEM . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23Preview . . . . . ...
Box 2 E-Finance: Why Are Scandinavians So Far Ahead of Americans inUsing Electronic Payments? . . . . . . . . . . . . . . ...
Expected Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....
Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...
Following the Financial News Stock Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159Box 1 Should You Hir...
CHAPTER 9BANKING AND THE MANAGEMENT OF FINANCIAL INSTITUTIONS . . . . . . . . . . . .201Preview . . . . . . . . . . . . . ...
Structure of the U.S. Commercial Banking Industry . . . . . . . . . . . . . . . . . . . . . . . .243Restrictions on Branch...
International Banking Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .272Problems in...
Box 2 E-Finance: Mutual Funds and the Internet . . . . . . . . . . . . . . . . . . . . . . . . .298Money Market Mutual Fun...
Factors Affecting the Prices of Option Premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .326Summary . ...
Box 6 Inside the Fed: Federal Reserve Transparency . . . . . . . . . . . . . . . . . . . . . . .352Should the Fed Be Indep...
Application The Great Depression Bank Panics, 1930–1933 . . . . . . . . . . . . . . . .387Summary, Key Terms, Questions an...
Fed Policy Procedures: Historical Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . .419The Early Years:...
Application Changes in the Equilibrium Exchange Rate: Two Examples . . . . . .452Changes in Interest Rates . . . . . . . ....
CHAPTER 21MONETARY POLICY STRATEGY: THE INTERNATIONAL EXPERIENCE . . . . . . . . . . .487Preview . . . . . . . . . . . . ....
Precautionary Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....
CHAPTER 25AGGREGATE DEMAND AND SUPPLY ANALYSIS . . . . . . . . . . . . . . . . . . . . . . . . .582Preview . . . . . . . ....
Historical Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...
CHAPTER 28RATIONAL EXPECTATIONS: IMPLICATIONS FOR POLICY . . . . . . . . . . . . . . . . . . .658Preview . . . . . . . . ....
I have continually strived to improve this textbook with each new edition, and theSeventh Edition of The Economics of Mone...
In light of continuing changes in financial markets and institutions, I have addedthe following new material to keep the t...
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Economics of money banking and financial markets
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Economics of money banking and financial markets
Economics of money banking and financial markets
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Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
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Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
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Economics of money banking and financial markets
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Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
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Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
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Economics of money banking and financial markets
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Economics of money banking and financial markets
Economics of money banking and financial markets
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Economics of money banking and financial markets
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Economics of money banking and financial markets
Economics of money banking and financial markets
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Economics of money banking and financial markets
Economics of money banking and financial markets
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Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
Economics of money banking and financial markets
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Economics of money banking and financial markets
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  4. 4. Abel/BernankeMacroeconomicsBade/ParkinFoundations of MicroeconomicsBade/ParkinFoundations of MacroeconomicsBierman/FernandezGame Theory with Economic ApplicationsBinger/HoffmanMicroeconomics with CalculusBoyerPrinciples of Transportation EconomicsBransonMacroeconomic Theory and PolicyBrucePublic Finance and the American EconomyByrns/StoneEconomicsCarlton/PerloffModern Industrial OrganizationCaves/Frankel/JonesWorld Trade and Payments:An IntroductionChapmanEnvironmental Economics:Theory, Application, and PolicyCooter/UlenLaw and EconomicsDownsAn Economic Theory of DemocracyEaton/MishkinOnline Readings to AccompanyThe Economics of Money, Banking, andFinancial MarketsEhrenberg/SmithModern Labor EconomicsEkelund/TollisonEconomics: Private Marketsand Public ChoiceFusfeldThe Age of the EconomistGerberInternational EconomicsGhiaraLearning Economics:A Practical WorkbookGordonMacroeconomicsGregoryEssentials of EconomicsGregory/StuartRussian and Soviet Economic Performanceand StructureHartwick/OlewilerThe Economics of Natural Resource UseHubbardMoney, the Financial System,and the EconomyHughes/CainAmerican Economic HistoryHusted/MelvinInternational EconomicsJehle/RenyAdvanced Microeconomic TheoryKleinMathematical Methodsfor EconomicsKrugman/ObstfeldInternational Economics:Theory and PolicyLaidlerThe Demand for Money:Theories, Evidence, and ProblemsLeeds/von AllmenThe Economics of SportsLipsey/Courant/RaganEconomicsMcCartyDollars and Sense:An Introduction to EconomicsMelvinInternational Moneyand FinanceMillerEconomics TodayMiller/Benjamin/NorthThe Economics of Public IssuesMills/HamiltonUrban EconomicsMishkinThe Economics of Money, Banking, andFinancial MarketsParkinEconomicsParkin/BadeEconomics in Action SoftwarePerloffMicroeconomicsPhelpsHealth EconomicsRiddell/Shackelford/Stamos/SchneiderEconomics: A Tool for CriticallyUnderstanding SocietyRitter/Silber/UdellPrinciples of Money, Banking,and Financial MarketsRohlfIntroduction to Economic ReasoningRuffin/GregoryPrinciples of EconomicsSargentRational Expectationsand InflationSchererIndustry Structure, Strategy,and Public PolicySchotterMicroeconomics:A Modern ApproachStock/WatsonIntroduction to EconometricsStudenmundUsing Econometrics:A Practical GuideTietenbergEnvironmental and NaturalResource EconomicsTietenbergEnvironmental Economics and PolicyTodaro/SmithEconomic DevelopmentWaldman/JensenIndustrial Organization:Theory and PracticeWilliamsonMacroeconomicsThe Addison-Wesley Series in Economics
  5. 5. Frederic S. MishkinColumbia University
