Tema 1 Ifim

International Financial Institutions and Markets
LESSON 1. Introduction to Money and Banking

Introduction
- Money is an officially issued legal tender that typically consists of notes and coins.
- Has taken many different forms throughout history
- Money is the circulating medium of exchange as defined by a government.
- Money is often synonymous with cash and includes various instruments such as checks.
- Each country has its own money that it and its residents exchange for goods within its borders.
Money is a
1. Medium of exchange
2. Unit of account
3. Store of value
Properties of money
Divisible when we buy something, money should have that characteristic to be allocated in different
amounts or numbers.
Fungible which means it should allow people to interchange
Portable which means it should enable people to carry it anywhere.
Durable it should last
Acceptable Acceptable to people anywhere and everywhere
Limited in supply to maintain its circulation and inherent
value
Evolution of money
Barter - Gold-Metal coins – Paper money – plastic cards – electronic money – cryptocurrencies
BANKS
A bank is a financial institution licensed to receive deposits and make loans. Banks may also provide financial
services, such as wealth management, currency exchange, and safe deposit boxes.
There are three types of banks:
1. Commercial/retail banks,
2. Investment banks,
3. Public banks
In most countries, banks are regulated by the national government or central bank
Financial markets
Any marketplace where the trading of securities occurs, including the stock market, bond market, forex markets and
derivatives market.
Derivative Financial contract whose value is dependent on an underlying asset, group of assets or
benchmark
Bond A fixed-income instrument that represents a loan made by an investor to a borrower
(typically corporate orr governmental)
Capital Markets The venues where funds are exchanged between buyers (capital suppliers) and sellers
in the form of equity securities, bonds, or other financial assets
Forex Market Where banks, funds and individuals can buy or sell currencies for hedging and
speculation
The relevance of monetary policy
Because money can affect many economic variables important to the well-being of our economy ➔ politicians and
policymakers throughout the world care about the conduct of monetary policy, the management of money and
interest rates.
- The organization responsible for the conduct of a nation’s monetary policy is the central bank.
- Central banks affect interest rates and the quantity of money in the economy and then look at how
monetary policy is actually conducted.
LESSON 2. THE FUNCTIONS OF MONEY

What is money?
- Economists define money as anything that is generally accepted in payment for goods or services or in the
repayment of debts.
- When most people talk about money, they re talking about currency (paper money and coins).
Economists make a distinction between money in the form of currency, demand deposits, and other items that are used
to make purchases and wealth.
- Wealth includes not only money but also other assets such as bonds, common stock, art, land, furniture, cars, and
houses.
- People also use the word money to describe what economists call income, as in the sentence
Income is a flow of earnings per unit of time. Money, by contrast, is a stock: it is a certain amount at a given point in
time. Refers to anything that is generally accepted in payment for goods and services or in the repayment of debts and
is distinct from income and wealth.
Examples: If someone tells you that he has an income of $1000, you cannot tell whether he earned a lot or a little with
out knowing whether this $1000 is earned per year, per month, or even per day.
Examples: But if someone tells you that she has $1000 in her pocket, you know exactly how much this is.
Money has three primary functions in any economy:
Medium of exchange Unit of account Store of value.

An intermediary unit used to A nominal monetary unit of An asset that retains its
facilitate trade measure used to represent purchasing power into the
the “real” value of an item future
1. Medium of exchange
- Money in the form of currency or cheques is a medium of exchange; it is used to pay for goods and services.
- The use of money as a medium of exchange promotes economic efficiency by eliminating much of the time spent
in exchanging goods and services.
Many commodities can serve effectively as money, but there are several criteria to be met:
1. It must be easily standardized, making it simple to ascertain its value;
2. it must be widely accepted;
3. it must be divisible so that it is easy to make change;
4. it must be easy to carry; and
5. it must not deteriorate quickly

→ BARTER ECONOMY (trueque)
Trading goods or services between two or more parties without the use of money
The time spent trying to exchange goods or services is called a transaction cost, in barter economy transaction costs
are high because people have to satisfy a double coincidence of needs, desires, objectives…
= money promotes economic efficiency by eliminating much of the time spent exchanging goods and services.
Money is therefore essential in an economy:
- it is a spillover allowing the economy to run more smoothly

