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The economics of money, banking and financial markets - 4th Canadian ed
Nội dung xem thử
Mô tả chi tiết
THE ECONOMICS
OF MONEY,BANKING,
AND FINANCIAL
MARKETS
FREDERIC S. MISHKIN
COLUMBIA UNIVERSITY
APOSTOLOS SERLETIS
UNIVERSITY OF CALGARY
FOURTH CANADIAN EDITION
Pearson Canada
Toronto
THE ECONOMICS
OF MONEY,BANKING,
AND FINANCIAL
MARKETS
To Aglaia
Library and Archives Canada Cataloguing in Publication
Mishkin, Frederic S.
The economics of money, banking and financial markets / Frederic S.
Mishkin, Apostolos Serletis. 4th Canadian ed.
Includes bibliographical references and index.
ISBN 978-0-321-58471-7
1. Finance Textbooks. 2. Money Textbooks. 3. Banks and banking Textbooks.
I. Serletis, Apostolos, 1954 II. Title.
HG173.M58 2011 332 C2009-906674-2
Copyright 2011, 2008, 2005, 2002 Pearson Canada Inc., Toronto, Ontario.
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Economics of Money, Banking, and Financial Markets: Business School Edition, Second Edition,
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Brief Contents
PART I Introduction. . . . . . . . . . . . . . . . 1
Chapter 1 Why Study Money, Banking,
and Financial Markets? . . . . . . . . . . . . . . . . . . 2
Chapter 2 An Overview of the
Financial System. . . . . . . . . . . . . . . . . . . . . . 17
Chapter 3 What is Money? . . . . . . . . . . . . . . 43
PART II Financial Markets . . . . . . . . . 57
Chapter 4 Understanding Interest Rates . . . . 58
Chapter 5 The Behaviour of Interest Rates . . 82
Chapter 6 The Risk and Term Structure
of Interest Rates . . . . . . . . . . . . . . . . . . . . . 113
Chapter 7 The Stock Market, the Theory
of Rational Expectations, and the Efficient
Market Hypothesis . . . . . . . . . . . . . . . . . . . 140
PART III Financial Institutions . . . . 165
Chapter 8 An Economic Analysis of
Financial Structure . . . . . . . . . . . . . . . . . . . 166
Chapter 9 Financial Crises and the
Subprime Meltdown . . . . . . . . . . . . . . . . . . 196
Chapter 10 Economic Analysis of Financial
Regulation . . . . . . . . . . . . . . . . . . . . . . . . . 225
Chapter 11 Banking Industry: Structure
and Competition . . . . . . . . . . . . . . . . . . . . . 252
Chapter 12 Nonbank Financial Institutions . 288
PART IV The Management of
Financial Institutions . . . . . . . . . . . . . 313
Chapter 13 Banking and the Management
of Financial Institutions . . . . . . . . . . . . . . . . 314
Chapter 14 Risk Management with
Financial Derivatives . . . . . . . . . . . . . . . . . . 346
PART V Central Banking and the
Conduct of Monetary Policy . . . . . . . 380
Chapter 15 Central Banks and the
Bank of Canada . . . . . . . . . . . . . . . . . . . . . 381
Chapter 16 The Money Supply Process . . . 404
Chapter 17 Tools of Monetary Policy . . . . . 431
Chapter 18 The Conduct of Monetary
Policy: Strategy, and Tactics. . . . . . . . . . . . . 462
PART VI International Finance and
Monetary Policy . . . . . . . . . . . . . . . . . 493
Chapter 19 The Foreign Exchange
Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . 494
Chapter 20 The International Financial
System . . . . . . . . . . . . . . . . . . . . . . . . . . . . 518
PART VII Monetary Theory . . . . . . . . 549
Chapter 21 The Demand for Money. . . . . . 551
Chapter 22 The ISLM Model. . . . . . . . . . . . 572
Chapter 23 Monetary and Fiscal Policy in
the ISLM Model. . . . . . . . . . . . . . . . . . . . . . 596
Chapter 24 Aggregate Demand and
Supply Analysis . . . . . . . . . . . . . . . . . . . . . 619
Chapter 25 Transmission Mechanisms of
Monetary Policy: The Evidence . . . . . . . . . . 638
Chapter 26 Money and Inflation. . . . . . . . . 666
Chapter 27 Rational Expectations:
Implications for Policy . . . . . . . . . . . . . . . . 691
Contents
Preface . . . . . . . . . . . . . . . . . . . . . . . . xxi
About the Authors . . . . . . . . . . . . . . xxx
PART I Introduction. . . . . . . . . . . . 1
The Subprime Crisis: An Introduction . . . . . . . 1
C H A P T ER 1
Why Study Money, Banking, and Financial
Markets? . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Learning Objectives . . . . . . . . . . . . . . . . . . . .2
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Why Study Financial Markets? . . . . . . . . . . . . 2
The Bond Market and Interest Rates . . . . . . . 3
The Stock Market . . . . . . . . . . . . . . . . . . . . . 3
Why Study Financial Institutions and
Banking? . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Structure of the Financial System . . . . . . . . . 5
Financial Crises . . . . . . . . . . . . . . . . . . . . . . . 5
Banks and Other Financial Institutions . . . . . . 5
Financial Innovation . . . . . . . . . . . . . . . . . . . 6
Why Study Money and Monetary Policy? . . . . 6
Money and Business Cycles. . . . . . . . . . . . . . 6
Money and Inflation . . . . . . . . . . . . . . . . . . . 7
Money and Interest Rates . . . . . . . . . . . . . . . 9
Conduct of Monetary Policy. . . . . . . . . . . . . . 9
Fiscal Policy and Monetary Policy . . . . . . . . 10
Why Study International Finance? . . . . . . . . . 10
The Foreign Exchange Market . . . . . . . . . . . 11
The International Financial System . . . . . . . . 12
How We Will Study Money, Banking, and
Financial Markets . . . . . . . . . . . . . . . . . . . 12
Exploring the Web . . . . . . . . . . . . . . . . . . . . 13
Collecting and Graphing Data . . . . . . . . . . . 13
Sample Web Exercise . . . . . . . . . . . . . . . . . . 13
Concluding Remarks . . . . . . . . . . . . . . . . . . 14
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Questions . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Quantitative Problems . . . . . . . . . . . . . . . . . 16
