ECON E 305 CHAPTER 1

An Introduction to Money and the Financial System

6 Parts of the Financial System

Money

Financial Instruments

Financial Markets

Financial Institutions

Regulatory Agencies

Central Banks

Money

To facilitate exchange and store wealth

• has changed from gold/silver coins to paper currency to electronic funds

• cash can be obtained from an ATM anywhere in the world

• bills are paid and transactions are checked online

Finanical Instruments

transfer resources from savers to investors and to transfer risk to those best equipped to bear it

buying/selling indiv stocks used to be only for the wealthy

(today) we have mutual funds and other stocks available through banks or online

putting together a portfolio is open to everyone

Financial Markets

Allow the buying and selling of financial instruments easily

went from being in coffee houses and tavern to well organized markets like NYSE

now transactions are mostly handled by electronic markets

• has reduced the cost of processing financial transactions making the way for a much broader away of financial instruments available

Financial Institutions

provide access to financial markets, collect information, and provide services

Provide all the services of the financial system like providing access to finanical markets and gathering information

Banks began as vaults, developed into institutions that accepted deposits and gave loans, and evolved today’s financial supermarket

Regulatory Agencies (GOV)

provide oversight for financial system
Make sure the elements of the financial system operate safely and reliably.

Government regulatory agencies were introduced by federal government after the Great Depression.

They provide wide-ranging financial regulation, rules, and supervision; and examine the systems a bank uses to manage its risk.

The 2007-2009 financial crises has led governments to greater regulation, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act

Central Banks

Monitor and stabilize the financial system (and economy)

began as large private banks to finance wars

ctrl the availability of money and credit to promote low inflation, high growth and stability of financial system
today’s policymakers strive for transparency in their operations

finanical crisis of 07-09 have led the US _______ ______ to try many new tools

5 Core principles of Money and Banking

1. Time

2. Risk

3. Information

4. Markets

5. Stability

Time

HAS VALUE

• affects the value of financial instruments

• interest is paid to compensate the lenders for the time the borrowers have their money

• chapter 4 develops an understanding of interest rates and how to use them

Risk

REQUIRES COMPENSATION

• in a world on uncertainty, indivs will accept risk only if they are compensated

• in the financial world, compensation comes in the form of explicit payments:

• higher the risk, bigger the payment

Markets

DETERMINE PRICES AND ALLOCATE RESOURCES

• core of the economic system

• markets channel resources and minimize the cost of gathering information and making transactions

• in general, the better developed the financial markets, the faster the country will grow

Stability

IMPROVES WELFARE

• stable economy reduces risk and improves everyone’s welfare

• fin instability in the autumn of 08 triggered the worse global downturn since the Great Depression

• a stable economy grows faster than an unstable one

• one the main roles of central banks