Money, the financial system, and the economy / R. Glenn Hubbard.

Contents
Part 1. Introduction 1
Chapter 1. Introducing Money and the Financial System 2
Getting Started 3
The Financial System and the Economy 3
Financial Markets 5
Financial Institutions 7
Money 8
Economic Analysis as a Tool 9
Developing an Economic Approach 10
Applying an Economic Approach 10
Review Questions 12
Analytical Problems, Data Question 13
Other times, other places . . . The Only Thing Constant in the Financial System Is Change 6
Consider this . . . Is the Financial System Truly Global? 7

Chapter 2. Money and the Payments System 14
Meeting the Needs of Exchange with Money 14
Barter 15
Government Allocation 16
Money 16
What Can Serve as Money? 19
The Payments System 20
Commodity Money 21
Fiat Money 21
Checks 22
Electronic Funds and Electronic Cash 23
Measuring the Money Supply 25
Measuring Monetary Aggregates 25
Selecting Monetary Aggregates 28
Review Questions, Analytical Problems 32
Data Questions 33
Appendix: Calculating Price Indexes 34
Other times, other places . . . Will the Euro Be a Success? 20
Consider this . . . What's Money? Ask a Taxi Driver! 22
Using the news . . . Finding Up-to-Date Information on Money 27
Moving from theory to practice . . . E-Cash 2.0, The Economist, 2/19/00 30

Chapter 3. Overview of the Financial System 35
What Is the Purpose of the Financial System? 35
Key Services Provided by the Financial System 38
Risk Sharing 39
Liquidity 39
Information 40
Financial Markets in the Financial System 41
Matching Savers and Borrowers: Debt and Equity 41
Providing Risk-Sharing, Liquidity, and Information Services 43
Financial Intermediaries in the Financial System 45
Matching Savers and Borrowers 46
Providing Risk-Sharing, Liquidity, and Information Services 46
Competition and Change in the Financial System 48
Financial Innovation 49
Changes in Financial Integration and Globalization 49
Financial Regulation 51
Provision of Information 52
Maintenance of Financial Stability 52
Advancement of Other Policy Objectives 53
Effects of Regulation 54
Review Questions 58
Analytical Problems, Data Question 59
Appendix: Financial Instruments 60
Case Study Where Do Households Put Their Savings? 47
Consider this . . . Financial Innovation: Home Mortgages or Rock Star Bonds? 50
Other times, other places . . . The Growth of International Bond and Stock Markets 51
Moving from theory to practice . . . Mrs. Watanabe Learns to Invest, The Economist,
12/18/99 56

Part 2. Interest Rates 67
Chapter 4.Interest Rates and Rates of Return 68
Comparing Debt Instruments 68
Timing of Payments 69
Present Value 72
Using Yield to Maturity as a Yardstick 75
Bond Yields and Prices 80
Why Can Price and Face Value Differ? 80
How Are Bond Yields and Prices Related? 82
Finding the Total Rate of Return 86
Real versus Nominal Interest Rates 87
Review Questions, Analytical Problems 94
Data Questions 96
Consider this . . . Can They STRIP? Creating New Financial Instruments 71
Consider this . . . Who Will Buy Those Fabulous Fifties? 82
Using the news . . . Keeping Up with Bond Prices and Yields 84
Other times, other places . . . Principal Derailed: Inflation and Long-Term Bond Prices 88
Moving from theory to practice . . . A Bond Anybody Can Love, Business Week, 6/19/00 92

Chapter 5. The Theory of Portfolio Allocation 97
Determinants of Portfolio Choice 97
Wealth 99
Expected Returns on Assets 100
Risk Associated with Asset Returns 101
Liquidity of Assets 102
Costs of Acquiring Information 102
Advantages of Diversification 104
Putting It All Together: Explaining Portfolio Allocation 108
Review Questions 111
Analytical Problems 114
Data Questions 115
Case Study How Much Risk Should You Tolerate in Your Portfolio? 103
Case Study Modeling Risk Premiums in Financial Markets 108
Other times, other places . . . Are Investors (Globally) Well Diversified? 110
Moving from theory to practice . . . Sex Matters, Mutual Funds, 4/00 112

