WHY STUDY MONEY, BANKING AND FINANCIAL MARKETS

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WHY STUDY MONEY, BANKING AND FINANCIAL MARKETS

You wake up in the morning and find out on the news that the central bank has increased its funds rate by 0.5 percent. How would that change your life? How would it affect the price of a home you are considering buying next year? Would it make it easier or harder for you to find a job?

In this video series, the role of financial markets (such as bonds, stocks, and exchange rates) and financial institutions such as banks on the functioning of the economy will be examined and answers will be sought to questions about what money is and how it is created.

Why Study Financial Markets?

Financial markets are markets that bring together people who have surplus funds and people who need funds. Well-functioning financial markets are extremely important for the healthy growth of the economy. The inability of financial markets to work well in a country is one of the reasons why that country remains poor.

The Bond Markets and Interest Rates

A security is an exchangeable, transferable piece of paper of value that the issuer undertakes to pay. A bond is a debt security that undertakes to make payments at regular intervals within a specified period. The bond market is particularly important for economic activities. In addition, interest rates are determined in this market. The interest rate is the cost of borrowing or the opportunity cost of money. There are many interest rates in the economy. These interest rates can fluctuate greatly over the years.

Although interest rates differ, economists often call one interest rate because they often move together. Interest rates play a very important role in the economic decisions of individuals. The biggest reason for this is that it is one of the biggest factors that cause the decision between saving or spending. Interest rates may discourage you from buying a new car.

Stock Market

The most followed and most speculated market in the world is the stock market. For this reason, people often refer to the stock market as just the market. In fact, stock is simply a security that shows you have rights over the company’s earnings and assets. Firms often use the way of supplying stocks for their investments or other needs.

The stock market is an extremely volatile one. You can see this volatility in the “DJIA: Dow Jones Industrial Average” market opposite.

The Foreign Exchange Market

In order for funds to move from one country to another, they must be converted from the national currency of the country of origin to the national currency of the country of destination. The foreign exchange market is where this transformation takes place and is therefore a useful market for funds to move between countries. In addition, the foreign exchange market is also important in that it is the place where the value of a country’s currency in terms of the currency of other countries, that is, the exchange rate, is determined.

Here is a graph of a basket index showing the value of the US dollar in terms of some major currencies.

The exchange rate directly affects the purchasing behavior of the citizens of the country, especially the tendency to prefer imported or domestic goods. Because an increase in exchange rates may increase a US citizen’s tendency to prefer a US-made wine over French wine, while a French person’s tendency to prefer a US-made car.

Why Study Banking and Financial Institutions?

Banks and other financial institutions are the institutions that make the financial markets work. Without them, economic savers would not be able to divert their funds to productive business opportunities and make money from that transfer. For this reason, financial institutions have vital importance in the economy.

Banks and Other Financial Institutions

Banks are financial institutions that accept deposits and make loans. Banks deserve scrutiny as they are the financial institutions with which the average person interacts most frequently. But banks are not the only financial institutions that matter. Today, financial institutions such as insurance companies, finance companies, pension and mutual funds are developing rapidly.

Why Study Money and Monetary Policy

Money is defined as anything that is used to purchase goods and services or to pay debts. Money is associated with changes in economic variables that affect us all and is important to the health of the economy.

Money and Business Cycles

Recession, that is, the situations in which the total production in the economy decreases, is a situation that is seen in every economy from time to time. Generally, in these periods, the total production, that is, the gross domestic product, decreases and the unemployment rate rises. So why do economies go into recession?

The findings show that the cyclical fluctuations of money, that is, the upward and downward movement of total production in the economy, play an important role. The cyclical waves affect all of us instantly and directly. A downward cyclical wave may cause us to lose our job, while an upward cyclical wave may cause a raise in our salary.

The figure opposite shows the changes in the monetary growth rate in the 1950–2005 period. The shaded areas in the figure show recession periods. We see that there is a decrease in the monetary growth rate before each recession. However, this does not mean that there will be a recession every time monetary growth declines.

Money and Inflation

You have often heard from your family elders complaining that money has lost a lot of value. Indeed, with a few exceptions, the general level of prices in all countries is much higher than it was 30 years ago. So much so that in a country like Turkey where high inflation rates are chronically experienced, prices have increased more than 10 times in 20 years.

The aggragate price of goods and services in a country is called the general price level or price level. Inflation, defined as a continuous increase in the price level, affects individuals, firms and governments and is therefore seen as one of the most important problems to be solved in policy making. However, in order to solve the inflation problem, the causes of inflation must be understood.

There is a close relationship between the price level and the money supply. This relationship can be seen in the image in figure 5.

As seen in the figure, the price level and the money supply generally increase together. This data reveals that a continuous increase in money supply is one of the factors causing inflation.

Another indicator, Figure 6, allows us to compare the monetary growth rates of some countries with the inflation rates.

As can be seen, countries with high monetary growth rates also have high inflation rates. These findings led Nobel Prize-winning economist Milton Friedman to postulate that “Inflation is always and everywhere a monetary phenomenon”.

Money and Interest Rates

Among other factors, money plays a very important role in interest rate fluctuations, which are of great importance for companies and consumers. Figure 7 plays an important role in understanding that money and the interest rate fluctuate together.

Conduct of Monetary Policy

Since money affects many economic variables that are important to the health of the economy, politicians and policy makers all over the world attach importance to the conduct of monetary policy and the management of money and interest rates. The institution responsible for the monetary policy of a state is the central bank.

Fiscal Policy and Monetary Policy

It includes decisions on fiscal policy, public spending and taxation. Budget deficit is the portion of public expenditures exceeding tax revenues, usually in a one-year period, while budget surplus occurs when tax revenues exceed public expenditures. In the chart in front of you, there is a chart showing the state of the US budget compared to its GDP from 1930 to the present.

References:

Frederic S. Mishkin, Economics of Money Banking and Financial Markets 8th edition

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