Web Exercises . . . . . . . . . . . . . . . . . . . . . . . 16
C H A P T ER 2
An Overview of the Financial System . . . 17
Learning Objectives . . . . . . . . . . . . . . . . . . .17
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Function of Financial Markets . . . . . . . . . . . . 18
Structure of Financial Markets . . . . . . . . . . . . 20
Debt and Equity Markets . . . . . . . . . . . . . . 20
Primary and Secondary Markets . . . . . . . . . . 20
Exchanges and Over-the-Counter Markets . . 21
Money and Capital Markets . . . . . . . . . . . . . 21
Financial Market Instruments . . . . . . . . . . . . 22
Money Market Instruments. . . . . . . . . . . . . . 22
Financial News Money Rates . . . . . . . . . . . . . . 24
Capital Market Instruments . . . . . . . . . . . . . 25
Internationalization of Financial Markets . . . . 27
International Bond Market, Eurobonds,
and Eurocurrencies . . . . . . . . . . . . . . . . . 27
Global Are U.S. Capital Markets Losing
Their Edge? . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
World Stock Markets . . . . . . . . . . . . . . . . . . 28
Function of Financial Intermediaries:
Indirect Finance . . . . . . . . . . . . . . . . . . . . 29
Financial News Foreign Stock Market
Indexes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Global The Importance of Financial
Intermediaries to Securities Markets:
An International Comparison . . . . . . . . . . . . 31
Transaction Costs . . . . . . . . . . . . . . . . . . . . 31
Risk Sharing . . . . . . . . . . . . . . . . . . . . . . . . 32
Asymmetric Information: Adverse
Selection and Moral Hazard. . . . . . . . . . . 32
Types of Financial Intermediaries . . . . . . . . . 34
Depository Institutions (Banks) . . . . . . . . . . 34
Contractual Savings Institutions . . . . . . . . . . 35
viii Contents
Investment Intermediaries . . . . . . . . . . . . . . 37
Regulation of the Financial System . . . . . . . . 37
Increasing Information Available to
Investors . . . . . . . . . . . . . . . . . . . . . . . . 37
Ensuring the Soundness of Financial
Intermediaries. . . . . . . . . . . . . . . . . . . . . 38
Financial Regulation Abroad . . . . . . . . . . . . 40
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . 41
Questions . . . . . . . . . . . . . . . . . . . . . . . . . . 41
Web Exercises . . . . . . . . . . . . . . . . . . . . . . . 42
C H A P T ER 3
What Is Money? . . . . . . . . . . . . . . . . . . . . . 43
Learning Objectives . . . . . . . . . . . . . . . . . . 43
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Meaning of Money . . . . . . . . . . . . . . . . . . . . 43
Functions of Money . . . . . . . . . . . . . . . . . . . 44
Medium of Exchange. . . . . . . . . . . . . . . . . . 44
Unit of Account. . . . . . . . . . . . . . . . . . . . . . 45
FYI Money in a Prisoner-of-War Camp and
Modern Prisons . . . . . . . . . . . . . . . . . . . . . . . 46
Store of Value . . . . . . . . . . . . . . . . . . . . . . . 46
Evolution of the Payments System . . . . . . . . 47
Commodity Money . . . . . . . . . . . . . . . . . . . 47
Fiat Money . . . . . . . . . . . . . . . . . . . . . . . . . 48
Cheques . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
Electronic Payment . . . . . . . . . . . . . . . . . . . 49
E-Money . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
Measuring Money . . . . . . . . . . . . . . . . . . . . 49
FYI Are We Headed for a Cashless Society? . . 50
The Bank of Canada s Monetary
Aggregates . . . . . . . . . . . . . . . . . . . . . . . 50
FYI Where Are All the Dollars? . . . . . . . . . . . . . 52
Money as a Weighted Aggregate . . . . . . . . . 53
How Reliable Are the Money Data? . . . . . . . . 54
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . 55
Questions . . . . . . . . . . . . . . . . . . . . . . . . . . 55
Quantitative Problems . . . . . . . . . . . . . . . . . 56
Web Exercises . . . . . . . . . . . . . . . . . . . . . . . 56
PART II Financial Markets. . . . . . . . . . 57
Crisis and Response: Credit Market Turmoil
and the Stock Market Crash in
October 2008 . . . . . . . . . . . . . . . . . . . . . . 57
C H A P T ER 4
Understanding Interest Rates . . . . . . . . . . 58
Learning Objectives . . . . . . . . . . . . . . . . . . .58
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
Measuring Interest Rates . . . . . . . . . . . . . . . . 59
Present Value . . . . . . . . . . . . . . . . . . . . . . . 59
Application How to UseYour Financial
Calculator . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
Application Simple Present Value . . . . . . . . . . . 61
Application How Much IsThat Jackpot
Worth? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Four Types of Credit Market Instruments . . . 62
Yield to Maturity . . . . . . . . . . . . . . . . . . . . 63
Application Yield to Maturity on a
Simple Loan . . . . . . . . . . . . . . . . . . . . . . . . . . 63
Application Yield to Maturity on a
Fixed-Payment Loan . . . . . . . . . . . . . . . . . . . 65
Application Yield to Maturity on a
Coupon Bond . . . . . . . . . . . . . . . . . . . . . . . . . 66
Application Yield to Maturity on a
Perpetuity . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
Global NegativeT-Bill Rates? Japan
Shows the Way . . . . . . . . . . . . . . . . . . . . . . . . 70
The Distinction Between Interest Rates and
Returns . . . . . . . . . . . . . . . . . . . . . . . . . . 71
Application Calculating the Rate of Return . . . 72
Application Calculating the Rate of
Capital Gain . . . . . . . . . . . . . . . . . . . . . . . . . . 73
Maturity and the Volatility of Bond Returns:
Interest-Rate Risk . . . . . . . . . . . . . . . . . . 74
FYI Helping Investors to Select Desired