Chapter 6. Determining Market Interest Rates 116
Supply and Demand in the Bond Market and Loanable Funds 116
The Demand Curve 117
The Supply Curve 119
Market Equilibrium 119
Explaining Changes in Equilibrium Interest Rates 121
Shifts in Bond Demand 122
Shifts in Bond Supply 127
Using the Model to Explain Changes in Interest Rates 132
Back to the Bond Market's Votes 135
The International Capital Market and the Interest Rate 136
Small Open Economy 137
Large Open Economy 138
Review Questions 143
Analytical Problems 144
Data Questions 145
Consider this . . . Where Do Savings Come from? 125
Other times, other places . . . Do Interest Rates Rise During Wartime? 131
Moving from theory to practice . . . Interest Rates: Up or Down?, The Economist,
12/2/00 140

Chapter 7. Risk Structure and Term Structure of Interest Rates 146
Risk Structure of Interest Rates 146
Default Risk 147
Liquidity 152
Information Costs 153
Taxation 156
Using the Risk Structure for Forecasting 158
Term Structure of Interest Rates 159
Segmented Markets Theory 161
Expectations Theory 162
Preferred Habitat Theory 166
Using the Term Structure for Forecasting 168
Review Questions, Analytical Problems 174
Data Question 176
Using the news . . . Using Bond Yields to Assess Risk 148
Consider this . . . Will a Consumption Tax Kill Munis' Allure? 159
Other times, other places . . . Asian Flu for European Bonds? 160
Using the news . . . How to Read the Yield Curve 161
Consider this . . . Can the Treasury Change the Shape of the Yield Curve? 170
Moving from theory to practice . . . What If Treasury Debt Disappears?, The Wall Street Journal, 8/3/00 172


Part 3. Financial Markets 177
Chapter 8. The Foreign-Exchange Market and Exchange Rates 178
Exchange Rates and Trade 179
Nominal versus Real Exchange Rates 180
Foreign-Exchange Markets 182
Determining Long-Run Exchange Rates 183
Supply and Demand 183
Economic Fundamentals and Long-Run Exchange Rate Trends 184
The Law of One Price and the Purchasing Power Parity Theory 186
Does the Theory Match Reality? 187
Determining Short-Run Exchange Rates 188
Comparing Expected Returns on Domestic and Foreign Assets 190
Foreign-Exchange Market Equilibrium 192
Interest Rate Parity 194
Exchange Rate Fluctuations 196
Changes in Domestic Real Interest Rates 196
Changes in Domestic Expected Inflation 198
Changes in Foreign Interest Rates 199
Changes in the Expected Future Exchange Rate 200
Currency Premiums in Foreign-Exchange Markets 202
A (Big) New Kid on the Block: The Euro 204
Review Questions 205
Analytical Problems 208
Data Question 209
Using the news . . . Reading Exchange Rates 185
Case Study Should You Bank on International Investments? 197
Other times, other places . . . Interest and Exchange Rates in the 1980s 203
Moving from theory to practice . . . The Euro Recovers, Financial Times, 12/16-17/00 206

Chapter 9. Derivative Securities and Derivative Markets 210
Forward Transactions and Derivatives 210
Futures 212
Futures Pricing 212
Using Futures to Manage Risk 214
Options 217
Options Pricing 218
Using Options to Manage Risk 220
Benefits of Derivative Markets for the Financial System 221
Standardization and Liquidity 224
Anonymous Trading and Information 224
Review Questions 228
Analytical Problems 229
Data Question 230
Appendix: Swaps 230
Using the news . . . Reading Financial Futures Listings 213
Using the news . . . Reading Options Listings 219
Other times, other places . . . Futures Trading, Index Arbitrage, and the Stock Market Crash
of 1987 221
Case Study Citron Pressed-The Orange County Fiasco 222
Case Study Barings Lost-The Queen's Banker Goes Bust 223
Moving from theory to practice . . . Futures of Pollution, The Banker, 10/99 226

