Notes on Mishkin Chapter 1 (Econ 353, Tesfatsion)

Notes on Mishkin Chapter 1:
Some Additional Empirical Context

Econ 353: Money, Banking,
and Financial Institutions

Last Updated: 17 January 2011
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--1952: 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--Present: 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

Effects of money, banking, and financial markets on everyday life and on the longer-run well being of nations
Key Empirical Time Series for the U.S. Economy since 1950
- U.S. Interest Rates Since 1950 (M-Fig 1)
- U.S. Stock Prices Since 1950 (M-Fig 2)
- Relationship in the U.S. Between Money Growth and the Business Cycle (M-Fig 3)
- U.S. Aggregate Price Level and Money Supply Since 1950 (M-Fig 4)
- Relationship in the U.S. and Other Countries Between the Average Inflation Rate and Money Growth (M-Fig 5)
- Relationship in the U.S. Between Money Growth and Long-Run Interest Rates (M-Fig 6)
- U.S. Government Budget (Deficit or Surplus) Since 1950 (M-Fig 7)
- U.S. Dollar Exchange Rate Since 1970 (M-Fig 8)
- U.S. Real GDP Since 1950 (In-Class Slide)
- U.S. Real GDP Growth Rate since 1950 (In-Class Slide)
- U.S. Inflation Rate Since 1950 (In-Class Slide)
- U.S. Employment Since 1959 (In-Class Slide)
- U.S. Unemployment Rate Since 1950 (In-Class Slide)