spring midterm 2 reading summaries

spring midterm 2 reading summaries - Social Analysis 10...

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Social Analysis 10 Midterm 2 – Reading Summaries THE BUSINESS OF BANKING A bank's liabilities come in the form of deposits which come in two forms, current accounts and deposit or savings account. A banks assets come in the form of short-term credit and longer-term loans such as loans for buying homes and such (mortgages). The problem arises when people begin to doubt a bank's lending book (the quality of it) and thus they demand their savings back. Because longer-term loans are much less liquid, people demanding their savings back (which have been redistributed to people in loans) cannot be retrieved easily. Borrowers also might not be able to repay their loans (credit risk). When banks relax their lending criteria because the economy is prosperous and thus people are more prone to defaulting on their loans. The other risk is interest-rate risk, which says that a bnak will pay more interest on deposits than it is able to charge for loans. This means that the interest rate goes so far up that a bank is obligated to pay out more for interest deposits than it can make on loans. A way around this is to lend at variable rates. Banks can pay for their own regulation through interest on its loans. Also, in order to avoid a liquidity crisis, the central bank can act as lender of last resort which means that they can bale a bank out if they're in a crisis. Also, reserves act as a cushion to avoid a bank from a crisis. Moral hazard arises from the fact that banks have deposit-guarentee schemes and thus people invest indifferent of the riskiness of banks' lending. Another difficulty is that a ton of institutions now offer banking, such as super markets which makes banking a lot messier than it was in the past. Moreover, a lot of companies in the US raise money through disintermediation which is the selling of bonds rather than borrowing fromb anks. Finally, crediting online and banking online is at a huge increase. Online banks have lower costrs and can thus offer cheaper products or higher interest rates to despositors as a result. STEERING BY A FAULTY COMPASS Are central banks watching the wrong measure of inflation? Fed forecasted inflation for first time so it could start targeting and therefore increase transparency of monetary policy and credibility
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But which measure of inflation should the Fed target? A central bank’s main goal is price stability, but current indices don’t take some important things into account, like homes and shares o CPI too narrow; 2.3% vs. 13% rise in house prices o Many argue for a broader index o Ian Morris’ index: includes houses, gives them weight of 30%; calculations of 4.9% inflation (over 2x rise in CPI) o Really big gap between 2 measures A long economic pedigree Irving Fisher argued for broader index 1911, not new Asset-price inflation is harmful: rise and crash of markets for shares or property, big swings in prices that lead to misallocation of resources and slow growth (i.e. so people invest too much in property but not enough in other things)
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This note was uploaded on 04/07/2008 for the course SOC-ANAL 10 taught by Professor Mankiw during the Fall '05 term at Harvard.

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spring midterm 2 reading summaries - Social Analysis 10...

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