Chapter 4

Chapter 4 - Short Run: Financial Markets (Blanchard ch. 4)...

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Unformatted text preview: Short Run: Financial Markets (Blanchard ch. 4) Prof. Irina A. Telyukova UCSD Econ 110A Spring 2008 2 Outline Last time we talked about the goods market. Today we will study another side of the economy: financial markets. I. We will discuss demand for money . II. We will look at the determination of interest rates in the simplest model of financial markets. III. We will discuss the role of private banks in the economy. 3 Prelude: What is Money? s In economics, money is a specific term referring to currency and checkable bank accounts. s Money has three roles: a unit of account; a store of value; a medium of exchange. s In our treatment, money will not be the same as income, or financial investment, or wealth/savings. s Why? – because we distinguish between money (liquidity) and other types of financial assets which usually comprise savings and financial investment. They have very different characteristics in reality. 4 Two Assets in our Model of Financial Markets s We will talk about money versus bonds: s We will assume that money is just physical currency (cash), for now. s Bonds will be the other, less liquid, asset under consideration. It will be the asset that we assume pays interest. s We a b s t r a c t from things like stocks, savings accounts, retirement accounts, etc. for simplicity. 5 Distinguishing Money and Bonds s Money (currency) does not carry an interest rate. s Even if we included in the definition of money deposits at the bank, their interest yield is still very low, usually near or at 0. s Bonds carry a positive interest rate. 6 Choosing between Money and Bonds s Which would people prefer? s Bonds yield an interest income, but cannot pay for a cab or rent with bonds. L i q u i d i t y is the term used to describe versatility of money relative to assets like bonds as a medium of exchange. s Bonds are c o s t l y : have to call a broker and pay a fee to trade them. Money does not carry such a cost. s Deciding how to allocate one’s p o r t f o l i o between money and bonds is a fundamental problem for any household, and of interest to economists....
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This note was uploaded on 04/29/2008 for the course ECON 110A taught by Professor Staff during the Spring '08 term at UCSD.

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Chapter 4 - Short Run: Financial Markets (Blanchard ch. 4)...

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