Chapter 10. Information and Financial Market Efficiency 234
Rational Expectations 235
The Efficient Markets Hypothesis 237
Determining an Asset's Expected Price 238
Price Fluctuations 239
Investment Strategies 241
Actual Efficiency in Financial Markets 244
Pricing Anomalies 245
Mean Reversion 246
Excessive Volatility 246
Market Efficiency and the Crash of 1987 247
Value Investing versus Efficient Markets 250
Costs of Inefficiency in Financial Markets 251
Costs of Excessive Price Fluctuations 251
Information Costs 252
Review Questions, Analytical Problems 256
Data Question 257
Consider this . . . Are Investors Really Rational? 242
Other times, other places . . . Charting the Civil War with the Gold Market 243
Case Study What Goes Up . . . 249
Moving from theory to practice . . . So, Is the Stock Market Overvalued?, The Wall Street Journal, 3/17/99 254

Chapter 11.Reducing Transactions Costs and Information Costs 258
Obstacles to Matching Savers and Borrowers 258
Transactions Costs 259
Asymmetric Information and Information Costs 260
Adverse Selection 260
"Lemons Problems" in Financial Markets 261
Reducing Information Costs 262
Moral Hazard 264
Moral Hazard in Equity Financing 264
Moral Hazard in Debt Financing 266
Information Costs and Financial Intermediaries 269
Financial Intermediaries and Adverse Selection 270
Financial Intermediaries and Moral Hazard 270
Review Questions 273
Analytical Problems, Data Question 276
Consider this . . . Are Stock Market Signals Affected by Adverse Selection? 265
Consider this . . . Can Falling Prices Raise Information Costs? 268
Other times, other places . . . Investor Protection and Economic Growth 271
Moving from theory to practice . . . On the Cutting Edge of Corporate Control in China, The Economist, 6/3/00 274


Part 4. Financial Institutions 277
Chapter 12. What Financial Institutions Do 278
Securities Market Institutions 279
Information: Investment Banking 280
Liquidity and Risk Sharing: Secondary Markets 282
Investment Institutions 285
Mutual Funds 285
Finance Companies 288
Contractual Saving: Insurance Companies 289
Principles of Insurance Management 289
Life Insurance Companies 292
Property and Casualty Insurance Companies 293
Regulation of Insurance Companies and Recent Trends 295
Contractual Saving: Pension Funds 295
Ownership of Pension Funds Assets 296
Funding of Pension Plans 297
Regulation of Private Pension Plans 297
Public Pension Plans 298
Recent Trends 298
Depository Institutions 299
Commercial Banks 299
Savings Institutions 300
Credit Unions 300
Government Financial Institutions 301
Direct Role: Federal Credit Agencies 301
Indirect Role: Loan Guarantees 305
Recent Trends 305
Financial Institutions: Blurring the Lines 305
Review Questions 310
Analytical Problems, Data Question 311
Using the news . . . A Tombstone for Something New? 283
Consider this . . . Can Investors Keep "Captives" at Bay? 291
Case Study What Kind of Financial Institution Is a Hedge Fund? 302
Case Study What Kind of Financial Institution Is a Venture Capital Fund? 303
Moving from theory to practice . . . Federal Credit Agencies: Is "Too Much" Lending Possible?, The Wall Street Journal, 7/14/00 308


Chapter 13. The Business of Banking 312
How Banks Earn Profits 313
Bank Liabilities 313
Bank Assets 316
Bank Net Worth 317
Bank Failure 317
Determining Bank Profits 318
The Relationship Between Banks and Savers 320
Managing Moral Hazard 321
Managing Liquidity Risk 323
The Relationship Between Banks and Borrowers 325
Managing Credit Risk 326
Managing Interest Rate Risk 330
Expanding the Boundaries of Banking 333
Opportunities and Financial Innovation 334
Off-Balance-Sheet Activities 334
Review Questions 342
Analytical Problems 343
Data Questions 344
Appendix: Measuring the Duration of Bank Assets and Liabilities 344
Consider this . . . How Do Banks Account for Loan Losses? 319
Consider this . . . When Is Credit-Risk Analysis "Discrimination"? 327
Consider this . . . Grading Bank Derivatives: Extra Credit? 338
Moving from theory to practice . . . Banking: "Clicks" or "Bricks"?, The Economist,
11/11/00 340

