PA974-001Monetary Policy and Financial Regulation in aFinancial Regulation in a Globalized EconomyyInstructor: Menzie ChinnFall 2010Administrative IssuesAdministrative Issues•Course website:Course website: http://www.ssc.wisc.edu/~mchinn/web974_f10.html• OH: MW 4-5, 7418 Soc Sci• Textbook: Mishkin, The Economics of Money, Banking and Financial Marketsyg(9/e)• Additional Readings: from WWW, Econbrowser, CBO, IMF• NYT, FT, WSJ, EconomistAdministrative IssuesAdministrative Issues•Grading:30%PS80% Final Paper•Grading: 30% PS, 80% Final Paper• Make-ups: None. Points are re-allocated ifhlititNltyou have a legitimate excuse. Nolate assignments accepted (must be handed in during lecture)lecture)RiskLibor-3 mo. T-bill (TED) spread()pLendingMonetary Policy (I)yy()Monetary Policy (II)Source: Econbrowser, 8/11/2010, using data thru 8/4Asset Prices: Rational or NotSource: Calculated Risk, 7/27/2010Function of Financial MarketsFunction of Financial MarketsPerform the essential f nction of channeling•Perform the essential function of channeling funds from economic players that have saved surplus funds to those that have asaved surplus funds to those that have a shortage of funds•Promotes economic efficiency by producing•Promotes economic efficiency by producing an efficient allocation of capital, which increases productionincreases production • Directly improve the well-being of consumers by allowing them to time purchases betterCopyright © 2007 Pearson Addison-Wesley All rights2-10by allowing them to time purchases betterCopyright © 2007 Pearson Addison-Wesley All rights2-11Structure of Financial MarketsStructure of Financial Markets• Debt and Equity Marketsqy• Primary and Secondary Markets– Investment Banks underwrite securities in primary markets– Brokers and dealers work in secondary markets• Exchanges and Over-the-Counter (OTC) Markets• Money and Capital Markets– Money markets deal in short-term debt instrumentsCitl ktdliltdbtd–Capital markets deal in longer-term debt and equity instrumentsCopyright © 2007 Pearson Addison-Wesley All rights2-12Copyright © 2007 Pearson Addison-Wesley All rights2-13Copyright © 2007 Pearson Addison-Wesley All rights2-14Internationalization of Financial Markets•Foreign Bondssold in a foreign country and•Foreign Bonds—sold in a foreign country and denominated in that country’s currency•Eurobond—bond denominated in a currency•Eurobond—bond denominated in a currency other than that of the country in which it is sold•Eurocurrencies—foreign currencies depositedEurocurrenciesforeign currencies deposited in banks outside the home country–Eurodollars—U.S. dollars deposited in foreign pgbanks outside the U.S. or in foreign branches of U.S. banksWorld Stock MarketsCopyright © 2007 Pearson Addison-Wesley All rights2-15•World Stock MarketsFunction of Financial Intermediaries: Indirect Finance• Lower transaction costs– Economies of scale– Liquidity servicesReduce Risk•Reduce Risk– Risk Sharing (Asset Transformation)– Diversification• Asymmetric Information– Adverse Selection (before the transaction)—more likely to select risky borrowery– Moral Hazard (after the transaction)—less likely borrower will repay loanCopyright © 2007 Pearson Addison-Wesley All rights2-16Copyright © 2007 Pearson Addison-Wesley All rights2-17Copyright © 2007 Pearson Addison-Wesley All rights2-18Regulation of the Financial System• To increase the information available to investors:– Reduce adverse selection and moral hazard problems– Reduce insider trading• To ensure the soundness of financial intermediaries:– Restrictions on entry–DisclosureDisclosure– Restrictions on Assets and Activities– Deposit InsuranceLimits on Competition–Limits on Competition– Restrictions on Interest RatesCopyright © 2007 Pearson Addison-Wesley All rights2-19Copyright © 2007 Pearson Addison-Wesley All rights2-20Copyright © 2007 Pearson Addison-Wesley All rights2-21Copyright © 2007 Pearson Addison-Wesley All