Interest-Rate Risk . . . . . . . . . . . . . . . . . . . . . . 75
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 76
The Distinction Between Real and Nominal
Interest Rates . . . . . . . . . . . . . . . . . . . . . . 76
Application Calculating Real Interest Rates . . . 77
FYI With Real Return Bonds, Real Interest
Rates Have Become Observable in
Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
Application Calculating the Principal and
Coupon Payment of Real Return Bonds . . . . 79
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . 80
Questions . . . . . . . . . . . . . . . . . . . . . . . . . . 80
Quantitative Problems . . . . . . . . . . . . . . . . . 80
Web Exercises . . . . . . . . . . . . . . . . . . . . . . . 81
C H A P T ER 5
The Behaviour of Interest Rates . . . . . . . . 82
Learning Objectives . . . . . . . . . . . . . . . . . . .82
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82
Determinants of Asset Demand . . . . . . . . . . 83
Wealth . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
Expected Return . . . . . . . . . . . . . . . . . . . . . 83
Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
Theory of Asset Demand . . . . . . . . . . . . . . . 84
Supply and Demand in the Bond Market . . . 85
Demand Curve . . . . . . . . . . . . . . . . . . . . . . 85
Supply Curve . . . . . . . . . . . . . . . . . . . . . . . 86
Market Equilibrium . . . . . . . . . . . . . . . . . . . 87
Supply and Demand Analysis. . . . . . . . . . . . 88
Changes in Equilibrium Interest Rates . . . . . . 88
Shifts in the Demand for Bonds . . . . . . . . . . 88
Shifts in the Supply of Bonds . . . . . . . . . . . 92
Application Changes in the Interest Rate
Due to Expected Inflation: The Fisher
Effect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
Application Changes in the Interest Rate
Due to a Business Cycle Expansion . . . . . . . 95
Application Explaining Low Japanese
Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . 97
Application Have Low Savings Rates in
Canada Led to Higher Interest Rates? . . . . . 98
Supply and Demand in the Market for
Money: the Liquidity Preference
Framework . . . . . . . . . . . . . . . . . . . . . . . 99
Changes in Equilibrium Interest Rates . . . . . 101
Shifts in the Demand for Money . . . . . . . . 101
Shifts in the Supply of Money. . . . . . . . . . . 102
Application Changes in the Equilibrium
Interest Rate Due to Changes in Income,
the Price Level, or the Money Supply . . . . 102
Application Money and Interest Rates . . . . . . 105
Does a Higher Rate of Growth of the
Money Supply Lower Interest Rates? . . . 106
FYI Forecasting Interest Rates . . . . . . . . . . . . . 109
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 110
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . 110
Questions . . . . . . . . . . . . . . . . . . . . . . . . . 110
Quantitative Problems . . . . . . . . . . . . . . . . 111
Web Exercises . . . . . . . . . . . . . . . . . . . . . . 112
C H A P T ER 6
The Risk and Term Structure of
Interest Rates . . . . . . . . . . . . . . . . . . . . . . 113
Learning Objectives . . . . . . . . . . . . . . . . . .113
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . 113
Risk Structure of Interest Rates . . . . . . . . . . 113
Default Risk. . . . . . . . . . . . . . . . . . . . . . . . 114
Application The Subprime Collapse and
the BAA-Treasury Spread in the
United States . . . . . . . . . . . . . . . . . . . . . . . . 117
Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . 117
Income Tax Considerations . . . . . . . . . . . . 118
Application Tax-Exempt versusTaxable
Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118
Summary . . . . . . . . . . . . . . . . . . . . . . . . . 119
Term Structure of Interest Rates . . . . . . . . . 119
Application Effects of the BushTax Cut on
Bond Interest Rates in the United States . . 119
Financial News Yield Curves . . . . . . . . . . . . . . 120
Expectations Theory . . . . . . . . . . . . . . . . . 121
Application ExpectationsTheory . . . . . . . . . . 122
Application ExpectationsTheory and the
Yield Curve . . . . . . . . . . . . . . . . . . . . . . . . . . 124
Segmented Markets Theory . . . . . . . . . . . . 126
Liquidity Premium and Preferred Habitat
Theories . . . . . . . . . . . . . . . . . . . . . . . 127
Application Liquidity PremiumTheory . . . . . . 128
The Predictive Power of the Yield Curve . . 131
Summary. . . . . . . . . . . . . . . . . . . . . . . . . . 131
FYI TheYield Curve as a ForecastingTool
for Inflation and the Business Cycle . . . . . . 132
Application InterpretingYield Curves,
1990 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . 132
Application Using theTerm Structure to
Forecast Interest Rates . . . . . . . . . . . . . . . . . 133
Application Forward Rate . . . . . . . . . . . . . . . . 136
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 136
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . 137
Questions . . . . . . . . . . . . . . . . . . . . . . . . . 137
Quantitative Problems . . . . . . . . . . . . . . . . 138
Web Exercises . . . . . . . . . . . . . . . . . . . . . . 139
Contents ix
x Contents
C H A P T ER 7
The Stock Market, the Theory of
Rational Expectations, and the
Efficient Market Hypothesis . . . . . . . . . . 140
Learning Objectives . . . . . . . . . . . . . . . . . .140
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . 140
Computing the Price of Common Stock . . . . 141
The One-Period Valuation Model . . . . . . . . 141
Application Stock Valuation . . . . . . . . . . . . . . . 142
The Generalized Dividend Valuation
Model. . . . . . . . . . . . . . . . . . . . . . . . . . 142
The Gordon Growth Model . . . . . . . . . . . . 143
Application Stock Valuation, Constant
Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144
Price Earnings Valuation Method . . . . . . . . 144
Application Stock Valuation, PE Ratio
Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145
How the Market Sets Stock Prices . . . . . . . . 145
Application Monetary Policy and Stock
Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146
Application The Subprime Financial
Crisis and the Stock Market . . . . . . . . . . . . . 147
The Theory of Rational Expectations . . . . . . 147
FYI Adaptive Expectations . . . . . . . . . . . . . . . . 148
Formal Statement of the Theory . . . . . . . . . 149
Rationale Behind the Theory . . . . . . . . . . . 149
Implications of the Theory . . . . . . . . . . . . . 150
The Efficient Market Hypothesis: Rational
Expectations in Financial Markets . . . . . . 151
Application The Efficient Market
Hypothesis . . . . . . . . . . . . . . . . . . . . . . . . . . 153
Rationale Behind the Theory . . . . . . . . . . . 153
Stronger Version of the Efficient
Market Hypothesis . . . . . . . . . . . . . . . . 154
Application Practical Guide to Investing
in the Stock Market . . . . . . . . . . . . . . . . . . . 155
Financial News Stock Prices . . . . . . . . . . . . . . 156
FYI ShouldYou Hire an Ape asYour
Investment Adviser? . . . . . . . . . . . . . . . . . . 157
Application What Do the Black Monday
Crash of 1987 and theTech Crash of
2000Tell Us About Rational Expectations
and Efficient Markets? . . . . . . . . . . . . . . . . . 158
Behavioural Finance . . . . . . . . . . . . . . . . . . 159
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 160
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . 161
Questions . . . . . . . . . . . . . . . . . . . . . . . . . 161
Quantitative Problems . . . . . . . . . . . . . . . . 162
Web Exercises . . . . . . . . . . . . . . . . . . . . . . 162
PART III Financial Institutions . . . . . 165
Crisis and Response: Bailout Packages in
the Trillions of Dollars . . . . . . . . . . . . . . 165
C H A P T ER 8
An Economic Analysis of Financial
Structure . . . . . . . . . . . . . . . . . . . . . . . . . . 166
Learning Objectives . . . . . . . . . . . . . . . . . .166
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . 166
Basic Facts About Financial Structure
Throughout the World . . . . . . . . . . . . . . 166
Transaction Costs . . . . . . . . . . . . . . . . . . . . 169
How Transaction Costs Influence
Financial Structure. . . . . . . . . . . . . . . . . 169
How Financial Intermediaries Reduce
Transaction Costs . . . . . . . . . . . . . . . . . 170
Asymmetric Information: Adverse
Selection and Moral Hazard . . . . . . . . . . 171
The Lemons Problem: How Adverse
Selection Influences Financial Structure . . 171
Lemons in the Stock and Bond Markets . . . 172
Tools to Help Solve Adverse Selection
Problems . . . . . . . . . . . . . . . . . . . . . . . 173
FYI The Enron Implosion . . . . . . . . . . . . . . . . . 174
Summary . . . . . . . . . . . . . . . . . . . . . . . . . 177
How Moral Hazard Affects the Choice
Between Debt and Equity Contracts . . . . 177
Moral Hazard in Equity Contracts:
The Principal Agent Problem . . . . . . . . . . . 177
Tools to Help Solve the Principal Agent
Problem . . . . . . . . . . . . . . . . . . . . . . . . 178
How Moral Hazard Influences Financial
Structure in Debt Markets . . . . . . . . . . . . 180
Tools to Help Solve Moral Hazard in
Debt Contracts . . . . . . . . . . . . . . . . . . . 180
Summary. . . . . . . . . . . . . . . . . . . . . . . . . . 182
Application Financial Development and
Economic Growth . . . . . . . . . . . . . . . . . . . . 184
FYI Let the Lawyers Live! . . . . . . . . . . . . . . . . 185
Application Is China a Counter Example
to the Importance of Financial
Development? . . . . . . . . . . . . . . . . . . . . . . . 186
Conflicts of Interest . . . . . . . . . . . . . . . . . . 186
Why Do We Care About Conflicts of
Interest? . . . . . . . . . . . . . . . . . . . . . . . . 187
Why Do Conflicts of Interest Arise?. . . . . . . 187
Credit Assessment and Consulting in
Credit-Rating Agencies . . . . . . . . . . . . . 189
What Has Been Done to Remedy
Conflicts of Interest? . . . . . . . . . . . . . . . 189
FYI Credit-Rating Agencies and the
Subprime Financial Crisis. . . . . . . . . . . . . . . 190
FYI The Demise of Arthur Andersen . . . . . . . . 191
Summary. . . . . . . . . . . . . . . . . . . . . . . . . . 192
FYI Has Sarbanes-Oxley Led to a Decline
in U.S. Capital Markets? . . . . . . . . . . . . . . . 193
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 192
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . 194
Questions . . . . . . . . . . . . . . . . . . . . . . . . . 194
Web Exercises . . . . . . . . . . . . . . . . . . . . . . 195
C H A P T ER 9
Financial Crises and the Subprime
Meltdown . . . . . . . . . . . . . . . . . . . . . . . . . 196
Learning Objectives . . . . . . . . . . . . . . . . . .196
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . 196
Factors Causing Financial Crises . . . . . . . . . 197
Asset Market Effects on Balance Sheets. . . . 197
Deterioration in Financial Institutions
Balance Sheets . . . . . . . . . . . . . . . . . . . 198
Banking Crises. . . . . . . . . . . . . . . . . . . . . . 198
Increases in Uncertainty . . . . . . . . . . . . . . . 198
Increases in Interest Rates . . . . . . . . . . . . . 199
Government Fiscal Imbalances . . . . . . . . . . 199
Dynamics of Past Canadian Financial
Crises . . . . . . . . . . . . . . . . . . . . . . . . . . 199
Stage One: Initiation of Financial Crisis. . . . 200
Stage Two: Banking Crisis . . . . . . . . . . . . . 203
Stage Three: Debt Deflation . . . . . . . . . . . . 203
