Chapter 30 Notes

Chapter 30 Notes - [ChapterThirty]...

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[Chapter Thirty] The Financial Sector and the Economy Learning Objectives After reading the material in this chapter, you will be able to do the following: 1. Explain why the financial sector is central to almost all macroeconomic debates. 2. Demonstrate graphically how the long-term interest rate is determined. 3. Explain what money is. 4. Enumerate the three functions of money. 5. State the alternative measures of money and their primary components. 6. Explain how banks create money. 7. Calculate both the simple money multiplier and the money multiplier. 8. Explain why people hold money and how the short-term interest rate is determined in the money market. Chapter Outline The Financial Sector and the Economy In thinking about the economy, students often focus on the real sector, but the financial sector (the market for the creation and exchange of financial assets such as money, socks, and bonds) plays a central role; it makes modern economic society possible. The efficient use of markets requires a financial sector that facilitates and lubricates those trades. The modern financial sector is highly sophisticated. Example: when a bank makes you a loan, that loan is often securitized (packaged with other loans) into a security (bond) and sold to individuals. These bonds are called derivatives, because they are derived from another loan. Sometimes these securitized bonds are packaged with different types of loans into second-order derivative bonds.
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Packaging loans spreads the risk of default, but cannot reduce systemic risk—the risk that all or many of the loans default together. Why Is the Financial Sector Important to Macro? For every real transaction, there is a financial transaction that mirrors it. Example: the financial transaction is the transfer of 50 cents; the real transaction is the transfer of the apple. When the financial system is operating smoothly, you hardly know it’s there. In 2008 people lost faith in the existing financial institutions, and the financial sector nearly came to a halt. In October 2008, people were seriously concerned that the U.S. economy would totally seize up (like a car without oil) because of a meltdown of the financial sector. The financial sector has two roles: it facilitates trade, and it transfers saving back into spending. The second role is shown in Figure 13-1. Financial Assets: “Assets such as stocks or bonds, whose benefit to the owner depends on the issuer of the asset meeting certain obligations.” Flows from the spending stream are channeled into the financial sector as saving when individuals buy financial assets. For every financial asset, there is a corresponding financial liability. The Roles of Interest Rates in the Financial Sector
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This note was uploaded on 12/03/2011 for the course ECON 101 taught by Professor Smith during the Fall '11 term at North Shore.

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Chapter 30 Notes - [ChapterThirty]...

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