- It lowers transaction costs,
- It encourages specialization
- It favours the division of labour
2. Unit of Account
We measure the value of goods, resources and services in terms of money, just as we measure weight in terms of
kilograms or distance in terms of kilometers.
Example: If the economy has only three goods, say, peaches, economics lectures, and movies, then we need to know
only three prices to tell us how to exchange one for another: the price of peaches in terms of economics lectures (that
is, how many economics lectures you have to pay for a peach), the price of peaches in terms of movies, and the price
of economics lectures in terms of movies.
- Introduce money into the economy  have all prices quoted in terms of units of that money
- Enables citizens, governments, companies… to express, quote and compare the price of economics lectures,
peaches, and movies in terms of, say, dollars, euros, yens, yuans, pounds, crowns….
- We can see that using money as a unit of account reduces transaction costs in an economy by reducing the number
of prices that need to be considered.
- The more complex an economic system is, the more benefits introducing money has
Development as Economic Growth
Measured by GDP, GNP, GDP per capita, and growth rate..
3. Store of Value
Money also functions as a store of value; it is a repository (deposit) of purchasing power over time.
- What for? Keep purchasing power from the time income is received until the time it is spent.
- Income is not spent immediately.
- Basics of savings – consumption – investment - welfare economy……
Money is not unique as a store of value; any asset, whether money, stocks, bonds, land, houses, art, or jewelry, can be
used to store wealth (riqueza)
- Many such assets have advantages over money as a store of value

- Other assets (diamonds, stocks, shares….) often
- Pay the owner a higher interest rate than money
- Experience price appreciation
- Deliver services such as providing a roof over one’s head.
If these assets are a more desirable store of value than money, why do people hold money at all? Liquidity
Meaning: the relative ease and speed with which an asset can be converted into a medium of exchange
Liquidity is highly desirable in any economic system
- Money is the most liquid asset of all assets because it is also a medium of exchange; it does not have to be converted
into anything else in order to make purchases.
- Other assets involve transaction costs when they are converted into money
Another key idea: the value of money
How good a store of value money is depends on the price level, because its value is fixed in terms of the price level.
Example: A doubling of all prices means that the value of money has dropped by half . Conversely, a halving of all prices
means that the value of money has doubled
- Typical: high inflation periods increase price level rapidly

- Money loses value notably
- Governments, firms, companies, more reluctant (unwilling) to hold their wealth in this form
Cases: This is especially true during periods of extreme inflation, known as hyperinflation, in which the inflation rate
exceeds 50% per month.
Evolution of the payment system
The payments system is the method of conducting transactions in the economy.
Where the payments system is heading has an important bearing on how money will be defined in the future.
- Readiness, movement of the economy

- Social relations
- Macroeconomics of the country
Commodity Money
- For any object to function as money, it must be universally acceptable; everyone must be willing to take it in
payment for goods and services.
- Money made up of precious metals or another valuable commodity is called commodity money.
- The problem: such a form of money is very heavy and is hard to transport from one place to another.
Fiat Money
- Definition; type of currency that’s issued by the government and is not backed by physical commodities, such as
gold. The U.S dollar, the euro and the pound are examples of fiat money
The next development in the payments system was paper currency (pieces of paper that function as a medium of
exchange).
Paper currency decreed by governments as legal tender (meaning that legally it must be accepted as payment for debts)
but not convertible into coins or precious metal
Characteristics
- Much lighter than coins or precious metal

- Can be accepted as a medium of exchange only if there is some trust in the authorities who issue it
- Printing has reached a sufficiently advanced stage that counterfeiting (fake) is extremely difficult.
Major drawbacks of paper currency and coins are that
- They are easily stolen or counterfeited.

