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THE ECONOMICS OFMONEY, BANKING, ANDFINANCIAL MARKETSBusiness School EditionA01 MISH4200 05 BSE FM.indd 127/10/17 6:03 PM

The Pearson Series in eneEconometric artRussian and Soviet Economic Performanceand StructureBade/ParkinFoundations of Economics*Berck/HelfandThe Economics of the EnvironmentBierman/FernandezGame Theory with Economic ApplicationsBlair/RushThe Economics of Managerial Decisions*BlanchardMacroeconomics*BoyerPrinciples of Transportation EconomicsBransonMacroeconomic Theory and PolicyBrucePublic Finance and the American EconomyCarlton/PerloffModern Industrial OrganizationCase/Fair/OsterPrinciples of Economics*ChapmanEnvironmental Economics: Theory,Application, and PolicyDaniels/VanHooseInternational Monetary & FinancialEconomicsDownsAn Economic Theory of DemocracyHartwick/OlewilerThe Economics of Natural Resource UseHeilbroner/MilbergThe Making of the Economic SocietyHeyne/Boettke/PrychitkoThe Economic Way of ThinkingHubbard/O’BrienEconomics*InEconMoney, Banking, and the Financial ghes/CainAmerican Economic HistoryHusted/MelvinInternational EconomicsJehle/RenyAdvanced Microeconomic TheoryKeat/Young/ErfleManagerial EconomicsKleinMathematical Methods for EconomicsKrugman/Obstfeld/MelitzInternational Economics: Theory & Policy*LaidlerThe Demand for MoneyThe Economics of Money, Banking, andFinancial Markets, Business School Edition*Macroeconomics: Policy and Practice*MurrayEconometrics: A Modern IntroductionO’Sullivan/Sheffrin/PerezEconomics: Principles, Applications roeconomics: Theory and Applicationswith Calculus*Perloff/BranderManagerial Economics and hackelford/Stamos/SchneiderEconomics: A Tool for Critically Understanding SocietyRobertsThe Choice: A Fable of Free Trade andProtectionSchererIndustry Structure, Strategy, and PublicPolicySchillerThe Economics of Poverty and DiscriminationShermanMarket RegulationStock/WatsonIntroduction to EconometricsFarnhamEconomics for ManagersLynnEconomic Development: Theory and Practicefor a Divided WorldFroyenMacroeconomics: Theories and PoliciesMillerEconomics Today*Todaro/SmithEconomic DevelopmentFusfeldThe Age of the EconomistMiller/BenjaminThe Economics of Macro IssuesGerberInternational Economics*Miller/Benjamin/NorthThe Economics of Public /O’NeillEconversations: Today’s Students DiscussToday’s IssuesGordonMacroeconomics*MishkinThe Economics of Money, Banking, andFinancial Markets*StudenmundUsing Econometrics: A Practical GuideWilliamsonMacroeconomics*denotes MyLab Economics titles. Visit www.pearson.com/mylab/economics to learn more.A01 MISH4200 05 BSE FM.indd 227/10/17 6:03 PM

THE ECONOMICS OFMONEY, BANKING, ANDFINANCIAL MARKETSBusiness School EditionFifth EditionFrederic S. MishkinColumbia UniversityNew York, NYA01 MISH4200 05 BSE FM.indd 331/10/17 11:13 AM

