Test Bank for The Economics of Money, Banking and Financial Markets: The Business School Edition, 3/E Frederic S. Mishkin

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• ISBN-10 ‏ : ‎ 0132741377
• ISBN-13 ‏ : ‎ 978-0132741378
• Author: Frederic S. Mishkin

The historic economic events and financial crises of late 2008 have changed the entire landscape of money and banking. Having just served as Governor of the Federal Reserve, only Mishkin has the unique insider’s perspective needed to present the current state of money and banking and explain the latest debates and issues for today’s students.

By applying a unified analytical framework to the models, The Economics of Money, Banking, and Financial Markets makes theory intuitive for students, and the rich array of current, real-world events keeps students motivated. Authoritative, comprehensive, and flexible, the text is easy to integrate into a wide variety of syllabi, and its ancillaries provide complete support when teaching the course.

Table of contents:

part I
Introduction 1
Chapter 1
Why Study Money, Banking, and Financial Markets?	3
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	8
Money and Inflation	10
Money and Interest Rates	11
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
Collecting and Graphing Data 	15
Web Exercises 	15
Concluding Remarks	16
Summary 	17 
Key Terms, Questions and Problems 	18
Web Exercises and Web References	19
Appendix to Chapter 1
Defining 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
Financial Markets Instruments	28
Money Maker Instruments	28
Following the Financial News Money Market Rates	30
Capital Market Instruments	31
Internationalization of Financial Markets	33
International Bond Market, Eurobonds, and Eurocurrencies	33
World Stock Markets	33
Following the Financial News Foreign Stock Market Indexes	34
Function of Financial Intermediaries	35
Transaction Costs	35
Box 1 Global: The Importance of Financial Intermediaries to Securities 
Markets: An International Comparison	36
Risk Sharing	36
Asymmetric Information: Adverse Selection and Moral Hazard	37
Types of Financial Intermediaries	39
Depository Institutions	39
Contractual Savings Institutions	40
Investment Intermediaries	42
Regulation of the Financial System	42
Increasing Information Available to Investors	44
Ensuring the Soundness of Financial Intermediaries	44
Financial Regulation Abroad	45
Summary	46
Key Terms, Questions and Problems	47
Web Exercises and Web References	48
Chapter 3
What Is Money?	49
Preview	49
Meaning of Money	49
Functions of Money	50
Medium of Exchange	50
Unit of Account	51
Store of Value	52
Evolution of the Payments System	53
Commodity Money	53
Fiat Money	53
Checks	53
Electronic Payment	54
E-Money	54
Box 1 E-Finance: Why Are Scandinavians So Far Ahead of Americans in 
Using Electronic Payments?	55
Box 2 E-Finance: Are We Headed for a Cashless Society?	56
Measuring Money	56
The Federal Reserve's Monetary Aggregates	56
Following the Financial News The Monetary Aggregates	58
Box 3 Where Are All the U. S. Dollars?	59
How Reliable Are the Money Data?	59
Summary	61
Key Terms, Questions and Problems	62
Web Exercises and Web References	63
part II
Financial Markets 65
Chapter 4
Understanding Interest Rates	67
Preview	67
Measuring Interest Rates	67
Present Value	67
Application Simple Present Value	69
Application How Much Is That Jackpot Worth?	69
Four Types of Credit Market Instruments	70
Yield to Maturity	71
Application Yield to Maturity on a Simple Loan	71
Application Reading the Wall Street Journal: The Bond Page	72
Application Yeild to Maturity and the Yearly Payment on a Fixed-Payment Loan	73
Application Yeild to Maturity and the Bond Price for a Coupon Bond	74
Application Perpetuity	76
Box 1 Global: Negative T-Bill Rates? Japan Shows the Way	78
Yield on a Discount Basis	78