- Can be expensive to transport because of their bulk if there are large amounts.
To combat this problem, another step in the evolution of the payment system occurred with the development of
modern banking: the invention of cheques.
Cheques
A cheque is an instrument from you to your bank. Used to transfer money from your account to someone else’s account
when she deposits the cheque.
Cheques allow transactions to take place without the need to carry around large amounts of currency.
- The use of cheques thus reduces the transportation costs associated with the payments system and improves
economic efficiency.
- Cheques are advantageous in that loss from theft is greatly reduced, and they provide convenient receipts for
purchases. (crossed)
- However, there are two problems with a payments system based on cheques
First
- It takes time to get cheques from one place to another, a particularly serious problem if you are paying someone in
a different location who needs to be paid quickly.
- Usually takes several business days before a bank will allow you to make use of the funds from a cheque you have
deposited.
- If your need for cash is urgent, this feature of paying by cheque can be frustrating
Second
- All the paper shuffling required to process cheques is costly. (Paperwork)
Electronic Payment
The development of inexpensive computers and the spread of the Internet now make it cheap to pay bills electronically.
In the past, you had to pay your bills by mailing a cheque. Recurring bills can be automatically deducted from your bank
account
Electronic payment technology can not only substitute for cheques, but can substitute for cash, as well, in the form of
electronic money (or e-money), money that exists only in electronic form.
The first form of e-money was the debit card.
- Enable customers to purchase goods and services by electronically transferring funds directly from their bank
accounts to a merchant’s account.
- Becoming faster to use than cash.
Stored-value cards: Simplest form is prepaid like phone cards.
Smart cards: Advanced version with computer chips for loading digital cash.
E-cash: Used online, transferred from bank account to merchant electronically.
Potential for a cashless society with widespread electronic payment adoption.
Measuring Money
Why is money such a valuable asset? People believe it will be accepted by others when making payment.
- To measure money, we need a precise definition that tells us exactly what assets should be included.
- The problem of measuring money has become especially crucial because extensive financial innovation has
produced new types of assets that might properly belong in a measure of money. (cryptocurrencies?)
How reliable are money data?
For example, monetary aggregates that grow too rapidly may cause fear of over inflation.
- If there is a greater amount of money in circulation than what is needed to pay for the same amount of goods and
services, prices are likely to rise.
- If over inflation occurs, central banking groups may be forced to raise interest rates or stop the growth in money
supply.
RESUMEN TEMA 2
 Money defined: Accepted payment for goods/services, repayment of debts.

 Functions: Medium of exchange, unit of account, store of value.
 Benefits: Facilitates trade, lowers transaction costs, encourages specialization.
 Challenges: Inflation affects value as a store of value.
 Evolution of payments system.
 Central banks define various money supply measures.
 Measures not interchangeable, affect monetary policy.
 Accuracy of money measurement varies, more reliable over longer periods.
LESSON 3. Banking industry. Structure and competition

What Is a Dual Banking System?
A dual banking system is the system of banking that exists in the United States in which state banks and national banks
are chartered and supervised at different levels. Under the dual banking system, national banks are chartered and
regulated under federal law and standards and supervised by a federal agency.
- State banks chartered and regulated under state laws

- Supervised by a state supervisor
- Variances in credit regulation, legal lending limits, and
regulations across states
- Dual structure of state and federal banking systems enduring
over time
- Considered necessary by most economists for a healthy
banking system
National banks; offer efficiencies that come from economies of scale and product and service innovations derived from
the application of greater resources
State banks; on the other hand, are more nimble (agile/quick) and flexible in responding to the unique needs of
customers in their own states.
Bank of the United States.
Banking industry in the US initiated with the chartering of the Bank of North America in Philadelphia in 1782. Early
controversy centered around whether federal or state governments should charter banks.Federalists, led by Alexander
Hamilton, advocated for centralized control and federal chartering of banks. Resulted in the establishment of the Bank
of the United States in 1791. Until 1863, all commercial banks were chartered by state banking commissions.
Lack of national currency led banks to rely on issuing banknotes for funding. Due to lax regulations in many states, banks
frequently failed, causing their banknotes to become worthless. State banks survived by acquiring funds through
deposits.
 Today, the US operates under a dual banking system with both federal and state supervised banks coexisting.
Money Market Mutual Fund? MMMF
A money market fund is a kind of mutual fund that invests only in
- highly liquid instruments such as cash, cash equivalent securities,

- high credit rating debt-based securities
- with a short-term, maturity—less than 12 months.
= As a result, these funds offer high liquidity with a very low level of risk
How does a Money Market Fund Work?