Chapter 14. The Banking Industry 346
Origins of Today's U.S. Banking Industry 347
Who Regulates Banks 348
Chartering and Examination 349
Regulating Commercial Banks 349
Regulating Savings Institutions 350
Regulating Credit Unions 350
Why the Banking Industry Is Regulated 351
Bank Runs 352
The Cost of a Bank Run 352
Government Intervention in the Banking Industry 354
Lender of Last Resort 355
Federal Deposit Insurance 356
Restrictions on Banking Industry Competition 361
The Banking Industry in Other Countries 368
Japanese Banking 371
German Banking 373
Integration of European Banking 374
Review Questions, Analytical Problems 378
Data Question 379
Other times, other places . . . Lessons from the Free Banking Period 348
Consider this . . . Is Bank Consolidation Good for Business? 362
Case Study Is Banking a Declining Industry? 369
Moving from theory to practice . . . The Bigger They Come . . . , The Economist, 10/28/00 376

Chapter 15. Banking Regulation: Crisis and Response 380
The Pattern of Regulation 381
Lender of Last Resort 381
The Great Depression 381
Success in Recent Years 383
Concluding Remarks 385
Anticompetitive Bank Regulation 385
The Credit Crunch of 1966 387
Banks' Response 387
Regulatory Response 389
Concluding Remarks 390
The U.S. Deposit Insurance Crisis of the 1980s 391
Beginning of the Crisis: Worsening Conditions in S&Ls 391
Financial System Response 391
Regulatory Response: The S&L Bailout 394
The Widening Crisis: Commercial Banks 395
Options for Regulatory Reform 397
Current Issues in Regulatory Reform 401
Concluding Remarks 402
Lessons from Banking Regulation for Other Institutions 404
Insurance Regulation 404
Pension Fund Regulation 405
Review Questions 408
Analytical Problems 409
Data Question 410
Consider this . . . How Does a Lender of Last Resort Protect the Payments System? 384
Other times, other places . . . The Cycle of Crisis and Response: Russia and Japan 403
Moving from theory to practice . . . Japanese Bank Reform, Vital to the Economy, Snags on Political Reef, The Wall Street Journal, 12/11/00 406

Chapter 16.Banking in the International Economy 411
Organization of International Banks 412
Overseas Organization of U.S. Banks 413
Organization of Foreign Banks in the United States 414
Leaders in Global Banking 415
Managing Exchange Rate Risk 415
Services Provided by International Banks 417
Reducing Transactions Costs 417
Providing Information Services 418
The Rise of Euromarkets 420
Euromarket Customers 422
Loans in Euromarkets 423
Financial Regulation in International Banking 424
Capital Requirements 425
Deposit Insurance 426
Central Bank Intervention 427
International Coordination 427
Review Questions 430
Analytical Problems, Data Question 431
Consider this . . . Why Did Closing BCCI Take So Long? 416
Consider this . . . Will Europe Kill the Eurobond? 423
Other times, other places . . . Do Sovereigns Default? 425
Moving from theory to practice . . . New Basle Committee Proposals, The Financial Times,
2/17/01 428

Part 5. The Money Supply Process and Monetary Policy 433
Chapter 17. The Money Supply Process 434
The Fed and the Monetary Base 435
The Fed's Liabilities 435
The Fed's Assets 436
How the Fed Changes the Monetary Base 437
Comparing Open Market Operations and Discount Loans 441
The Simple Deposit Multiplier 443
Multiple Deposit Expansion 443
Multiple Deposit Contraction 448
The Money Multiplier and Decisions of the Nonbank Public 450
Determinants of Portfolio Choice 450
Concluding Remarks 452
Bank Behavior: Excess Reserves and Discount Loans 453
Excess Reserves 454
Discount Loans 455
Deriving the Money Multiplier and the Money Supply 456
Review Questions 466
Analytical Problems 467
Data Question 469
Appendix: The Money Supply Process for M2 469
Consider this . . . What Are the Origins of Multiple Deposit Expansion? 445
Other times, other places . . . The Money Multiplier and Money Supply During the Early
1930s 459
Case Study Using the Money Supply Equation to Predict Money Growth 461
Moving from theory to practice . . . The Fed and the Monetary Base: Thwarting a Slowdown,
The New York Times, 1/4/01 464