Application Reading the Wall Street Journal: The Bond Page	80
Following the Financial News Bond Prices and Interest Rates	81
The Distinction Between Interest Rates and Returns	82
Box 2 Helping Investors to Select Desired Interest-Rate Risk	85
Maturity and the Volatility of Bond Returns: Interest-Rate Risk	85
The Distinction Between Real and Nominal Interest Rates	87
Application Calculating Real Interest Rates	88
Box 3 With TIPS, Real Interest Rates Have Become Observable in the 
United States	90
Summary	90
Key Terms, Questions and Problems	91
Web Exercise sand Web References	92
Chapter 5
The Behavior of Interest Rates	93
Preview	93
Determinants of Asset Demand	93
Wealth	94
Expected Returns	94
Risk	95
Liquidity	95
Theory of Asset Demand	95
Supply and Demand in the Bond Market	95
Demand Curve	96
Supply Curve	98
Market Equilibrium	98
Supply and Demand Analysis	99
Changes in Equilibrium Interest Rates	99
Shifts in the Demand for Bonds	100
Shifts in the Supply of Bonds	103
Application Changes in the Interest Rate Due to Expected Inflation: The Fisher 	
	Effect
	105
Application Changes in the Interest Rate Due to a Business Cycle Expansion	106
Application Explaining Low Japanese Interest Rates	109
Application Reading the Wall Street Journal "Credit Markets" Column	109
Following the Financial News The "Credit Markets" Column	110
Supply and Demand in the Market for Money: The Liquidity 
Preference Framework	111
Changes in Equilibrium Interest Rates in the Liquidity Reference Framework	113
Shifts in the Demand for Money	113
Shifts in the Supply of Money	114
Application Changes in the Equilibrium Interest Rate Due to Changes 
in Income, the Price Level, or the Money Supply	114
Changes in Income	114
Changes in the Price Level	114
Changes in the Money Supply	115
Application Money and Interest Rates	116
Does a Higher Rate of Growth of the Money Supply Lower Interest Rates?	118
Following the Financial News Forecasting Interest Rates	122
Summary	123
Key Terms, Questions and Problems	124
Web Exercises	125
Web References	126
Chapter 6
The Risk and Term Structure of Interest Rates	127
Preview	127
Risk Structure of Interest Rates	127
Default Risk	127
Application The Enron Bankruptcy and the Baa-Aaa Spread	131
Liquidity	131
Income Tax Considerations	132
Summary	133
Application Effects of the Bush Tax Cut on Bond Interest Rates	134
Term Structure of Interest Rates	134
Following the Financial News Yield Curves	136
Expectations Theory	136
Segmented Markets Theory	139
Liquidity Premium and Preferred Habitat Theories	140
Evidence on the Term Structure	143
Box 2 The Yield Curve as a Forecasting Tool for Inflation and the Business Cycle
	144
Summary	144
Application Interpreting Yield Curves, 1980/2003	145
Summary	146
Key Terms, Questions and Problems	147
Web Exercises	148
Web References	149
Chapter 7
The Stock Market, the Theory of Rational Expectations, 
and the Efficient Market Hypothesis	151
Preview	151
Computing the Price of Common Stock	151
The One-Period Valuation Model	152
The Generalized Dividend Valuation Model	153
The Gordon Growth Model	153
How the Market Sets Security Prices	154
Application Monetary Policy and Stock Prices	155
Application The September 11 Terrorist Attacks, the Enron Scandal, 
and the Stock Market	156
The Theory of Rational Expectations	156
Formal Statement of the Theory	158
Rationale Behind the Theory	158
Implications of the Theory	159
The Efficient Markets Hypothesis: Rational Expectations in Financial Markets	160
Rationale Behind the Hypothesis	161
Stronger Version of the Efficient Market Hypothesis	162
Evidence on the Efficient Market Hypothesis	162
Evidence in Favor of Market Efficiency	162
Application Should Foreign Exchange Rates Follow a Random Walk?	165
Evidence Against Market Efficiency	165
Overview of the Evidence on the Efficient Market Hypothesis	168