Application The Mother of All Financial
Crises:The Great Depression in the United
States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203
The Subprime Financial Crisis of
2007 2008 . . . . . . . . . . . . . . . . . . . . . . . 204
Financial Innovations Emerge in the
Mortgage Markets . . . . . . . . . . . . . . . . . 204
Housing Price Bubble Forms . . . . . . . . . . . 205
Agency Problems Arise . . . . . . . . . . . . . . . 205
Information Problems Surface . . . . . . . . . . 206
Housing-Price Bubble Bursts . . . . . . . . . . . 206
Crisis Spreads Globally. . . . . . . . . . . . . . . . 206
Banks Balance Sheets Deteriorate . . . . . . . 207
FYI Canada s Asset-Backed Commercial
Paper Saga . . . . . . . . . . . . . . . . . . . . . . . . . . 208
High-Profile Firms Fail . . . . . . . . . . . . . . . . 209
Bailout Package Debated . . . . . . . . . . . . . . 210
Recovery in Sight? . . . . . . . . . . . . . . . . . . . 210
Subprime Mortgages in Canada . . . . . . . . . 210
Global The U.S.Treasury Asset Relief Plan
and Government BailoutsThroughout
the World . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211
Why Canada s Banking System Is the
Envy of the World . . . . . . . . . . . . . . . . . 212
Dynamics of Financial Crises in EmergingMarket Economies . . . . . . . . . . . . . . . . . 212
Stage One: Initiation of Financial Crisis. . . . 213
Stage Two: Currency Crisis. . . . . . . . . . . . . 216
Stage Three: Full-Fledged Financial Crisis . . 216
Application Financial Crises in Mexico,
1994 1995; East Asia, 1997 1998; and
Argentina, 2001 2002 . . . . . . . . . . . . . . . . . 217
Global The Perversion of the Financial
Liberalization and Globalization Process:
Chaebols and the South Korean Crisis . . . . 219
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 222
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . 223
Questions . . . . . . . . . . . . . . . . . . . . . . . . . 223
Web Exercises . . . . . . . . . . . . . . . . . . . . . . 224
C H A P T ER 10
Economic Analysis of Financial
Regulation . . . . . . . . . . . . . . . . . . . . . . . . 225
Learning Objectives . . . . . . . . . . . . . . . . . .225
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . 225
Asymmetric Information and Financial
Regulation . . . . . . . . . . . . . . . . . . . . . . . 225
Government Safety Net . . . . . . . . . . . . . . . 226
Global The Spread of Government Deposit
InsuranceThroughout the World: Is It a
GoodThing? . . . . . . . . . . . . . . . . . . . . . . . . . 227
Restrictions on Asset Holdings . . . . . . . . . . 229
Capital Requirements . . . . . . . . . . . . . . . . . 230
Prompt Corrective Action . . . . . . . . . . . . . . 231
Financial Supervision: Chartering and
Examination . . . . . . . . . . . . . . . . . . . . . 231
Global Basel 2: How Well Will It Work? . . . . . . 232
Assessment of Risk Management . . . . . . . . 233
Disclosure Requirements . . . . . . . . . . . . . . 234
Consumer Protection . . . . . . . . . . . . . . . . . 235
Restrictions on Competition . . . . . . . . . . . . 235
Summary. . . . . . . . . . . . . . . . . . . . . . . . . . 235
FYI Mark-to-Market Accounting and
Financial Stability . . . . . . . . . . . . . . . . . . . . . 236
FYI The Subprime Mortgage Crisis and
Consumer Protection Regulation . . . . . . . . 237
Contents xi
xii Contents
The 1980s Canadian Banking Crisis . . . . . . . 237
Early Stage of the Crisis . . . . . . . . . . . . . . . 239
Global International Financial Regulation . . . 240
Later Stage of the Crisis: Regulatory
Forbearance . . . . . . . . . . . . . . . . . . . . . 241
CDIC Developments . . . . . . . . . . . . . . . . . . 242
Differential Premiums . . . . . . . . . . . . . . . . 242
Opting-Out . . . . . . . . . . . . . . . . . . . . . . . . 243
Application Evaluating CDIC and Other
Proposed Reforms of the Banking
Regulatory System . . . . . . . . . . . . . . . . . . . . 244
Banking Crises Throughout the World . . . . . 246
D j Vu All Over Again . . . . . . . . . . . . . . 246
Whither Financial Regulation After the
Subprime Financial Crisis? . . . . . . . . . . . . 248
Increased Regulation of Mortgage
Brokers. . . . . . . . . . . . . . . . . . . . . . . . . 249
Fewer Subprime Mortgage Products . . . . . . 249
Regulation Compensation . . . . . . . . . . . . . 249
Higher Capital Requirements . . . . . . . . . . . 249
Additional Regulation of Privately
Owned Government-Sponsored
Enterprises . . . . . . . . . . . . . . . . . . . . . . 249
Heightened Regulation to Limit Financial
Institutions Risk Taking. . . . . . . . . . . . . 250
Increased Regulation of Credit-Rating
Agencies. . . . . . . . . . . . . . . . . . . . . . . . 250
Additional Regulation of Derivatives . . . . . . 250
The Danger of Overregulation . . . . . . . . . . 250
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 250
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . 251
Questions . . . . . . . . . . . . . . . . . . . . . . . . . 251
Web Exercises . . . . . . . . . . . . . . . . . . . . . . 251
C H A P T ER 11
Banking Industry: Structure and
Competition . . . . . . . . . . . . . . . . . . . . . . . 252
Learning Objectives . . . . . . . . . . . . . . . . . .252
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . 252
Historical Development of the
Canadian Banking System . . . . . . . . . . . 253
The Free Banking Experiment . . . . . . . . . . 254
FYI The Dual Banking System in the
United States . . . . . . . . . . . . . . . . . . . . . . . . 254
The Provincial Notes Act, 1866 . . . . . . . . . . 255
The Dominion Notes Act, 1870. . . . . . . . . . 255
The First Bank Act, 1871 . . . . . . . . . . . . . . 256
The Bank Act, 1881-1913 . . . . . . . . . . . . . . 256