Chapter 18. Changes in the Monetary Base 471
Balance Sheet of the Federal Reserve System 471
The Fed's Assets 472
The Fed's Liabilities 473
Determining the Monetary Base 474
Changes in the Monetary Base 475
Determinants That Increase the Monetary Base 476
Determinants That Decrease the Monetary Base 479
Concluding Remarks 480
The Federal Budget Deficit and the Monetary Base 481
Alternative Strategies 483
The Government Budget Constraint and the Monetary Base 485
Review Questions, Analytical Problems 487
Data Questions 490
Using the news . . . Federal Reserve Data and Change in the Monetary Base 477
Other times, other places . . . Dealing with the Debt: The Treasury-Federal Reserve Accord 482
Moving from theory to practice . . . ECB Warns on Budget Deficits, The Financial Times,
3/18/99 488

Chapter 19.Organization of Central Banks 491
Power Sharing in the Federal Reserve System 492
Creation of the System 492
Federal Reserve Banks 493
Member Banks 495
Board of Governors 495
Federal Open Market Committee 496
Power and Authority Within the Fed 497
How the Fed Operates 498
Handling External Pressure 499
Examples of Treasury-Fed Conflict 500
Factors That Motivate the Fed 501
Fed Independence 503
Central Bank Independence in Other Countries 505
Organization and Independence of the European Central Bank 506
Review Questions, Analytical Problems 510
Data Questions 511
Consider this . . . Importance of Selecting a Fed Chairman 501
Other times, other places . . . Conflicts Between the Treasury and the Central Bank in Japan
over Independence 504
Moving from theory to practice . . . The ECB's Terrible Twos, The Economist, 1/6/01 508

Chapter 20.Monetary Policy Tools 512
Open Market Operations 512
Implementing Open Market Operations 513
Open Market Operations versus Other Policy Tools 516
Fed Watching and FOMC Directives 516
Open Market Operations in Other Countries 517
Discount Policy 518
Using the Discount Window 518
Policing the Discount Window 519
Benefits of Discount Policy 520
Drawbacks of Discount Policy as a Monetary Policy Tool 522
Discount Policy in Other Countries 522
Reserve Requirements 522
Changes in Reserve Requirements 523
Measurement and Compliance 524
Criticism of Reserve Requirements 524
Reserve Requirements in Other Countries 527
Fed Watching: Analyzing the Policy Tools 527
The Federal Funds Market 527
Open Market Operations 528
Changes in the Discount Rate 529
Changes in Reserve Requirements 529
Other Disturbances of the Monetary Base 530
The Federal Funds Rate and Monetary Policy 531
Concluding Remarks 533
Review Questions 536
Analytical Problems 537
Data Question 538
Consider this . . . A Day's Work at the Open Market Trading Desk 515
Consider this . . . How Do You Decode FOMC Statements? 517
Other times, other places . . . An Early Mistake in Setting Reserve Requirements 526
Moving from theory to practice . . . Fed Rate Cut Combats a Contagion, The Wall Street Journal, 2/1/01 534

Chapter 21. The Conduct of Monetary Policy 539
Goals of Monetary Policy 539
Price Stability 540
High Employment 540
Economic Growth 541
Financial Market and Institution Stability 541
Interest Rate Stability 542
Foreign-Exchange Market Stability 542
Problems in Achieving Monetary Policy Goals 542
Using Targets to Meet Goals 543
Monetary Aggregates and Interest Rates as Targets 545
Selecting Intermediate Targets 547
Selecting Operating Targets 550
The Monetary Policy Record 550
Early Interest in Targets: 1951-1970 551
Experimenting with Monetary Targets: 1970-1979 552
De-emphasizing Interest Rates: 1979-1982 553
Policy After 1982: Back to Interest Rates 554
Increasing International Concerns: The 1980s and 1990s 556
Concluding Remarks 557
Reevaluating Fed Targeting Policy 557
Alternative Intermediate Targets 557
The Taylor Rule 558
The Future of Targeting 559
International Comparison of Monetary Policy Conduct 562
Review Questions 565
Analytical Problems, Data Question 568
Other times, other places . . . Does the Conduct of Monetary Policy Respond to Political Pressures? 556
Case Study Is Inflation Targeting a Good Idea? 560
Moving from theory to practice . . . The Chairman's Upbeat View, The Wall Street Journal, 2/14/01 566