Application Practical Guide to Investing in the Stock Market	168
How Valuable Are Published Reports by Investment Advisers?	168
Following the Financial News Stock Prices	169
Should You Be Skeptical of Hot Tips?	169
Box 1 Should You Hire an Ape as Your Investment Adviser?	170
Do Stock Prices Always Rise When There Is Good News?	170
Efficient Market Prescription for the Investor	171
Evidence on Rational Expectations in Other Markets	171
Application What Do the Black Monday Crash of 1987 and the Tech 
Crash of 2000 Tell Us About Rational Expectations and Efficient Markets?	172
Behavioral Finance	173
Summary	174
Key Terms, Questions and Problems	175
Web Exercises	176
WebReferences	177
part III
Financial Institutions 179
Chapter 8
An Economic Analysis of Financial Structure	181
Preview	181
Basic Puzzles About Financial Structure Throughout the World	181
Transaction Costs	184
How Transaction Costs Influence Financial Structure	184
How Financial Intermediaries Reduce Transaction Costs	185
Asymmetric Information: Adverse Selection and Moral Hazard	186
The Lemons Problem: How Adverse Selection Influences Financial Structure	186
Lemons in the Stock and Bond Markets	187
Tools to Help Solve Adverse Selection Problems	188
Box 1 The Enron Implosion 	189
How Moral Hazard Affects the Choice Between Debt and Equity Contracts	192
Moral Hazard in Equity Contracts: The Principal/Agent Problem	192
Tools to Help Solve the Principal/Agent Problem	193
How Moral Hazard Influences Financial Structure in Debt Markets	195
Tools to Help Solve Moral Hazard in Debt Contracts	195
Summary	197
Conflicts of Interest	198
Why Do We Care About Conflicts of Interest?	199
Why Do Conflicts of Interesst Arise?	199
Box 2 Conflicts of Interest The King, Queen, and the Jack of the Interest	200
What Has Been Done to Remedy Conflicts of Interest?	201
Box 3 Conflicts of Interest The Demise of Arthur Andersen	194
Application Financial Development and Economic Growth	203
Application Is China a Counter-Example to the Importance of Financial 
Developement?	204
Financial Crises and Aggregate Economic Activity	205
Factors Causing Financial Crises	206
Application Financial Crises in the United States	208
Box 4 Case Study of a Financial Crisis: The Great Depression	210
Application Financial Crises in Emerging-Market Countries: 
Mexico, 1994/1995; East Asia, 1997/1998; and Argentina, 2001/2002	211
Summary and Key Terms	215
Questions and Problems and Web Exercises	216
Web References	217
Chapter 9
Banking and the Management of Financial Institutions	219
Preview	219
The Bank Balance Sheet	219
Liabilities	219
Assets	222
Basic Banking	223
General Principles of Bank Management	226
Liquidity Management and the Role of Reserves	226
Asset Management	229
Liability Management	230
Capital Adequacy Management	231
Application Strategies for Managing Bank Capital	233
Application Did the Capital Crunch Cause a Credit Crunch in the 
Early 1990s?	234
Managing Credit Risk	234
Screening and Monitoring	235
Long-Term Customer Relationships	236
Loan Commitments	237
Collateral and Compensating Balances	237
Credit Rationing	238
Managing Interest-Rate Risk	238
Gap and Duration Analysis	239
Application Strategies for Managing Interest-Rate Risk	240
Off-Balance-Sheet Activities	241
Loan Sales	241
Generation of Fee Income	241
Trading Activities and Risk Management Techniques	242
Box 1 Global: Barings, Daiwa, Sumitomo, and Allied Irish: 
Rogue Traders and the Principal/Agent Problem	243
Summary and Key Terms	244
Questions and Problems	245
Web Exercises and Web References	246
Chapter 10
Banking Industry: Structure and Competition	247
Preview	247
Historical Development of the Banking System	247
Multiple Regulatory Agencies	249
Financial Innovation and the Evolution of the Banking Industry	250
