Monetary Economics I
Lecture 1: Introduction
Undergraduate Program
Faculty of Economics and Business
Universitas Gadjah Mada
2021
Introduction
An Overview of the Financial System
Why Study Monetary Economics
Structure of the Course
Financial Market
Lender- funds funds Borrower-
Saver FINANCIAL MARKET Spenders
Domestic and Foreign: Financial market is a market in Domestic and Foreign:
§ Households which funds are transferred § Households
§ Businesses (direct or indirect) from people § Businesses
§ Governments who have an excess of available § Governments
funds to people who have a
shortage.
Direct finance
Indirect finance
Financial Market
Regulator
The government regulates financial markets for
two main reasons: to increase the information
available to investors and to ensure the soundness
FINANCIAL MARKET of the financial system
Assets/
Structure Instruments
Institutions An asset that represents a claim on
someone else for a payment.
The financial system is complex, comprising many
different types of private sector financial institutions
Financial Market: Structure
FINANCIAL MARKET
Money Market Capital Market
The money market is a financial market in The capital market is the market in which longer
which only short-term debt instruments term debt instruments (generally those with original
(generally those with original maturity terms maturity terms of one year or greater) and equity
of less than one year) are traded. instruments are traded
Financial Market: Structure
FINANCIAL MARKET
Money Market Capital Market
Equity/Stock Debt/Bond
Market Market
Stock market is a financial market Bond market is a financial market in
in which claims on the earnings which a debt security, that promises to
and assets of corporations make periodic payments for a specified
(shares of stock) are traded. period of time, are traded.
Financial Market: Assets/Instruments
FINANCIAL MARKET
Money Market Capital Market
§ Treasury Bills Equity/Stock Debt/Bond
§ Certificates of Deposit Market Market
§ Commercial Paper § Stocks/equities § Bond
§ Repurchase Agreements § Derivatives (e.g. § Fixed income
ETF) securities (e.g. MBS)
Financial Market: Assets/Instruments
FINANCIAL MARKET
Money Market Capital Market
Equity/Stock Debt/Bond
Market Market
Primary Market Primary Market
Secondary Market Secondary Market
Financial Market: Primary Markets
FINANCIAL MARKET
Money Market Capital Market
Equity/Stock Debt/Bond
Market Market
Primary Market A primary market is a financial market in which new Primary Market
issues of a security, such as a bond or a stock, are
Secondary Market sold to initial buyers by the corporation or Secondary Market
government agency borrowing the funds.
The Primary Market
§ The primary markets for securities are not well known to the
public because the selling of securities to initial buyers often
takes place behind closed doors.
§ An important financial institution that assists in the initial sale of
securities in the primary market is the investment bank.
§ The investment bank does this by underwriting securities: It
guarantees a price for a corporation’s securities and then sells
them to the public.
Financial Market: Secondary Markets
FINANCIAL MARKET
Money Market Capital Market
Equity/Stock Debt/Bond
Market Market
Primary Market A secondary market is a financial market in which Primary Market
securities that have been previously issued can be
Secondary Market resold (e.g. foreign exchange markets, futures Secondary Market
markets, and options markets)
Financial Market: Secondary Markets
FINANCIAL MARKET
Money Market Capital Market
Equity/Stock Debt/Bond
Market Market
Primary Market Secondary markets can be organized in two ways. Primary Market
1. Exchanges
Secondary Market 2. Over-the-Counter Markets Secondary Market
The Secondary Market
§ Securities brokers and dealers are crucial to a well-functioning
secondary market.
§ Brokers are agents of investors who match buyers with sellers
of securities; dealers link buyers and sellers by buying and
selling securities at stated prices.
The Function of Secondary Market
§ First, they make it easier and quicker to sell these financial § Second, secondary markets determine the price of the
instruments to raise cash; that is, they make the financial security that the issuing firm sells in the primary
instruments more liquid. market.