- Also called money market mutual funds, money market funds work like any mutual fund.
- They issue redeemable units or shares to investors and are mandated to follow the guidelines drafted by
financial regulators, like those set by the U.S. Securities and Exchange Commission (SEC).
- Returns from these instruments are dependent on the applicable market interest rates, and therefore the
overall returns from the money market funds are also dependent on interest rates
A money market fund may invest in the following types of debt-based financial instruments:
- Bankers' Acceptances (BA)—short term debt guaranteed by a commercial bank

- Certificates of deposit (CDs)—bank-issued savings certificate with short-term maturity
- Commercial paper—unsecured short-term corporate debt
- Repurchase agreements (Repo)—short-term government securities
- U.S. Treasurys—short-term government debt issues
Bruce Bent, one of the originators of money market mutual funds, almost brought down the industry during the
subprime financial crisis in the fall of 2008.
 In 2008, the subprime financial crisis struck, triggered by the housing market collapse in the US. It caused mortgage
defaults, bank failures, and a global recession, prompting government interventions to stabilize the economy.
When Lehman Brothers went into bankruptcy on September 15, 2008, the Reserve Primary Fund, with assets of over
$60 billion, was caught holding the bag on $785 million of Lehman’s debt, which then had to be marked down to zero.
- The resulting losses meant that on September 16, Bent’s fund could no longer afford to redeem its shares at the
par value of $1, a situation known as breaking the buck.
Bent’s shareholders began to pull their money out of the fund, causing it to lose 90% of its assets.
→ The fear of a similar scenario occurring in other money market mutual funds prompted a classic panic, with
shareholders rapidly withdrawing their funds. The possibility of a widespread collapse of the entire money
market mutual fund industry loomed large. To prevent this potential catastrophe, the Federal Reserve and the
US Treasury stepped in on September 19, 2008, with a significant intervention famously known as the "bailout."
LESSON 4. Understanding central banks

What is a Central Bank
A central bank is a financial institution given privileged control over the production and distribution of money and
credit for a nation or a group of nations.
- In modern economies, the central bank is usually responsible for the formulation of monetary policy and the
regulation of member banks.
- Central banks are inherently non-market-based or even anticompetitive institutions.
- Although some are nationalized, many central banks are not government agencies, and so are often touted as
being politically independent. However, even if a central bank is not legally owned by the government, its
privileges are established and protected by law.
- The critical feature of a central bank is its privilege to issue cash
How a central bank works
1. Control and manipulate the national money supply

- Issuing currency
- Setting interest rates on loans and bonds
Typically, central banks raise interest rates to slow growth and avoid inflation; they lower them to spur growth,
industrial activity, and consumer spending.
In this way, they manage monetary policy to guide the country's economy and achieve economic goals, such as
full employment
2. Regulate member banks

- Capital requirements
- Reserve requirements (which dictate how much banks can lend to customers, and how much cash they must keep
on hand)
- Deposit guarantees, among other tools.
They also provide loans and services for a nation’s banks and its government and manage foreign exchange
reserves.
3. Emergency lender to distressed commercial banks and others institutions, sometimes even a government
Examples: By purchasing government debt obligations the central bank provides a politically attractive alternative
to taxation when a government needs to increase revenue.
Monetary policy – set interest rates

Ensure stability – stable banking system
Function of Central Bank Lender of last resort – lender to commercial banks
Lender of last resort – lender to government
Issue Money – currency notes and coins
Central Banks and the Economy
Central banks have other actions at their disposal
For example: In the U.S. the central bank is the Federal Reserve System, aka the Fed.
The Federal Reserve Board, the governing body of the Fed, can affect the national money supply by changing
reserve requirements.
- When the requirement minimums fall, banks can lend more money, and the economy’s money supply climbs. In
contrast, raising reserve requirements decreases the money supply.
- When the Fed lowers the discount rate that banks pay on short-term loans, it also increases liquidity.
- Lower rates increase the money supply, which in turn boosts economic activity.
- Decreasing interest rates can fuel inflation, so the Fed must be careful.
History of Central Banks
→ The first prototypes for modern central banks were the Bank of England and the Swedish Riksbank, which date
back to the 17th century.
→ The Bank of England was the first to acknowledge the role of lender of last resort.
→ Other early central banks, notably Napoleon’s Bank of France and Germany's Reichsbank, were established to
finance expensive government military operations.
→ United States have both official national banks and numerous state-chartered banks for the first decades of
its existence, until a “free banking period” was established between 1837 and 1863.
→ The National Banking Act of 1863 created a network of national banks and a single U.S. currency, with New
York as the central reserve city
→ The United States subsequently experienced a series of bank panics in 1873, 1884, 1893, and 1907.
→ In response, in 1913 the U.S. Congress established the Federal Reserve System and 12 regional Federal Reserve
Banks throughout the country to stabilize financial activity and banking operations.
→ The new Fed helped finance World War I and World War II by issuing Treasury bonds.
CENTRAL BANKS AND DEFLATION
- Deflation: The decline in prices for goods and services