Responses to Changes in Demand Conditions: Interest Rate Volatility	251
Responses to Changes in Supply Conditions: Information Technology	252
Box 1 E-Finance: Will "Clicks" Dominate "Bricks" in the Banking Industry?	254
Avoidance of Existing Regulations	255
Financial Innovation and the Decline of Traditional Banking	257
Structure of the U.S. Commercial Banking Industry	261
Restrictions on Branching	261
Response to Branching Restrictions	262
Bank Consolidation and Nationwide Banking	263
Box 2 E-Finance: Information Technology and Bank Consolidation	265
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994	265
What Will the Structure of the U.S. Banking Industry Look Like in the Future?	266
Box 3 Global: Comparison of Banking Structure in the United States 
and Abroad	266
Are Bank Consolidation and Nationwide Banking Good Things?	267
Separation of the Banking and Other Financial Service Industries	268
Erosion of Glass-Steagall	268
The Gramm-Leach-Bliley Financial Services Modernization Act of 1999: 
Repeal of Glass-Steagall	268
Implications for Financial Consolidation	269
Separation of Banking and Other Financial Services Industries Throughout the World
	269
Thrift Industry: Regulation and Structure	270
Savings and Loan Associations	270
Mutual Savings Banks	270
Credit Unions	271
International Banking	271
Eurodollar Market	272
Box 4 Global: Ironic Birth of the Eurodollar Market	273
Structure of U.S. Banking Overseas	273
Foreign Banks in the United States	273
Summary and Key Terms	275
Questions and Problems, and Web Exercises	276
Web References	277
Chapter 11
Economic Analysis of Banking Regulation	279
Preview	279
Asymmetric Information and Banking Regulation	279
Government Safety Net: Deposit Insurance and the FDIC	279
Box 1 Global: The Spread of Government Deposit Insurance Throughout 
the World: Is This a Good Thing?	281
Restrictions on Asset Holdings and Bank Capital Requirements	283
Bank Supervision: Chartering and Examination	284
Box 2 Global: Basel 2: Is It Unworkable?	285
Assessment of Risk Management	286
Disclosure Requirements	287
Consumer Protection	288
Restrictions on Competition	288
Box 3 E-Finance: Electronic Banking: New Challenges for Bank Regulation	289
International Banking Regulation	291
Problems in Regulating International Banking	291
Summary	291
The 1980s U.S. Savings and Loan and Banking Crisis: Why?	293
Early Stages of the Crisis	293
Later Stages of the Crisis: Regulatory Forbearance	294
Competitive Equality in Banking Act of 1987	295
Political Economy of the Savings and Loan Crisis	295
The Principal/Agent Problem for Regulators and Politicians	296
FYI The Principal-Agent Problem in Action: Charles Keating and the Lincoln Savings 
and Loan Scandal 297
Savings and Loan Bailout: The Financial Institutions Reform, Recovery, and 
Enforcement Act of 1989
	298
Federal Deposit Insurance Corporation Improvement Act of 1991	299
Banking Crises Throughout the World	300
Scandinavia	301
Latin America	302
Russia and Eastern Europe	302
Japan	303
China	304
East Asia	305
"Døjø Vu All Over Again"	305
Summary	305
Key Terms, Questions and Problems	306
 Web Exercises and Web References	307
Part IV Central Banking and the Conduct of Monetary Policy	309
Chapter 12
Structure of Central Banks and the Federal Reserve System	311
Preview	311
Origins of the Federal Reserve Systems	311
Box1 Inside the Fed The political Genius of the Founders of the Federal Reserve 
System	312
Structure of the Federal Reserve System	312
Federal Reserve Banks	313
Box2 Inside the Fed The special Role of the Federal Reserve Bank of New York	315
Member Banks	316
Board of Governors of the Federal Reserve System	316
Federal Open market Committee (FOMC)	317
Box3 Inside the Fed The Role of the Research Staff	318
The FOMC Meeting	319
Box4 Inside the Fed Green, Blue, and Beige: What Do These Colors Mean at the Fed?