Chapter 22. The International Financial System and Monetary Policy 569
Foreign-Exchange Intervention and the Money Supply 570
Foreign-Exchange Intervention and the Exchange Rate 572
Unsterilized Intervention 572
Sterilized Intervention 574
Capital Controls 575
Recent Fed Interventions 576
Balance of Payments 577
The Current Account 579
The Capital Account 580
The Official Settlements Balance 580
Relationships Among the Accounts 581
Exchange Rate Regimes and the International Financial System 582
Fixed Exchange Rates and the Gold Standard 582
Adapting Fixed Exchange Rates: The Bretton Woods System 584
Central Bank Intervention After Bretton Woods 591
Fixed Exchange Rates in Europe 593
How Successful Are Fixed Exchange Rates Likely to Be in the Long Run? 599
Review Questions 602
Analytical Problems 603
Data Questions 604
Case Study Do Sterilized Interventions Affect the Exchange Rate? 577
Using the news . . . The U.S. Balance of Payments 578
Consider this . . . Are the IMF and the World Bank Obsolete? 586
Other times, other places . . . Speculative Attack: 1990s Style 595
Case Study Financial Collapse in Mexico 596
Case Study Financial Collapse in Asia 597
Consider this . . . Back to the (Currency) Drawing Board 598
Moving from theory to practice . . . Central Banks Boost the Euro, The Wall Street Journal,
9/25/00 600

Part 6. The Financial System and the Macroeconomy 605
Chapter 23.The Demand for Money 606
Transactions Motives 606
Real Money Balances 607
Velocity and the Demand for Real Balances 608
Changes in Velocity over Time 609
Portfolio Allocation Motives 614
Motives for Holding Money: Keynes's Liquidity Preference Theory 615
Broader Portfolio Factors: Friedman's Money Demand Model 617
Comparing the Two Models: Keynes versus Friedman 617
Explaining Money Demand 618
The Money Demand Function 619
Measuring Money Demand 619
Review Questions 624
Analytical Problems 625
Data Question 626
Consider this . . . The Money Growth Slowdown in the Early 1990s: Was Velocity the Culprit? 610
Other times, other places . . . The Case of the Missing Money 621
Moving from theory to practice . . . A Legal Tender of One's Own, The New York Times,
1/30/01 622

Chapter 24. Linking the Financial System and the Economy:
The IS-LM-FE Model 627
A Model for Goods and Asset Markets: Assumptions 628
The IS Curve 629
Saving, Investment, and Aggregate Demand 629
Determinants of National Saving 630
Determinants of National Investment 631
Constructing the IS Curve 632
The IS Curve for an Open Economy 634
Shifts of the IS Curve 636
Determining Output: The Full Employment Line 637
The LM Curve 639
Asset Market Equilibrium 640
Constructing the LM Curve 641
Shifts of the LM Curve 645
The Financial System and the Economy: The IS-LM-FE Model 647
Using the Model to Explain the Economy's Equilibrium 648
Restoring Equilibrium: Price-Level Adjustment 650
Money, Output, and Prices in the Long Run 652
Review Questions, Analytical Problems 656
Data Question 658
Appendix: Derivation of the IS Curve 659
Consider this . . . Are Savings Internationally Mobile? 636
Other times, other places . . . The Gulf War and "Confidence" 638
Moving from theory to practice . . . Productivity: The Magic Elixir, The Wall Street Journal,
2/15/01 654