The Finance Act, 1914 . . . . . . . . . . . . . . . . 257
Financial Innovation and the Growth of
the Shadow Banking System . . . . . . . . 258
Responses to Changes in Demand
Conditions: Interest Rate Volatility . . . . . 258
Responses to Changes in Supply
Conditions: Information Technology . . . 259
Global Will Clicks Dominate Bricks
in the Banking Industry? . . . . . . . . . . . . . . . 262
Avoidance of Existing Regulations . . . . . . . 263
FYI Bruce Bent and the Money Market
Mutual Fund Panic of 2008 . . . . . . . . . . . . . 265
Financial Innovation and the Decline
of Traditional Banking. . . . . . . . . . . . . . 266
Structure of the Canadian Chartered
Banking Industry . . . . . . . . . . . . . . . . . . 268
Schedule I, Schedule II, and Schedule III
Banks . . . . . . . . . . . . . . . . . . . . . . . . . . 268
Competition and Technology . . . . . . . . . . 269
Comparison with the United States . . . . . . . 270
Response to Branching Restrictions in
the United States . . . . . . . . . . . . . . . . . . 271
Competition Across all Four Pillars . . . . . . . 272
Convergence . . . . . . . . . . . . . . . . . . . . . . 272
Implications for Financial Consolidation . . . 273
FYI The Subprime Financial Crisis and the
Demise of Large, Free-Standing
Investment Banks . . . . . . . . . . . . . . . . . . . . . 274
Separation of Banking and Other
Financial Services Industries
Throughout the World. . . . . . . . . . . . . . 274
The Near Banks: Regulation and Structure . . 275
Trust Companies . . . . . . . . . . . . . . . . . . . . 275
Mortgage Loan Companies . . . . . . . . . . . . . 275
Cooperative Banks: Credit Unions and
Caisses Populaires. . . . . . . . . . . . . . . . . 276
Government Savings Institutions. . . . . . . . . 277
International Banking . . . . . . . . . . . . . . . . . 277
Eurocurrencies Market . . . . . . . . . . . . . . . 278
Global Ironic Birth of the Eurodollar
Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 278
Canadian Banking Overseas. . . . . . . . . . . . 279
Foreign Banks in Canada . . . . . . . . . . . . . . 280
The 2001 Bank Act Reform . . . . . . . . . . . . . 282
Bank Holding Companies . . . . . . . . . . . . . 282
Permitted Investments . . . . . . . . . . . . . . . . 283
Ownership Rules . . . . . . . . . . . . . . . . . . . . 283
The CP Act and Access to the Payments
and Clearance System . . . . . . . . . . . . . 284
Merger Review Policy . . . . . . . . . . . . . . . . 284
The National Financial Services
OmbudService . . . . . . . . . . . . . . . . . . . 285
Implications for the Canadian Banking
Industry . . . . . . . . . . . . . . . . . . . . . . . . 285
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 285
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . 286
Questions . . . . . . . . . . . . . . . . . . . . . . . . . 286
Web Exercises . . . . . . . . . . . . . . . . . . . . . . 287
C H A P T ER 1 2
Nonbank Financial Institutions . . . . . . . . 288
Learning Objectives . . . . . . . . . . . . . . . . . .288
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . 288
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . 288
Life Insurance . . . . . . . . . . . . . . . . . . . . . . 289
Property and Casualty Insurance . . . . . . . . 290
Credit Insurance . . . . . . . . . . . . . . . . . . . . 291
FYI The AIG Blowup . . . . . . . . . . . . . . . . . . . . . 292
The New Legislative Framework. . . . . . . . . 292
Application Insurance Management . . . . . . . 293
Pension Funds . . . . . . . . . . . . . . . . . . . . . . 296
Registered Pension Plans (RPPs) . . . . . . . . 297
Social Security and Public Pension Plans. . . 297
FYI Should Public Pension Plans Be
Privatized? . . . . . . . . . . . . . . . . . . . . . . . . . . . 298
Personal Pension Plans . . . . . . . . . . . . . . . 299
Finance Companies . . . . . . . . . . . . . . . . . . 299
Securities Market Operations . . . . . . . . . . . . 300
Investment Banking . . . . . . . . . . . . . . . . . . 300
Securities Brokers and Dealers . . . . . . . . . . 301
Organized Exchanges . . . . . . . . . . . . . . . . 301
Mutual Funds . . . . . . . . . . . . . . . . . . . . . . . 302
FYI Sovereign Wealth Funds: AreThey a
Danger? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 304
Money Market Mutual Funds . . . . . . . . . . . 305
Hedge Funds. . . . . . . . . . . . . . . . . . . . . . . 305
FYI The Long-Term Capital Management
Debacle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 306
Private Equity and Venture Capital Funds . . . 307
Government Financial Intermediation . . . . . 307
Crown Finance Companies. . . . . . . . . . . . . 308
Government-Sponsored Enterprises in
the United States . . . . . . . . . . . . . . . . . . 308
FYI The Subprime Financial Crisis and the
Bailout of Fannie Mae and Freddie Mac . . . 309
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 310
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . 311
Questions . . . . . . . . . . . . . . . . . . . . . . . . . 311
Web Exercises . . . . . . . . . . . . . . . . . . . . . . 312
PART IV The Management of Financial
Institutions . . . . . . . . . . . . . . . . 313
Crisis and Response: Canadian Banks
Are the World s Best . . . . . . . . . . . . . . . . 313
C H A P T ER 1 3
Banking and the Management of
Financial Institutions . . . . . . . . . . . . . . . . 314
Learning Objectives . . . . . . . . . . . . . . . . . .314
Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . 314
The Bank Balance Sheet . . . . . . . . . . . . . . . 314
Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . 315
Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . 317
Basic Banking . . . . . . . . . . . . . . . . . . . . . . 318
General Principles of Bank Management . . . 321