	320
Why the Chairman of the Board of Governors Really Runs the Show	320
How Independent is the Fed?	321
Structure and Independence of the European Central Bank	322
Differences Between the European System of Central Banks and the Federal Reserve 
System	323
Governing Council	323
How Independent Is the ECB?	324
Structure and Independence of other Foreign Central Banks	325
Bank of Canada	325
Bank of England	325
Bank of Japan	326
The Trend Toward Greater Independence	326
Explaining Central Bank Behavior	326
Box5 Inside the Fed Federal Reserve Transparency	327
Should the Fed be Independent?	328
The Case for Independence	328
The Case Against Independence	329
Central Bank Independence and Macroeconomic Performance Throughout The World	330
Summary	330
Key Terms	331
Questions and Problems	331
Web Exercises and Web References	332
Chapter 13
Multiple Deposit Creation and the Money Supply Process	333
Preview	333
Four Players in the Money Supply Process	333
The Fed's Balance Sheet	334
Liabilities	334
Control of the Monetary Base	335
Federal Reserve Open Market Operations	336
Shifts from Deposits into Currency	339
Discount Loans	340
Other Factors That Affect the Monetary base	341
Overview of the Fed's Ability to Control the Monetary Base	341
Multiple Deposit Creation: A Simple Model	341
Deposit Creation: The Single Bank	41
Deposit Creation: The Banking System	343
Deriving the Formula for Multiple Deposit Creation	345
Critique of the Simple Model	347
Summary	347
Key Terms and Questions and Problems	348
Web Exercises and Web References	349
Chapter 14
Determinants of the Money Supply	351
Preview	351
The Money Supply Model and the Money Multiplier	352
Deriving the Money Multiplier	352
Intuition Behind the Money Multiplier	354
Factors that Determine the Money Multiplier	355
Changes in the Required Reserve Ratio r	355
FYI The Declining Importance of Reserve Requirements	356
Changes in the Currency Ratio c	357
Changes in the Excess Reserves Ratio e	357
Additional Factors That Determine the Money Supply	359
Changes in the Nonborrowed Monetary Base MBn	360
Changes in the Discount Loans DL from the Fed	360
Overview of the Money Supply Process	360
Application Explaining Movements in the Money Supply, 1980/2005	362
Application The Great Depression Bank Panics, 1930/1933	364
Summary, Key Terms, Questions and Problems	368
Web Exercises and References	369
Appendix to Chapter 14
The M2 Money Multiplier	370
Factors that Determine the M2 Money Multiplier	371
Response to Changes in t and mm	371
Chapter 15
Tools of Monetary Policy	373
Preview	373
The Market for Reserves and the Federal Funds Rate	373
Supply and Demand in the Market for Reserves	374
How Changes in the Tools of Monetary Policy Affect the Federal Funds Rate	375
Open Market Operations	378
A Day at the Trading Desk	378
Advantages of Open Market Operations	380
Discount Policy	380
Operation of the Discount Window	381
Lender of Last Resort	381
Advantages and Disadvantages of Discount Policy	383
Reserve Requirements	383
Box 1 Inside the Fed: Using Discount Policy	384
Disadvantages of Reserve Requirements	385
Application Why Have Reserve Requirements Been Declining Worldwide?	385
Application The Channel/Corridor System for Setting Interest Rates in 
Other Countries	386
Monetary Policy Tools of the European Central Bank	388
Open Market Operations	388
Reserve Requirements	389
Summary	389
Key Terms and Questions and Problems	390
Web Exercises and Web References	391
Chapter 16
What Should Central Banks Do? Monetary Policy Goals, Strategy, and Tactics	393
Preview	393
The Price Stability Goal and the Nominal Anchor	393
The Role of a Nominal Anchor	394
The Time-Inconsistency Problem	394
Other Goals of Monetary Policy	395
High Employment	395
Economic Growth	396
Stability of Financial Markets	396
Interest-Rate Stability	396
Stability in Foreign Exchange Markets	396
Should Price Stability be the Primary Goal of Monetary Policy?	397
Hierarchical Versus Dual Mandates	397
Price Stability as the Primary, Long-Run Goal of Monetary Policy	398
Monetary Targeting	398
Monetary Targeting in the United States, Japan, and Germany	398
Box1 Global: The European Central Bank's Monetary Policy Strategy 	401
Advantages of Monetary Targeting	402
Disadvantages of Monetary Targeting	402
Inflation Targeting	402
Inflation Targeting in New Zealand, Canada, and the United Kingdom	403
Advantages of Inflation Targeting	405
Disadvantages of Inflation Targeting	406
Monetary Policy with an Implicit Nominal Anchor	408
Advantages of the Fed's Approach	409
Disadvantages of the Fed's Approach	409
Box2 Inside the Fed The New Fed Chairman and Inflation Targeting	410
Tactics: Choosing the Policy Instrument	412
The Taylor Rule, NAIRU, and the Phillips Curve	414
Box3 Inside the Fed Fed Watchers	416
Summary	417
Key Terms, Questions and Problems	418
Web Exercises and Web References		419
Appendix to Chapter16
Fed Policy Procedures: Historical Perspective	420
The Early Years: Discount Policy as the Primary Tool	420
Discovery of Open Market Operations	421
The Great Depression	421
Box4 Inside the Fed Bank Panics of 1930-1933: Why Did the Fed Let Them Happen?