Chapter 25.Aggregate Demand and Aggregate Supply 662
The Aggregate Demand Curve 662
Deriving the Aggregate Demand Curve 663
Shifts of the Aggregate Demand Curve 664
The Aggregate Supply Curve 668
Short-Run Aggregate Supply Curve 668
Long-Run Aggregate Supply Curve 674
Shifts in the Short-Run Aggregate Supply Curve 674
Shifts in the Long-Run Aggregate Supply Curve 675
Equilibrium in Aggregate Demand and Aggregate Supply 677
Short-Run Equilibrium 678
Long-Run Equilibrium 679
The Real Business Cycle View 680
Economic Fluctuations in the United States 681
Shocks to Aggregate Demand, 1964-1969 682
Supply Shocks, 1973-1975 and 1995-2000 682
Credit Crunch and Aggregate Demand, 1990-1991 683
Are Investment Incentives Inflationary? 684
Review Questions, Analytical Problems 685
Data Questions 689
Consider this . . . Do Tax Cuts Stimulate Aggregate Demand? 666
Other times, other places . . . Shock Therapy and Aggregate Supply in Poland 676
Consider this . . . Can Shifts in Aggregate Demand Affect Output in the Long Run? 679
Moving from theory to practice . . . Memo to Tokyo: Print Money, The Financial Times, 2/7/00 686

Chapter 26. Money and Output in the Short Run 690
Tracking Money and Output Movements in the Short Run 690
The Real Business Cycle Model 692
Money and Output: The New Classical Model 694
Money and Output: The New Keynesian Model 696
Should Public Policy Stabilize Economic Fluctuations? 700
The Real Business Cycle and New Classical Views 700
The New Keynesian View 701
Explaining Events of the 1980s and 1990s 704
Effects of Policy Shifts in the Early 1980s 705
Effects of Policy Shifts in the Early 1990s 706
Concluding Remarks 707
Review Questions 710
Analytical Problems 711
Data Questions 713
Consider this . . . Can One Size Fit All in Europe? 698
Case Study How Does Money Affect Aggregate Demand in the New Keynesian View? 699
Other times, other places . . . Yasushi Mieno and the Stabilization Policy Debate in Japan 703
Moving from theory to practice . . . Will the Fed Step on the Gas?, The Financial Times, 2/5/01 708

Chapter 27.Information Problems and Channels for Monetary Policy 714
Macroeconomic Costs of Information Problems 715
Information Problems in Lending: Role of Financial Intermediaries 716
Information Problems in Lending: Role of Net Worth 716
Consequences of a Drop in Bank Lending 717
Consequences of a Fall in Borrowers' Net Worth 718
Financial Panics 719
Credit Controls and Credit Crunches 720
Expanded Channels for Monetary Policy 722
The Money Channel: Monetary Policy and Interest Rates 722
The Bank Lending Channel: Monetary Policy and Banks 724
Money Channel and Bank Lending Channel Predictions 724
The Balance Sheet Channel: Monetary Policy and Net Worth 727
Validity of the Bank Lending and Balance Sheet Channels 729
Implications for Public Policy 733
Review Questions, Analytical Problems 737
Data Question 738
Other times, other places . . . The Global Banking Crisis and the Great Depression 721
Consider this . . . Was There a Credit Crunch During the 1990-1991 Recession? 732
Moving from theory to practice . . . A New Credit Crunch for Japan?, The Financial Times, 12/22/00 734

Chapter 28. Inflation: Causes and Consequences 739
Explaining Price Level Changes 739
Causes of Price Level Changes 740
Causes of Price Level Fluctuations 741
Sustained Changes in the Price Level: Inflation 744
Costs of Inflation 746
Expected Inflation 746
Unexpected Inflation 747
Inflation Uncertainty 748
Inflation and Monetary Policy 749
Cost-Push Inflation 749
Demand-Pull Inflation 750
Costs of Reducing Inflation 752
New Classical Disinflation: Reducing Inflation Cold Turkey 752
New Keynesian Disinflation: Reducing Inflation Gradually 753
Central Bank Credibility 754
Strategies for Building Credibility 755
Rules versus Discretion 758
Price Controls and Credibility 760
Review Questions 761
Analytical Problems 764
Data Questions 765
Appendix: Inflation versus Unemployment: The Phillips Curve 766
Other times, other places . . . Central Bank Credibility in the United States and Japan 755
Consider this . . . Can Credibility Enhance Central Bank Flexibility? 759
Moving from theory to practice . . . Growth or Inflation?, The New York Times, 1/30/00 762
Glossary A-1
Answer Section A-17

Includes index.