- Value deflation: When retailers and service providers cut their costs and sell smaller packages, give out smaller
portions, or generally provide less so as to maintain the same sticker price
Quantitative easing; a form of monetary policy in which a central bank purchases securities on the open market to
achieve a desired outcome
- QE essentially involves a central bank creating new money and using it to buy securities from the nation's banks
so as to pump liquidity into the economy and drive down long-term interest rates.
ECB (European Central Bank)
In January 2015, the European Central Bank (ECB) embarked on its own version of QE, by pledging (promise) to buy at
least 1.1 trillion € worth of bonds, at a monthly pace of 60 billion euros, through to September 2016.
The ECB launched its QE program six years after the Federal Reserve did so, in a bid to support the fragile recovery in
Europe and avoid deflation
Previously, the ECB had cut the benchmark lending rate below 0% in late-2014
While the ECB was the first major central bank to experiment with negative interest rates, a number of central banks
in Europe, including those of Sweden, Denmark, and Switzerland, have pushed their benchmark interest rates below
the zero bound.
Results of Deflation-Fighting Efforts
- The measures taken by central banks seem to be winning the battle against deflation, but it is too early to tell if
they have won the war.
- Meanwhile, the concerted moves to reject deflation globally have had some strange consequences, namely three
- QE could lead to a covert currency war
- European bond yields have turned negative
- Central bank balance sheets are inflated
QE could lead to a covert currency war:
- QE programs have led to major currencies plunging across the board against the U.S. dollar.
- With most nations having exhausted almost all their options to stimulate growth, currency depreciation may be
the only tool remaining to boost economic growth, which could lead to a covert currency war
Modern central bank issues
→ Major central banks like the Federal Reserve and the European Central Bank are facing pressure to shrink their
balance sheets, which expanded significantly during recessionary periods.
→ Over the past decade, the top 10 central banks have increased their holdings by 265%.
→ However, reducing these large positions is likely to unsettle the market because an influx of supply may
suppress demand, especially at the brink.
→ Additionally, in less liquid markets such as Mortgage-Backed Securities (MBS), central banks have emerged as
the primary buyers.
Central Banks and Monetary/ Fiscal Policy
Monetary policy: Refers to action central banks take to pursue objectives such as price stability and maximum
employment.
Fiscal Policy: Refers to the government’s revenue collection and spending decisions (congress and the
administration)
RETAIL BANKS INVESTMENT BANKS CENTRAL BANKS

Provides credit cards for customers Advise businesses wanting to borrow Provides a depositors’ protection
money in bond markets (debt) scheme
Provides personal loans for Advise businesses wanting to issue Acts as a banker to the banking
customers shares (equity) system i.e. Commercial banks
Currency exchange for people Advise businesses on strategy and Acts as a banker to the government
travelling growth (Mergers and acquisitions)
Mortgage lending for people to buy Buy and sell financial assets to make Regulates the domestic banking
homes a profit system
Provides savings and current Sets the official short-term rate of
accounts for individuals interest (base or bank rate)
Arranges overdraft facilities for Manages the national debt and
customer accounts Controls the money supply
Influences the value of a nation’s
currency
Holds the nation’s gold and money
supply
LESSON 5- The supply money process

Money supply; All the currency and other liquids instruments in a country’s economy on the date measured
The cast of characters in the money supply system
1. The central banks

- The financial agencies
- overseeing the banking system
- being responsible for the conduct of monetary policy
2. Banks
- depository institutions and/or
- financial intermediaries
- Accept deposits from individuals and institutions and make loans: chartered banks and nearby banks.
3. Depositors
- individuals and institutions that hold deposits in banks
 Example of model of money supply: the U.S

1. The Federal reserve; responsible for controlling the money supply and regulating the banking system
2. The banking system: creates the checking accounts that are a major component of M1
3. The nonbank public (all households and firms): decides the form in which they wish hold money (e.g.
currency vs checking deposits)
Key takeaways
- Money supply is the total quantity of money in circulation at a point in time