	422
Reserve Requirements as a Policy Tool	422
War Finance and the Pegging of Interest Rates: 1942/1951	423
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	428
Box5 Global International Policy Coordination: The Plaza Agreement and the Louvre 
Accord	428
Part V
International Finance and Monetary Policy 429
Chapter 17
The Foreign Exchange Market	431
Preview	431
Foreign Exchange Market	431
What Are Foreign Exchange Rates?	432
Box1 Following the Financial News Foreign Exchange Rates	433
Why Are Exchange Rates Important?	433
How Is Foreign Exchange Traded?	433
Exchange Rates in the Long Run	434
Law of One Price	434
Theory of Purchasing Power Parity	434
Why the Theory of Purchasing Power Parity Cannot Fully Explain Exchange Rates	436
Factors That Affect Rates in the Long Run	437
Exchange Rates in the Short Run	438
Comparing Expected Returns on Domestic and Foreign Deposits	439
Interest Parity Condition	441
Demand Curve for Domestic Assets	442
Supply Curve for Domestic Assets	443
Equilibrium in the Foreign Exchange Market	443
Explaining Changes in Exchange Rates	444
Shifts in the Expected-Return Schedule for Foreign Deposits	444
Application Changes in the Equilibrium Exchange Rate: Two Examples	447
Changes in Interest Rates	447
Changes in the Money Supply	449
Exchange Rate Overshooting	450
Application Why Are Exchange Rates So Volatile?	451
Application The Dollar and Interest Rates, 1973/2005	452
Application The Euro's First Four Years	453
Application Reading the Wall Street Journal: The "Currency Trading" Column	453
Box 2 Following the Financial News The "Currency Trading" Column	454
Summary and Key Terms	455
Questions and Problems, and Web Exercises 	456
Web References	457
Chapter 18
The International Financial System	459
Preview	459
Intervention in the Foreign Exchange Market	459
Foreign Exchange Intervention and the Money Supply	459
Box 1 Inside the Fed: A Day at the Federal Reserve Bank of New York's 
Foreign Exchange Desk	460
Unsterilized Intervention	462
Sterilized Intervention	463
Balance of Payments	464
Box1 Global Why the Large U. S. Current Account Deficit Worries Economists	465
Exchange Rate Regimes in the International Financial System	465
Gold Standard	466
Bretton Woods System	466
Box 2 Global: The Euro's Challenge to the Dollar	467
How the Fixed Rate Regime Works	467
Application How Did China Accumulate Nearly $1 Trillion of International Reserves?