Vice President, Business, Economics, and UK Courseware:Donna BattistaDirector of Portfolio Management: Adrienne D’AmbrosioSenior Portfolio Manager: Christina MasturzoEditorial Assistant: Courtney PaganelliVice President, Product Marketing: Roxanne McCarleySenior Product Marketer: Tricia MurphyProduct Marketing Assistant: Marianela SilvestriManager of Field Marketing, Business Publishing:Adam GoldsteinExecutive Field Marketing Manager: Senior Field MarketingManager: Carlie MarvelVice President, Production and Digital Studio, Arts andBusiness: Etain O’DeaDirector of Production, Business: Jeff HolcombManaging Producer, Business: Alison KalilContent Producer: Carolyn PhilipsOperations Specialist: Carol MelvilleDesign Lead: Kathryn FootManager, Learning Tools: Brian SuretteContent Developer, Learning Tools: Sarah PetersonManaging Producer, Digital Studio and GLP, Media Productionand Development: Ashley SantoraManaging Producer, Digital Studio: Diane LombardoDigital Studio Producer: Melissa HonigDigital Studio Producer: Alana ColesDigital Content Team Lead: Noel LotzDigital Content Project Lead: Noel LotzProject Manager: Kathy Smith, Cenveo Publisher ServicesInterior Design: Cenveo Publisher ServicesCover Design: Cenveo Publisher ServicesCover Art: Isak55/Shutterstock; Hamik/Shutterstock; Photo.ua/Shutterstock; Sergey Dobrydnev/Shutterstock; Zodebala/E /Getty imagesPrinter/Binder: LSC Communications, Inc./KendallvilleCover Printer: Phoenix Color/HagerstownCopyright 2019, 2016, 2013 by Frederic S. Mishkin. All Rights Reserved. Manufactured in the United States of America. Thispublication is protected by copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise. For information regarding permissions, request forms, and the appropriate contacts within the PearsonEducation Global Rights and Permissions department, please visit www.pearsoned.com/permissions/.Acknowledgments of third-party content appear on the appropriate page within the text.PEARSON, ALWAYS LEARNING, and MYLAB are exclusive trademarks owned by Pearson Education, Inc. or its affiliates in theU.S. and/or other countries.Unless otherwise indicated herein, any third-party trademarks, logos, or icons that may appear in this work are the property oftheir respective owners, and any references to third-party trademarks, logos, icons, or other trade dress are for demonstrative ordescriptive purposes only. Such references are not intended to imply any sponsorship, endorsement, authorization, or promotionof Pearson’s products by the owners of such marks, or any relationship between the owner and Pearson Education, Inc., or itsaffiliates, authors, licensees, or distributors.Cataloging-in-Publication Data is available on file at the Library of Congress117ISBN 10: 0-13-473420-3ISBN 13: 978-0-13-473420-0A01 MISH4200 05 BSE FM.indd 427/10/17 6:03 PM

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About the AuthorFrederic S. Mishkin is the Alfred Lerner Professor of Banking and FinancialInstitutions at the Graduate School of Business, Columbia University. Heis also a Research Associate at the National Bureau of Economic Research,co-director of the U.S. Monetary Policy Forum, a member of the SquamLake Working Group on Financial Reform, and past president of the EasternEconomics Association. Since receiving his Ph.D. from the MassachusettsInstitute of Technology in 1976, he has taught at the University of Chicago,Northwestern University, Princeton University, and Columbia. He has alsoreceived an honorary professorship from the People’s (Renmin) University ofChina. From 1994 to 1997, he was Executive Vice President and Director ofResearch at the Federal Reserve Bank of New York and an associate economistof the Federal Open Market Committee of the Federal Reserve System. FromSeptember 2006 to August 2008, he was a member (governor) of the Boardof Governors of the Federal Reserve System.Professor Mishkin’s research focuses on monetary policy and its impact onfinancial markets and the aggregate economy. He is the author of more thantwenty books, including Macroeconomics: Policy and Practice, Second Edition(Pearson, 2015); Financial Markets and Institutions, Ninth Edition (Pearson, 2018); MonetaryPolicy Strategy (MIT Press, 2007); The Next Great Globalization: How Disadvantaged NationsCan Harness Their Financial Systems to Get Rich (Princeton University Press, 2006); InflationTargeting: Lessons from the International Experience (Princeton University Press, 1999); Money,Interest Rates, and Inflation (Edward Elgar, 1993); and A Rational Expectations Approach toMacroeconometrics: Testing Policy Ineffectiveness and Efficient Markets Models (University ofChicago Press, 1983). In addition, he has published more than 200 articles in such journalsas American Economic Review, Journal of Political Economy, Econometrica, Quarterly Journal ofEconomics, Journal of Finance, and Journal of Monetary Economics.Professor Mishkin has served on the editorial board of American Economic Review andhas been an associate editor at Journal of Business and Economic Statistics, Journal of AppliedEconometrics, Journal of Economic Perspectives, Journal of International Money and Finance, andJournal of Money, Credit and Banking; he also served as the editor of the Federal ReserveBank of New York’s Economic Policy Review. He is currently an associate editor (member ofthe editorial board) at six academic journals, including International Finance; Finance India;Review of Development Finance; Borsa Economic Review; PSU Research Review and EmergingMarkets, and Finance and Trade. He has been a consultant to the Board of Governors of theFederal Reserve System, the World Bank, and the International Monetary Fund, as well asto many central banks throughout the world. He was also a member of the InternationalAdvisory Board to the Financial Supervisory Service of South Korea and an advisor to theInstitute for Monetary and Economic Research at the Bank of Korea. Professor Mishkinwas a Senior Fellow at the Federal Deposit Insurance Corporation’s Center for BankingResearch and was an academic consultant to and serves on the Economic Advisory Paneland Monetary Advisory Panel of the Federal Reserve Bank of New York.viiA01 MISH4200 05 BSE FM.indd 727/10/17 6:03 PM

