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Ball’s Money, Banking, and Financial Markets closes the gap between economic theory and the day-to-day behavior of banks and financial markets. Working from a macro framework based on the Fed’s use of the interest rate as its major policy instrument, Ball presents the core concepts necessary to understand the problems affecting the stock market and the causes of recessions and banking crises. Underlying this framework are the intellectual foundations for the Fed’s inflation targeting using the dynamic consistency problem facing policymakers. Ball doesn’t explain how the Fed and financial markets should work; he explains how they do work on a daily basis.
PART I: FOUNDATION
1. The Financial System
The financial system and its fundamental roles: channeling funds from savers to investors, and helping savers reduce risk. The problem of asymmetric information in the financial system and how banks help overcome this problem. The influence of a healthy financial system on economic growth.
2. Money and the Central Bank
Money: what it is (its role as the medium of exchange), the types of money (commodity money vs. fiat money), and how the money supply is measured. The central banks and their roles in the economy.
PART II: FINANCIAL MARKETS
3. Asset Prices and Interest Rates
Classical theory that asset prices are determined by the present value of asset income. Possible deviations from the classical theory: asset-price bubbles and crashes. Computing the rates of return on assets, and real and nominal interest rates.
4. What Determines Interest Rates?
Determinants of the overall level of interest rates in an economy. Why different types of bonds and loans have different interest rates. The supply of and demand for loans (loanable funds theory) and the supply of and demand for money (liquidity preference theory). Primary reasons for differences among interest rates (default risk and maturity).
5. Securities Markets
How stocks and bonds are issued in primary markets and traded in secondary markets. Firms’ choices of which securities to issue (their capital structure) and savers’ choices of which securities to buy (their asset allocation). Efficient markets hypothesis and the debate over the validity of the hypothesis. Derivative securities and their economic functions.
6. Foreign Exchange Markets
The workings of currency markets, the effects of exchange-rate movements, and the determinants of exchange rates. Principle of purchasing power parity and the long-run behavior of nominal exchange rates. A model in which saving, investment, and capital flows determine real exchange rates in the short run. The business of currency speculation.
PART III: BANKING
7. Asymmetric Information in the Financial System
Adverse selection and moral hazard in financial markets. Activist shareholders, private equity firms, and the role of government regulation. Banks’ methods for overcoming information problems.
8. The Banking Industry
The banking industry and how it is evolving (consolidation within commercial banking and between commercial banks and securities firms). Securitization and subprime lending, and the controversies they have generated. Government efforts to promote lending to certain groups, including college students.
9. The Business of Banking
How banks seek to raise funds cheaply and earn profits from loans and off-balance sheet activities. How banks manage the many risks they face (liquidity, credit, and interest-rate risk). How failures of risk management lead to insolvency.
10. Bank Regulation
Bank runs and deposit insurance. Moral hazard problem in banking, how deposit insurance exacerbates this problem, and how bank regulators combat moral hazard with capital requirements, supervision, and closure of insolvent banks. The controversy over the separation of banking and commerce.
PART IV: MONEY AND THE ECONOMY
11. The Money Supply and Interest Rates
How the money supply is determined and the Fed’s tools for controlling the money supply. The choice between money and interest-rate targeting, why the Fed has chosen interest-rate targeting, and the Fed’s procedures for hitting its targets.
12. Short-Run Economic Fluctuations
Short-run economic fluctuations explained with a modern macroeconomic model. In this model, the interest rate is the central bank’s policy tool; real output is determined by the real interest rate and expenditure shocks; and inflation is determined by output and supply shocks. Using the model to explain U.S. economic fluctuations over the last half-century.
13. Economic Fluctuations, Monetary Policy, and the Financial System
The financial system’s role in economic fluctuations and the monetary transmission mechanism. The many channels through which shifts in Fed policy influence the economy. Time lags in the effects of policy and the problems they raise for stabilization policy.
14. Inflation and Deflation
The long-run relation between money growth and inflation. The reasons that central banks sometimes create excessive money growth, including government budget deficits and concerns about real output. The economic costs of inflation. The dangers of deflation and the liquidity trap.
PART V: MONETARY POLICY
15. Policies for Economic Stability
The optimal level of long-run inflation and policies for short-run economic stabilization. The Taylor rule. Problems caused by uncertainty about the economy. The Fed’s procedures for forecasting the economy and implementing police. The debate over asset prices and monetary policy.
16. Monetary Institutions and Strategies
Central bank independence, the rules vs. discretion debate, inflation targeting, and central bank communication. Kydland and Prescott’s theory of the dynamic consistency problem in monetary policy.
17. Monetary Policy and Exchange Rates
How concerns about exchange rates complicate monetary policy. Central banks’ efforts to control exchange rates, including foreign exchange interventions, capital controls, and international policy coordination. The history of and debates over fixed exchange rates and currency unions.
18. Financial Crises
What happens in financial markets and the banking system during financial crises, the effects on the economy, and central bank responses.