	470
Managed Float	471
European Monetary System(EMS)	472
Application Recent Foreign Exchange Crises of September 1992	472
Application Recent Foreign Exchange Crises in Emerging Market Countries: Mexico 
1994, East Asia 
1997, Brazil 1999, and Argentina 2002	474
Capital Controls	475
Controls on Capital Outflows	475
Controls on Capital Inflows	476
The Role of the IMF	477
How Should the IMF Operate?	478 
International Considerations and Monetary Policy	479
Should the IMF Be an International Lender of Last Resort?	480
Direct Effects of the Foreign Exchange Market on the Money Supply	479
Balance-of-Payments Considerations	480
Exchange Rate Considerations	480
To Peg or Not to Peg: Exchange-Rate Targeting as an alternative Monetary Policy 
Strategy	481
Advantages of Exchange-Rate Targeting	481
Disadvantages of Exchange-Rate Targeting	482
When is Exchange-Rate Targeting Desirable for Industrialized Countries	484
When is Exchange-Rate Targeting Desiravle for Emerging Market Countries?	484
Currency Boards	485
Dollarization	485
Box3 Global Argentina's Currency Board	486
Summary	487
Key Terms, Questions and Problems	488
Web Exercises and Web References		489
Part VI
Chapter 19
Monetary Theory		491
The Demand for Money	493
Preview	493
Quantity Theory of Money		493
Velocity of Money and Equation of Exchange	494
Quantity Theory 	495
Quantity Theory of Money Demand		495
Is Velocity a Constant?	496
Keynes's Liquidity Preference Theory	497
Transactions Motive	497
Precautionary Motive	498
Speculative	498
Putting the Three Motives Together	499
Further Developments in the Keynesian Approach	501
Transactions Demand	501
Precautionary Demand	503
Speculative Demand	504
Friedman's Modern Quantity Theory of Money	505
Distinguishing Between The Friedman and Keynesian Theories		507
Empirical Evidence on the Demand for Money	509
Interest Rates and Money Demand	509
Stability of Money Demand	510
Summary	510
Key Terms, Questions and Problems	511
Web Exercises and Web References		512
Chapter 20
The ISLM Model	513
Preview	513
Determination of Aggregate Output	513
Consumer Expenditure and the Consumption Function	514
Investment Spending	526
Box1 FYI Meaning of the Word Investment	517
Equilibrium and the Keynesian Gross Diagram	517
Expenditure Multiplier	519
Application The Collapse of Investment Spending and the Great Depression	521
Government's Role	522
Role of International Trade		524
Summary of the Determinants of Aggregate Output	525
The ISLM Model	528
Equilibrium in the Goods Market: The IS Curve	528
Equilibrium in the Market for Money: The LM Curve	531
ISLM Approach to Aggregate output and Interest Rates	533
Summary and Key Terms	535
Questions and Problems and Web Exercises	536
Web References	537
Chapter 21
Monetary and Fiscal Policy in the ISLM Model	539
Preview	539
Factors That Cause The IS Curve to Shift	539
Factors That Cause The LM Curve to Shift	542
Changes in Equilibrium Level of the Interest Rate and Aggregate Output	544
Response to a Change in Monetary Policy	544
Response to a Change in Fiscal Policy	545
Effectiveness of Monetary Versus Fiscal Policy	546
Monetary Policy Versus Fiscal Policy: The Case of Complete Crowding Out	546
Application Targeting Money Supply Versus Interest Rates	549
ISLM Model in the Long Run	552
ISLM Model and the Aggregate Demand Curve	554
Deriving the Aggregate Demand Curve	555
Factors That Cause the Aggregate demand Curve to Shift	556
Summary and Key Terms	558
Questions and Problems, and Web Exercises	559
Web References	560
Chapter 22
Aggregate Demand and Supply Analysis	561
Preview	561
Aggregate Demand	561
Quantity Theory of Money Approach to Aggregate Demand	561
Box1 Following the Financial News Aggregate Output, Unemployment, and the Price 
Level
Deriving Aggregate Demand from the Behavior of It's Component Parts	564
Aggregate Supply	565
Long-Run Aggregate Supply Curve	567
Short-Run Aggregate Supply Curve	567
Shifts in the Short-Run Aggregate Supply Curve	568
Factors that Shift the Short-Run Aggregate Supply Curve	569
Equilibrium in Aggregate Supply and Demand Analysis	570
Equilibrium in the Short Run	570
Equilibrium in the long Run	571
Changes in Equilibrium Caused by Aggregate Demand Shocks	574
Changes in Equilibrium Caused by Aggregate Supply Shocks	575