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Brief ContentsPART 1Introduction11 Why Study Money, Banking, and Financial Markets?. 22 An Overview of the Financial System. 223 What Is Money?. 49PART 2Financial Markets4567PART 3An Economic Analysis of Financial Structure.Banking and the Management of Financial Institutions.Economic Analysis of Financial Regulation.Banking Industry: Structure and Competition.Financial Crises.Nonbank Finance.Financial Derivatives.Conflicts of Interest in the Financial Industry.164188217236268293317344Central Banking and the Conduct of Monetary Policy 36316171819PART 5The Meaning of Interest Rates. 64The Behavior of Interest Rates. 86The Risk and Term Structure of Interest Rates. 117The Stock Market, the Theory of Rational Expectations, and the EfficientMarket Hypothesis. 141Financial Institutions 16389101112131415PART 463Central Banks and the Federal Reserve System.The Money Supply Process.Tools of Monetary Policy.The Conduct of Monetary Policy: Strategy and Tactics.International Finance and Monetary Policy36438841343947320 The Foreign Exchange Market. 47421 The International Financial System. 502PART 6Monetary Theory22232425531Quantity Theory, Inflation, and the Demand for Money.Aggregate Demand and Supply Analysis.Monetary Policy Theory.Transmission Mechanisms of Monetary Policy.532550594623ixA01 MISH4200 05 BSE FM.indd 927/10/17 6:03 PM

xBrief ContentsAdditional Chapters on MyLab Economics12345A01 MISH4200 05 BSE FM.indd 10Financial Crises in Emerging Market EconomiesThe IS CurveThe Monetary Policy and Aggregate Demand CurvesThe Role of Expectations in Monetary PolicyThe ISLM Model27/10/17 6:03 PM

Contents in DetailPART 1Introduction 1CHAP T ER 1Why Study Money, Banking, and Financial Markets? 2Why Study Financial Markets?.2Debt Markets and Interest Rates. 3The Stock Market. 3Why Study Financial Institutions and Banking?.5Structure of the Financial System. 5Banks and Other Financial Institutions. 6Financial Innovation. 6Financial Crises. 6Why Study Money and Monetary Policy?.7Money and Business Cycles. 7Money and Inflation. 7Money and Interest Rates. 9Conduct of Monetary Policy. 9Fiscal Policy and Monetary Policy. 10Why Study International Finance?. 11The Foreign Exchange Market. 12The International Financial System. 13Money, Banking, and Financial Markets and Your Career. 14How We Will Study Money, Banking, and Financial Markets. 14Exploring the Web. 15Concluding Remarks. 15Summary 15     Key Terms 16     Questions 16     Applied Problems 17   Data Analysis Problems 17      Web Exercises 18      Web References 18AP P ENDIX TO CH A PT E R 1Defining Aggregate Output, Income, the Price Level,and the Inflation Rate 19Aggregate Output and Income. 19Real Versus Nominal Magnitudes. 19Aggregate Price Level. 20Growth Rates and the Inflation Rate. 21CHAP T ER 2An Overview of the Financial System 22Function of Financial Markets. 22Structure of Financial Markets. 25Debt and Equity Markets. 25Primary and Secondary Markets. 25xiA01 MISH4200 05 BSE FM.indd 1127/10/17 6:03 PM

xiiContents in DetailExchanges and Over-the-Counter Markets. 26Money and Capital Markets. 27Financial Market Instruments. 27Money Market Instruments. 27Following the Financial News Money Market Rates28Capital Market Instruments. 29Following the Financial News Capital Market Interest Rates30Internationalization of Financial Markets. 31Global Are U.S. Capital Markets Losing Their Edge?32International Bond Market, Eurobonds, and Eurocurrencies. 32World Stock Markets. 33Function of Financial Intermediaries: Indirect Finance. 33Following the Financial News Foreign Stock Market Indexes34Transaction Costs. 34Global  The Importance of Financial Intermediaries Relative to Securities Markets:An International Comparison 35Risk Sharing. 36Asymmetric Information: Adverse Selection and Moral Hazard. 36Economies of Scope and Conflicts of Interest. 38Types of Financial Intermediaries. 38Depository Institutions. 38Contractual Savings Institutions. 40Investment Intermediaries. 41Regulation of the Financial System. 42Increasing Information Available to Investors.

International Economics: Theory & Policy* Laidler The Demand for Money Lynn Economic Development: Theory and Practice for a Divided World Miller Economics Today* Miller/Benjamin The Economics of Macro Issues Miller/Benjamin/North The Economics of Public Issues Mishkin The Economics of Money, Banking, and Financial Markets* The Economics of .