Liquidity Management and the Role of
Reserves . . . . . . . . . . . . . . . . . . . . . . . . 322
Asset Management. . . . . . . . . . . . . . . . . . . 325
Liability Management . . . . . . . . . . . . . . . . . 325
Capital Adequacy Management. . . . . . . . . . 326
Application Strategies for Managing
Bank Capital . . . . . . . . . . . . . . . . . . . . . . . . . 329
Application How a Capital Crunch Caused a
Credit Crunch in 2008 . . . . . . . . . . . . . . . . . 329
Managing Credit Risk . . . . . . . . . . . . . . . . . 330
Screening and Monitoring . . . . . . . . . . . . . 330
Long-Term Customer Relationships. . . . . . . 332
Loan Commitments . . . . . . . . . . . . . . . . . . 332
Collateral and Compensating Balances . . . . 333
Credit Rationing. . . . . . . . . . . . . . . . . . . . . 333
Managing Interest-Rate Risk . . . . . . . . . . . . 334
Gap Analysis . . . . . . . . . . . . . . . . . . . . . . . 334
Application Gap Analysis . . . . . . . . . . . . . . . . 335
Duration Analysis . . . . . . . . . . . . . . . . . . . 336
Application Duration Analysis . . . . . . . . . . . . 337
Application Duration Gap Analysis . . . . . . . . 338
Application Strategies for Managing
Interest-Rate Risk . . . . . . . . . . . . . . . . . . . . . 339
Off-Balance-Sheet Activities . . . . . . . . . . . . 340
Loan Sales . . . . . . . . . . . . . . . . . . . . . . . . . 340
Generation of Fee Income . . . . . . . . . . . . . 340
Trading Activities and Risk-Management
Techniques . . . . . . . . . . . . . . . . . . . . . . 341
Global Barings, Daiwa, Sumitomo, and
Soci t G n rale: RogueTraders and the
Principal Agent Problem . . . . . . . . . . . . . . 342
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 343
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . 343
Contents xiii
xiv Contents
Questions . . . . . . . . . . . . . . . . . . . . . . . . . 344
Quantitative Problems . . . . . . . . . . . . . . . . 344
Web Exercises . . . . . . . . . . . . . . . . . . . . . . 345
C H A P T ER 1 4
Risk Management with Financial
Derivatives . . . . . . . . . . . . . . . . . . . . . . . . 346
Learning Objectives . . . . . . . . . . . . . . . . . .346
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . 346
Hedging . . . . . . . . . . . . . . . . . . . . . . . . . . . 346
Forward Contracts and Markets . . . . . . . . . . 347
Interest-Rate Forward Contracts . . . . . . . . . 347
Application Hedging with Interest-Rate
Forward Contracts . . . . . . . . . . . . . . . . . . . . 347
Pros and Cons of Forward Contracts. . . . . . 348
Financial Futures Contracts and Markets . . . 349
Interest-Rate Futures Contracts . . . . . . . . . . 349
FYI The Montreal Exchange and the
Canadian Derivatives Clearing
Corporation (CDCC) . . . . . . . . . . . . . . . . . . . 349
Financial News Interest-Rate Futures . . . . . . . 350
Application Hedging with Interest-Rate
Futures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 352
Organization of Trading in Financial
Futures Markets. . . . . . . . . . . . . . . . . . . 353
The Globalization of Financial Futures
Markets. . . . . . . . . . . . . . . . . . . . . . . . . 353
Explaining the Success of Futures
Markets. . . . . . . . . . . . . . . . . . . . . . . . . 355
FYI The Hunt Brothers and the Silver
Crash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 356
Application Hedging Foreign Exchange
Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 357
Stock Index Futures . . . . . . . . . . . . . . . . . . 358
FYI ProgramTrading and Portfolio
Insurance: WereThey to Blame for the
Stock Market Crash of 1987? . . . . . . . . . . . . 359
Stock Index Futures Contracts . . . . . . . . . . 359
Financial News Stock Index Futures . . . . . . . . 360
Application Hedging with Stock Index
Futures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 361
Options . . . . . . . . . . . . . . . . . . . . . . . . . . . 361
Stock Options . . . . . . . . . . . . . . . . . . . . . . 362
Futures Options. . . . . . . . . . . . . . . . . . . . . 365
Application Hedging with Futures
Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 368
Factors Affecting the Prices of Option
Premiums . . . . . . . . . . . . . . . . . . . . . . . 369
Summary. . . . . . . . . . . . . . . . . . . . . . . . . . 370
SWAPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . 370
Interest-Rate Swap Contracts . . . . . . . . . . . 371
Application Hedging with Interest-Rate
Swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 371
Advantages of Interest-Rate Swaps . . . . . . . 372
Disadvantages of Interest-Rate Swaps . . . . . 373
Financial Intermediaries in Interest-Rate
Swaps . . . . . . . . . . . . . . . . . . . . . . . . . 373
Credit Derivatives . . . . . . . . . . . . . . . . . . . . 374
Credit Options. . . . . . . . . . . . . . . . . . . . . . 374
Credit Swaps . . . . . . . . . . . . . . . . . . . . . . . 374
Credit-Linked Notes . . . . . . . . . . . . . . . . . . 375
Application Lessons from the Subprime
Financial Crisis: When Are Financial
Derivatives Likely to Be a Worldwide
Time Bomb? . . . . . . . . . . . . . . . . . . . . . . . . . 375
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 377
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . 377
Questions . . . . . . . . . . . . . . . . . . . . . . . . . 378
Quantitative Problems . . . . . . . . . . . . . . . . 378
Web Exercises . . . . . . . . . . . . . . . . . . . . . . 379
PART V Central Banking and the
Conduct of Monetary Policy. . . . . . . . 380
Crisis and Response: The Bank of Canada s
Monetary Policy and Liquidity Provision
During the Financial Crisis . . . . . . . . . . . 380
C H A P T ER 1 5
Central Banks and the Bank of
Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . 381