Shifts in the Long-Run Aggregate Supply Curve: Real Business Cycle Theory and 
Hysteresis	575
Conclusions	577
Application Explaining Past Business Cycle Episodes	577
Vietnam War Buildup, 1964-1970	577
Negative Supply Shocks, 1973/1975 and 1978/1980	578
Favorable Supply Shocks, 1995/1999	579
Negative Demand Shocks, 2001/2004	579
Summary and Key Terms	580
Questions and Problems	581
Web Exercises and Web References	582
Chapter 23
Transmission Mechanisms of Monetary Policy: The Evidence	583
Preview	583
Framework for Evaluation Empirical Evidence	583
Structural Model Evidence	584
Reduced-Form Evidence	584
Advantages and Disadvantages of Structural Model Evidence	585
Advantages and Disadvantages of Reduced-Form Evidence	585
Box1 FYI Perils of Reverse Causation: A Russian Folk Tale	586
Conclusion	586
Box2 FYI Perils of Ignoring an Outside Driving Factor: How to Lose a Presidential 
Election	587
Application The Debate on the Importance of Monetary Policy to Economic 
Fluctuations	587
Early Keynesian Evidence on the Importance of Money	587
Objections to Early Keynesian Evidence	588
Early Monetarist Evidence on the Importance of Money	591
Overview of the Monetarist Evidence	595
Box3 FYI Real Business Cycle Theory and the Debate on Money and Economic Activity
	596
Transmission Mechanisms of Monetary Policy	596
Traditional Interest-Rate Channels	597
Other Asset Price Channels	598
Credit view	601
Box4 FYI Consumers' Balance Sheets and the Great Depression		604
Why Are Credit Channels Likely to be Important	605
Application Corporate Scandals and the Slow Recovery from the March 2001 Recession
	605
Lessons for Monetary Policy	606
Application Applying the Monetary Policy Lessons to Japan	607
Summary	608
Key Terms and Questions and Problems	609
Web Exercises	610
Web References	611
Chapter 24
Money and Inflation	613
Preview	613
Money and Inflation: Evidence	613
German Huperinflation, 1921/1923	614
Recent Episodes of Raid Inflation	614
Meaning of Inflation	615
Views of Inflation	616
How money Growth Produces Inflation	616
Can Other Factors Besides Money Growth Produce a Sustained Inflation?	617
Summary	619
Origins of Inflationary Monetary Policy	620
High Employment Targets and Inflation	620
Budget Deficits and Inflation	623
Application Explaining the Rise in U. S. Inflation, 1960/1980	627
Activist/NonActivist Policy Debate	630
Responses to High Unemployment	630
Activist and Nonactivist Positions	632
Expectations and the Activist/Nonactivist Debate	632
Activist Versus Nonactivist: Conclusions	634
Application Importance of Credibility to Volcker's Victory over Inflation	634
Summary and Key Terms	635
Questions and Problems and Web Exercises	636
Web References	637
Chapter 25
Rational Expectations: Implications for Policy	639
Preview	639
The Lucas Critique of Policy Evaluation	640
Econometric Policy Evaluation	640
Example: The Term Structure of Interest Rates	640
New Classical Macroeconomic Model	641
Effects of Unanticipated and Anticipated Policy	642
Box 1 FYI Proof of the Policy Ineffectiveness Proposition	644
Can an Expansionary Policy Lead to a Decline in Aggregate Output?	644
Implications for Policymakers	645
New Keynesian Model	646
Effects of Unanticipated and Anticipated Policy	647
Implications for Policymakers	647
Comparison of the Two New Models with the Traditional Model	649
Short-Run Output and Price Responses	649
Stabilization Policy	652
Anti-inflation Policies	652
Credibility in Fighting Inflation	655
Box 2 Global: Ending the Bolivian Hyperinflation: Case Study of a 
Successful Anti-inflation Program	656
Application Credibility and the Reagan Budget Deficits	656
Impact of the Rational Expectations Revolution	656
Summary	658
Key Terms, Questions and Problems	659
Web Exercises and Web References		660
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: A Russian Folk Tale	606
Box 2 Perils of Ignoring an Outside Driving Factor: How to Lose a 
Presidential Election	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
Budget Deficits and Inflation	643
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: The Terrorism Dilemma	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
Glossary	 G-1
Answers to Selected Questions and Problems	 A-1
Credits	 C-1
Index	 I-1

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