How We Will Study Money Banking and Financial Markets

This textbook stresses the economic way of thinking by developing a unifying framework to study money, banking, and financial markets. This analytic framework uses a few basic economic concepts to organize your thinking about the determination of asset prices, the structure of financial markets, bank management, and the role of money in the economy. It encompasses the following basic concepts:

• A simplified approach to the demand for assets

• The concept of equilibrium

• Basic supply and demand to explain behavior in financial markets

• The search for profits

• An approach to financial structure based on transaction costs and asymmetric information

• Aggregate supply and demand analysis

The unifying framework used in this book will keep your knowledge from becoming obsolete and make the material more interesting. It will enable you to learn what really matters without having to memorize a mass of dull facts that you will forget soon after the final exam. This framework will also provide you with the tools to understand trends in the financial marketplace and in variables such as interest rates, exchange rates, inflation, and aggregate output.

To help you understand and apply the unifying analytic framework, simple models are constructed in which the variables held constant are carefully delineated, each step in the derivation of the model is clearly and carefully laid out, and the models are then used to explain various phenomena by focusing on changes in one variable at a time, holding all other variables constant.

To reinforce the models' usefulness, this text uses case studies, applications, and special-interest boxes to present evidence that supports or casts doubts on the theories being discussed. This exposure to real-life events and data should dissuade you from thinking that all economists make abstract assumptions and develop theories that have little to do with actual behavior.

To function better in the real world outside the classroom, you must have the tools to follow the financial news that appears in leading financial publications such as the Wall Street Journal. To help and encourage you to read the financial section of the newspaper, this book contains two special features. The first is a set of special boxed inserts titled "Following the Financial News" that contain actual columns and data from the Wall Street Journal that typically appear daily or periodically. These boxes give you the detailed information and definitions you need to evaluate the data being presented. The second feature is a set of special applications titled "Reading the Wall Street Journal" that expand on the "Following the Financial News" boxes. These applications show you how the analytic framework in the book can be used directly to make sense of the daily columns in the United States' leading financial newspaper. In addition to these applications, this book also contains nearly 400 end-of-chapter problems that ask you to apply the analytic concepts you have learned to other real-world issues. Particularly relevant is a special class of problems headed "Predicting the Future." So that you can work on many of these problems on your own, answers to half of them are found at the end of the book. These give you an opportunity to review and apply many of the important financial concepts and tools presented throughout the book.

Exploring the Web The World Wide Web has become an extremely valuable and convenient resource for financial research. We emphasize the importance of this tool in several ways. First, wherever we utilize the Web to find information to build the charts and tables that appear throughout the text, we include the source site's URL. These sites often contain additional information and are updated frequently. Second, in the margin of the text, we have included the URLs of sites related to the material being discussed. Visit these sites to further explore a topic you find of particular interest. Finally, we have added Web exercises to the end of each chapter. These exercises prompt you to visit sites related to the chapter and to work with real-time data and information.

Web site URLs are subject to frequent change. We have tried to select stable sites, but we realize that even government URLs change. The publishers web site ( /mishkin) will maintain an updated list of current URLs for your reference.

A sample Web exercise has been included in this chapter. This is an especially important example, since it demonstrates how to export data from a web site into Microsoft® Excel for further analysis. We suggest you work through this problem on your own so that you will be able to perform this activity when prompted in subsequent Web exercises.

You have been hired by Risky Ventures, Inc., as a consultant to help them analyze interest rate trends. They are initially interested in determining the historical relationship between long-and short-term interest rates. The biggest task you must immediately undertake is collecting market interest-rate data. You know the best source of this information is the Web.

1. You decide that your best indicator of long-term interest rates is the 30-year U.S. Treasury note. Your first task is to gather historical data. Go to and click "H.15 Selected Interest Rates, Historical data." The site should look like Figure 9. a. Click on "Historical data." Scroll down to "U.S. Government securities/Treasury constant maturities/30 year." Scroll over to the right and click on "annual."

FIGURE 9 Federal Reserve Board Web Site

b. While you have located an accurate source of historical interest rate data, getting it onto a spreadsheet will be very tedious. You recall that Excel will let you convert text data into columns. Begin by highlighting the two columns of data (the year and rate). Right-click on the mouse and choose copy. Now open Excel and put the cursor in a cell. Click paste. Now choose data from the tool bar and click on text to columns. Follow the wizard (Figure 10), checking the fixed-width option. The list of interest rates should now have the year in one column and the interest rate in the next column. Label your columns.

Repeat the above steps to collect the 1-year interest rate series. Put it in the column next to the 30-year series. Be sure to line up the years correctly and delete any years that are not included in both series.

c. You now want to analyze the interest rates by graphing them. Again highlight the two columns of data you just created in Excel. Click on the charts icon on the tool bar (or insert/chart). Select scatter diagram and choose any type of scatter diagram that connects the dots. Let the Excel wizard take you through the steps of completing the graph. (see Figure 11.)

FIGURE 10 Excel Spreadsheet with Interest Rate Data
FIGURE 11 Excel Graph of Interest Rate Data

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