Learning Objectives . . . . . . . . . . . . . . . . . .381
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . 381
Origins of the Bank of Canada . . . . . . . . . . 381
Global Establishment of Selected Central
Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 382
Formal Structure of the Bank of Canada . . . 383
The Functions of the Bank of Canada . . . . . 383
Inside the Central Bank The Political
Environment and the Bank of Canada . . . . 383
Bank Note Issue . . . . . . . . . . . . . . . . . . . . 384
Government Debt and Asset Management
Services . . . . . . . . . . . . . . . . . . . . . . . . 384
Central Banking Services . . . . . . . . . . . . . . 384
Monetary Policy. . . . . . . . . . . . . . . . . . . . . 385
Inside the Central Bank Role of the Bank s
Research Staff . . . . . . . . . . . . . . . . . . . . . . . . 386
How Independent Is the Bank of Canada? . . 386
The Changing Face of the Bank of
Canada . . . . . . . . . . . . . . . . . . . . . . . . . 389
From Opaqueness to Accountability
and Transparency . . . . . . . . . . . . . . . . . 390
Structure and Independence of Foreign
Central Banks . . . . . . . . . . . . . . . . . . . . 391
Federal Reserve System . . . . . . . . . . . . . . . 391
Inside the Central Bank The Special Role of
the Federal Reserve Bank of NewYork . . . . 394
European Central Bank . . . . . . . . . . . . . . . 394
Bank of England . . . . . . . . . . . . . . . . . . . . 397
Bank of Japan . . . . . . . . . . . . . . . . . . . . . . 397
The Trend Toward Greater Independence . 398
Explaining Central Bank Behaviour . . . . . . . 398
Should the Bank of Canada Be
Independent? . . . . . . . . . . . . . . . . . . . . . 399
The Case for Independence . . . . . . . . . . . . 399
FYI Economics and Politics . . . . . . . . . . . . . . . 400
The Case Against Independence. . . . . . . . . 400
Global Central Bank Independence and
Macroeconomic Performance. . . . . . . . . 401
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 401
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . 402
Questions . . . . . . . . . . . . . . . . . . . . . . . . . 402
Web Exercises . . . . . . . . . . . . . . . . . . . . . . 403
C H A P T ER 1 6
The Money Supply Process . . . . . . . . . . . 404
Learning Objectives . . . . . . . . . . . . . . . . . .404
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . 404
Three Players in the Money Supply Process . 404
The Bank of Canada s Balance Sheet . . . . . . 405
Liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . 405
Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . 406
Global The Worldwide Decline in Reserve
Requirements . . . . . . . . . . . . . . . . . . . . . . . . 407
Control of the Monetary Base . . . . . . . . . . . 408
Bank of Canada Open Market
Operations . . . . . . . . . . . . . . . . . . . . . . 408
Shifts from Deposits into Currency . . . . . . . 411
Bank of Canada Advances . . . . . . . . . . . . . 412
Other Factors That Affect the Monetary
Base . . . . . . . . . . . . . . . . . . . . . . . . . . . 413
Overview of the Bank s Ability to
Control the Monetary Base . . . . . . . . . . 413
Multiple Deposit Creation: A Simple
Model. . . . . . . . . . . . . . . . . . . . . . . . . . . 414
Deposit Creation: The Single Bank . . . . . . . 414
Deposit Creation: The Banking System . . . . 415
Deriving the Formula for Multiple
Deposit Creation . . . . . . . . . . . . . . . . . . 418
Critique of the Simple Model . . . . . . . . . . . 419
Factors That Determine the Money
Supply . . . . . . . . . . . . . . . . . . . . . . . . . . 420
Changes in the Non-borrowed
Monetary Base, MBn
. . . . . . . . . . . . . . . 420
Changes in Borrowed Reserves (BR )
from the Bank of Canada . . . . . . . . . . . 420
Changes in the Desired Reserve Ratio, r . . . 420
Changes in Currency Holdings . . . . . . . . . . 421
Overview if the Money Supply Process . . . . 421
The Money Multiplier . . . . . . . . . . . . . . . . . 422
Deriving the Money Multiplier . . . . . . . . . . 422
Intuition Behind the Money Multiplier . . . . 423
Money Supply Response to Changes in
the Factors . . . . . . . . . . . . . . . . . . . . . . 424
Application The Great Depression Bank
Panics, 1930 1933 . . . . . . . . . . . . . . . . . . . . . 425
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 428
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . 428
Questions . . . . . . . . . . . . . . . . . . . . . . . . . 428
Quantitative Problems . . . . . . . . . . . . . . . . 429
Web Exercises . . . . . . . . . . . . . . . . . . . . . . 430
C H A P T ER 17
Tools of Monetary Policy . . . . . . . . . . . . . 431
Learning Objectives . . . . . . . . . . . . . . . . . .431
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . 431
The Framework for the Implementation
of Monetary Policy . . . . . . . . . . . . . . . . . 432
The Large Value Transfer System (LVTS) . . . 432
Non-LVTS (ACSS) Transactions . . . . . . . . . . 433
The Bank of Canada s Policy Rate . . . . . . . 433
The Operating Band for the Overnight
Interest Rate . . . . . . . . . . . . . . . . . . . . . 434
FYI Monetary Policy Implementation in
the LVTS Environment . . . . . . . . . . . . . . . . . 435
The Bank of Canada s Standing Facilities . . 436
FYI The Worldwide Decline in Reserve
Requirements and the Channel/Corridor
System for Setting Interest Rates . . . . . . . . 436
The Bank of Canada s Implementation of
the Operating Band for the Overnight
Interest Rate . . . . . . . . . . . . . . . . . . . . . 437
The Market for Settlement Balances and the
Channel/Corridor System for Setting the
Overnight Interest Rate . . . . . . . . . . . . . . 437
Demand Curve . . . . . . . . . . . . . . . . . . . . . 437
Contents xv