Notes on Mishkin Chapter 1:
Some Additional Empirical Context

Econ 353: Money, Banking,
and Financial Institutions

Last Updated: 26 August 2015
Lastest Course Offering: Spring 2011

Course Instructor:
Professor Leigh Tesfatsion
tesfatsi AT iastate.edu

Econ 353 Homepage

Overview:

Throughout his text (Business School Edition, 2nd Ed, 2010), Mishkin stresses that the evolution of financial markets, both in the U.S. and throughout the world, has resulted from an intricate interplay of three factors: chance, necessity, and design. In short, history matters, and it matters a lot! You will see Mishkin's historical take on things better as we proceed through the course.

For example, Mishkin discusses the historical evolution of monetary payment systems in Chapter 3. In Chapters 8 and 9 he discusses the root causes and progression of major financial crises (e.g., the Great Depression). In Chapter 10 he discusses the decline of traditional banking in the U.S. In Chapters 11-15 he discusses the key historical forces -- in particular, the interplay between regulations and innovations -- that have shaped the current U.S. financial structure. And in Chapters 20 and 21 he discusses the historical evolution of the international financial system.

In addition, throughout his text, Mishkin consistently stresses the importance of information. He argues that it is impossible to understand the special nature of financial markets relative to markets for real goods and services unless one understands the peculiar types of "information problems" intrinsically associated with financial assets. He argues that these information problems have largely shaped the structure of financial markets in the past, and that the recent surge of innovations in information technology (IT) -- in particular, Internet-related IT -- is leading to a dramatic restucturing of financial markets today.

In Chapter 1 of his text, Mishkin sets the stage for later chapters by providing some historical perspective on the development of the U.S. economy. In our first few class meetings, we will focus on, and expand upon, this part of Mishkin's discussion in Chapter 1. Specifically, we will look at how a number of key economic variables (e.g, output, inflation, unemployment, interest rates,...) have varied over time, and we will see how various major historical events have had an impact on these variables. We will also discuss in broad terms some of the major IT innovations and their possible impacts on the U.S. economy.

The notes, below, provide basic background information for these introductory discussions. A time-line is provided for key events in recent U.S. history affecting the U.S. financial sector. Also, definitions are provided for basic terms that are used by Mishkin in Chapter 1 to describe and discuss the U.S. economy.

Key Historical Events Affecting the United States:

1913: Establishment of the U.S. Federal Reserve System

1929--1939: U.S. Great Depression

1933--1945: Franklin D. Roosevelt Administration

1941--1945: U.S. Participation in World War II

1944: The Bretton Woods Agreement (establishment of the World Bank and the International Monetary Fund)

1945: Establishment of the United Nations

1945--1953: Truman Administration

1946: U.S. Employment Act (e.g. Council of Economic Advisors created)

1952: U.S. Price Stabilization Act

1950--1953: Korean War

1953--1960: Eisenhower Administration

1961--1968: Kennedy-Johnson Administrations (Civil Rights Movement Begins)

1966--1974: Vietnam War Years and Continuation of Civil Rights Movement

1969--1976: Nixon-Ford Administrations

1971: Breakdown of the Bretton Woods Agreement on Fixed Exchange Rates

1973--1974: First Oil Price Shock (Major Recession in U.S.)

1977--1980: Carter Administration

1979: Second Oil Price Shock

1981--1988: Reagan Administration

1981--1982: Severe U.S. Recession

1989--1992: George H. W. Bush Administration

1993--2000: Clinton Administration

2001--2008: George W. Bush Jr. Administration

2007-2009: The Great Recession

2009--2016: Barack Obama Administration

Basic Definitions (in Simplified Form):

Distinction Between "Nominal" and "Real":

"Nominal" = Values measured using current prices, and "real" = values measured using constant (e.g. base year) prices. Real value measurements are thus measurements that attempt to reflect quantity amounts, controlling for possible changes in prices.

Nominal Gross Domestic Product (GDP) for an Economy in Period T:

Total value of final goods and services newly produced within the borders of the economy during time period T, measured in time period T prices.