  6. 6. Editor in Chief: Denise ClintonAcquisitions Editor: Victoria WarneckExecutive Development Manager: Sylvia MalloryDevelopment Editor: Jane TuftsProduction Supervisor: Meredith GertzText Design: Studio MontageCover Design: Regina Hagen Kolenda and Studio MontageComposition: Argosy PublishingSenior Manufacturing Supervisor: Hugh CrawfordSenior Marketing Manager: Barbara LeBuhnCover images: © PhotoDiscMedia Producer: Melissa HonigSupplements Editor: Diana TheriaultCredits to copyrighted material appear on p. C-1, which constitutes a continuation of the copyright page.Library of Congress Cataloguing-in-Publication DataMishkin, Frederic S.The economics of money, banking, and financial markets / Frederic S. Mishkin.—7th ed.p. cm. — (The Addison-Wesley series in economics)Supplemented by a subscription to a companion web site.Includes bibliographical references and index.ISBN 0-321-12235-61. Finance. 2. Money. 3. Banks and banking. I. Title. II. Series.HG173.M632 2004332—dc212003041912Copyright © 2004 by Frederic S. Mishkin. All rights reserved. No part of this publication may be repro-duced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical,photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed inthe United States of America.1 2 3 4 5 6 7 8 9 10—DOW—06050403
  7. 7. To Sally
  8. 8. Introduction 11 Why Study Money, Banking, and Financial Markets? . . . . . . . . . . . . . . . . . . . .32 An Overview of the Financial System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .233 What Is Money? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .44Financial Markets 594 Understanding Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .615 The Behavior of Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .856 The Risk and Term Structure of Interest Rates . . . . . . . . . . . . . . . . . . . . . . . .1207 The Stock Market, the Theory of Rational Expectations,and the Efficient Market Hypothesis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .141Financial Institutions 1678 An Economic Analysis of Financial Structure . . . . . . . . . . . . . . . . . . . . . . . .1699 Banking and the Management of Financial Institutions . . . . . . . . . . . . . . . . .20110 Banking Industry: Structure and Competition . . . . . . . . . . . . . . . . . . . . . . . .22911 Economic Analysis of Banking Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . .26012 Nonbank Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28713 Financial Derivatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .309Central Banking and the Conduct ofMonetary Policy 33314 Structure of Central Banks and the Federal Reserve System . . . . . . . . . . . . .33515 Multiple Deposit Creation and the Money Supply Process . . . . . . . . . . . . . .35716 Determinants of the Money Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37417 Tools of Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .39318 Conduct of Monetary Policy: Goals and Targets . . . . . . . . . . . . . . . . . . . . . .411International Finance and Monetary Policy 43319 The Foreign Exchange Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .43520 The International Financial System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46221 Monetary Policy Strategy: The International Experience . . . . . . . . . . . . . . . .487PA RT VPA RT I VPA RT I I IPA RT I IPA RT IviiCONTENTS IN BRIEF
  9. 9. Monetary Theory 51522 The Demand for Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51723 The Keynesian Framework and the ISLM Model . . . . . . . . . . . . . . . . . . . . . .53624 Monetary and Fiscal Policy in the ISLM Model . . . . . . . . . . . . . . . . . . . . . . .56125 Aggregate Demand and Supply Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . .58226 Transmission Mechanisms of Monetary Policy: The Evidence . . . . . . . . . . . .60327 Money and Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63228 Rational Expectations: Implications for Policy . . . . . . . . . . . . . . . . . . . . . . . .658PA RT V Iviii Contents in Brief
  10. 10. Introduction 1CHAPTER 1WHY STUDY MONEY, BANKING, AND FINANCIAL MARKETS? . . . . . . . . . . . . . . . . .3Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3Why Study Financial Markets? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3The Bond Market and Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3The Stock Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5The Foreign Exchange Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5Why Study Banking and Financial Institutions? . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7Structure of the Financial System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7Banks and Other Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8Financial Innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8Why Study Money and Monetary Policy? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8Money and Business Cycles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9Money and Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10Money and Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12Conduct of Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12Fiscal Policy and Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12How We Will Study Money, Banking, and Financial Markets . . . . . . . . . . . . . . . . . .13Exploring the Web . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14Concluding Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17Summary, Key Terms, Questions and Problems, and Web Exercises . . . . . . . . . . . . .17Appendix to Chapter 1Defining Aggregate Output, Income, the Price Level,and the Inflation Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20Aggregate Output and Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20Real Versus Nominal Magnitudes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20Aggregate Price Level . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21Growth Rates and the Inflation Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .22PA RT IixCONTENTS
  11. 11. CHAPTER 2AN OVERVIEW OF THE FINANCIAL SYSTEM . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23Function of Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23Structure of Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25Debt and Equity Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25Primary and Secondary Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26Exchanges and Over-the-Counter Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27Money and Capital Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27Internationalization of Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28International Bond Market, Eurobonds, and Eurocurrencies . . . . . . . . . . . . . . . . . . . . . . . .28World Stock Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29Function of Financial Intermediaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29Transaction Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29Following the Financial News Foreign Stock Market Indexes . . . . . . . . . . . . .