§ The increased liquidity of these instruments then makes § The higher the security’s price in the secondary
them more desirable and thus easier for the issuing firm to market, the higher the price the issuing firm will
sell in the primary market. receive for a new security in the primary market, and
hence the greater the amount of financial capital it can
raise.
Introduction
An Overview of the Financial System
Why Study Monetary Economics
Structure of the Course
The Importance of Financial Market
Money is linked to changes in economic
Money variables that affect all of us and are
important to the health of the economy such
as business cycle, inflation.
Financial Financial
Market Institutions
Interest Rates
The Importance of Financial Market
Money
§ Financial intermediaries can substantially reduce
transaction costs (the time and money spent in carrying
Financial Financial out financial transactions)
Market Institutions § Financial intermediaries can help reduce the exposure of
investors to risk - through the process known as risk
sharing
§ Financial intermediaries can help reduce adverse
selection and moral hazard.
Interest Rates
The Importance of Financial Market
Money
Financial Financial
Market Institutions
Interest rates are important on a number of level:
§ On a personal level, high interest rates might deter
consumers from buying because the cost of financing would
Interest Rates be high, vice versa.
§ On a more general level, interest rates have an impact on the
overall health of the economy because they affect not only
consumers’ willingness to spend or save, but also
businesses’ investment decisions.
The Importance of Financial Market
Money
Economic
Financial Financial
Market Institutions well-being of
countries
Activities in financial markets have direct effects on:
§ Individuals' wealth,
Interest Rates
§ The behavior or businesses, and
§ The efficiency of our economy.
The Importance of Financial Market
Money
Economic
Financial Financial
Market Institutions well-being of
countries
§ Well-functioning financial markets are a key
factor in producing high economic growth
Interest Rates § Poorly-performing financial markets are one
reason that many countries in the world
remain desperately poor
Financial Markets: A Recap
§ Financial markers are crucial to promoting a greater
economic efficiency by channeling funds from people who do
not have a productive use for them to those who do
§ Indeed, well-functioning financial markers are a key factor in
producing high economic growth
§ Activities in financial markets also have direct effects on
personal wealth, the behavior of businesses and consumers,
and the cyclical performance of the economy
Why Monetary Economics?
The course stresses the economic way or thinking by developing
a unifying analytical framework for the study of money, banking,
and financial markets using a few basic economic principles.
Introduction
An Overview of the Financial System
Why Study Monetary Economics
Structure of the Course
Structure of the Course: Part I
This part are introductory and contain an overview of the
Financial System roles of financial markets in the economy:
§ Examining the role of financial markets and
financial intermediaries?
FINANCIAL MARKET § Discussing why financial industries are the most
heavily regulated businesses in the economy?
§ Discussing how financial innovation takes place
Financial Institutions § Discussing financial crisis
Structure of the Course: Part II
This part discuss the essence of money in the economy:
Money
§ Discussing the definition and role of money
§ Relationship between money and payment
system
FINANCIAL MARKET § Deriving demand for money
§ Examining how money supply is determined
Financial Institutions
Money and Macroeconomy
Structure of the Course: Part III
This part contain an overview of the roles of interest rate
Money
in the economy:
§ Discussing interest rate and financial system
§ Examining how the overall level of interest rates is
FINANCIAL MARKET determined and which factors influence their behavior
§ Examining the relationship of the various interest rates
to one another
Interest Rates
Structure of the Course: Part IV
Financial Authorities This part contains the role that central banks play in
financial markets and the overall economy:
§ Discussing how central banks work and what
motivates their behavior
FINANCIAL MARKET § Examining how money supply is determined
§ Discussing policy tools that central banks can use to
manipulate the money supply and interest rates
Financial Institutions § Examining how central banks should conduct
monetary policy
Structure of the Course: Part V
FINANCIAL MARKET THE WHOLE ECONOMY
This part discusses the relationship between financial market and economy:
Financial Institutions
§ Discussing the more intricate IS-LM model of how aggregate output is determined, in which
monetary policy plays an important role
§ Discussing why inflation is a monetary phenomenon
§ Discussing the mechanisms through which monetary policy affects the economy.
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