Real GDP for an Economy in Period T (Traditional Measure -- pre-1995):

GDP for the economy in time period T measured in prices for some fixed base time period (e.g., 1992)

Growth Rate for Any Variable X From Period T to Period T+1 :

Let X(T) = Value of X at the beginning of time period T and X(T+1) = value of X at the beginning of time period T+1. Then
                                              X(T+1) -  X(T)
  Growth Rate of X   =  (100 Percent) times  ----------------
   from T to T+1                                   X(T)

Example: GDP Growth Rate

Suppose GDP(2000)=10 trillion and GDP(2001)=10.5 trillion. Then
                                      

                                             .5 trillion
  Growth Rate of GDP  =  (100 Percent) times ------------  =  5 Percent
   from T to T+1                              10 trillion

Time Series Data:

A plot of the measured values of some variable over successive time periods

Trend Line:

A measure of the average movement exhibited by the time series data for some variable, obtained by fitting a regression line to the data points (i.e., determining a line that minimizes the vertical distances between the data points and the line).

Business Cycle:

Recurrent fluctuations that occur in the time series data for real GDP and other key macro variables

Recession:

The time interval from peak to trough for real GDP in a business cycle (i.e., the time during which real GDP is declining). The time interval from trough to peak is known as an expansion.

Aggregate Price Level for an Economy in Period T:

A measure of the AVERAGE price of goods and services in the economy during time period T.

Example 1: The "GDP Deflator" P(T)

P(T) = Nominal GDP(T) divided by Real GDP(T)

If nominal GDP(T) = $1000 and real GDP(T) = 500 in base year dollars (byd), then P(T) = $1000/500 (byd) = $2.0 (per byd).

Example 2: The "Consumer Price Index" CPI(T)

CPI(T) = value of a basic basket of goods and services bought by a typical urban household over time period T

Inflation Rate from Period T to Period T+1:

Given some measure for the aggregate price level in time period T, say the GDP deflator P(T), the inflation rate Inf(T,T+1) is the percentage rate of change in this price measure from time period T to time period T+1. That is,

Inf(T,T+1) = (100 percent) times [P(T+1) - P(T)]/P(T)

Example: If P(T) = $10 and P(T+1) = $11, then Inf(T,T+1) = 100% times [$11-$10]/$10 = (100%) times (1/10) = 10%

Interest Rate:

The cost of borrowing, or the price paid for the rental of funds.

Government Budget Constraint:

A relation that shows how current government expenditures are being financed, either by current tax receipts, by receipts from new bond issue, or by receipts from new money issue.

Government Budget Deficit or Surplus:

If there exists an excess of current government expenditures over current tax receipts, then the government is said to be running a government budget deficit. If current government expenditures are less than current tax receipts, then government is said to be running a government budget surplus.

Current Account Deficit or Surplus:

The current account for an economy is a measure of international transactions for the economy that involve newly produced goods and services or transfers (e.g. foreign aid). If the net receipts from these transactions are negative (i.e., the economy is paying out more than it is taking in), the economy is said to be running a current account deficit. Otherwise it is said to be running a current account surplus.

Debt:

The net accumulation of deficits from past to present.

Foreign Exchange Rate:

The price of one country's currency in terms of another.

Basic Concepts: Mishkin Chapter 1 (plus M1 Appendix)

Financial markets
Security
Asset
Bond
Interest rate
(Common) stock
Foreign exchange market
Foreign exchange rate
Financial intermediaries
Bank
e-Finance
Money (supply)
Aggregate output
Unemployment rate
Time Series Data
Trend Line
Business cycle
Recession
Monetary theory
Aggregate price level (M1 Text & M1 Appendix)
Inflation
Inflation rate (M1 Text & M1 Appendix)
Monetary policy
Central bank
Federal Reserve System (the Fed)
Fiscal policy
Budget deficit (surplus)
Gross Domestic Product (GDP) (M1 Text & M1 Appendix)
Aggregate income (M1 Text & M1 Appendix)
Distinction Between Nominal and Real (M1 Appendix)
Nominal GDP (M1 Appendix)
Real GDP (M1 Appendix)
GDP Deflator (M1 Appendix)
Consumer Price Index - CPI (M1 Appendix)
Growth rate (M1 Appendix)
GDP growth rate (M1 Appendix)

Key Issues: Mishkin Chapter 1

Copyright © 2011 Leigh Tesfatsion. All Rights Reserved.