- Changes in the money supply are closely watched because of the relationship between money and macro
economic variables such as inflation
- The money supply can be measured in a various ways using narrower or broader definitions of which classes of
financial assets are considered to be money
The Worldwide Decline in Reserve Requirements
Reserve Requirements:
When people put money into banks, the banks need to

keep some of that money on hand. This is to make sure
they have enough to give back to customers who want to
take their money out or write checks.
RESERVE RATIO  The % of a commercial bank’s

deposits that it must keep in cash as a reserve in case of
mass customer withdrawals (retiro de dinero)
Why Required Reserves are Needed:
1. Monetary Control:
Central banks use reserve requirements to control how much money is flowing in the economy. By changing these
requirements, they can make it easier or harder for banks to lend money. This affects how much people are borrowing
and spending, which can impact the economy.
2. Depositor Protection:
Required reserves are like a safety net for depositors. If a bank doesn't have enough reserves and too many people want
their money back at once, it can cause problems. Requiring banks to keep reserves helps make sure customers can
access their money when they need it.
3. Banking System Stability:
Having enough reserves helps keep the banking system strong. If one bank runs into trouble and can't pay its debts, it
could affect other banks. Required reserves act as a cushion, making sure banks can handle unexpected situations
without causing a crisis.
In recent years, however, central banks in many countries in the world have been reducing or eliminating their reserve
requirements.
- In the euro area the required reserve ratio is 2% of bank deposits, while in the United States it is 3% (rising to
10% for large deposits).
- Canada has gone a step further: financial market legislation in 1992 eliminated all reserve requirements over a
two-year period.
- The central banks of Switzerland, New Zealand, and Australia have also eliminated reserve requirements almost
on its entire
No Interest Earned on Reserves:
Banks don't earn any interest on the reserves they're required to keep. So, they miss out on potential earnings they
could have made if they lent out that money instead.
Higher Cost for Banks:
Because banks have to set aside money for reserves, it means they have less money available to lend out and earn
interest on. This makes their overall cost of doing business higher compared to other financial institutions that don't
have to keep reserves. As a result, banks might be less competitive in terms of offering lower interest rates or other
benefits to customers.
IMPACT OF RESERVE REQUIREMENTS AND REQUIRED RESERVES ON BANKS
- Positive impact on financial stability

- Negative impact on profitability
- Impact on lending
Central banks have thus been reducing reserve requirements to make banks more competitive and stronger.
- Although central banks have been reducing or eliminating their reserve requirements, banks still want to hold
reserves to protect themselves against predictable and unpredictable cash and clearing drains.
THE GREAT DEPRESSION BANK PANICS, 1930 – 1933
What Happened?
It began with the U.S. stock market crash of 1929 until 1946.
- Bank Failures :Many banks failed during this time due to a combination of factors including economic downturn,
widespread unemployment, and a collapse in the stock market.
- Bank Runs: People lost confidence in the banking system and rushed to withdraw their money from banks. This
created a domino effect where banks couldn't meet the demands of depositors, leading to more failures.
- Loss of Savings: As banks failed, people lost their savings because there was no deposit insurance to protect
them at that time. This contributed to the financial hardship experienced by millions of Americans during the
Great Depression.
Impact:
- Economic Collapse: The banking crisis worsened the economic downturn, leading to widespread
unemployment, poverty, and a significant decrease in economic activity.
- Government Response: In response to the banking crisis, the U.S. government implemented various measures,
including the establishment of the Federal Deposit Insurance Corporation (FDIC) in 1933, which insured bank
deposits and restored confidence in the banking system.
- Legacy: The Great Depression and the banking crisis that accompanied it led to significant changes in banking
regulations and financial policies to prevent such a catastrophic event from happening again.
GREAT DEPRESSION AND THE MONEY SUPPLY MODEL
Money supply: The money supply represents the total amount of money circulating in the economy. During the Great
Depression, the money supply contracted significantly due to various factors, including bank failures, bank runs, and a
decrease in lending.
Money demand: the desire of individuals and businesses to hold money for transactions and as a store of value. During
the Great Depression, the demand for money increased as people lost confidence in banks and preferred to hold cash
rather than depositing it in banks.
Money Supply Shock: The Great Depression can be viewed as a negative money supply shock in the money supply
model. The contraction in the money supply was primarily driven by bank failures and the resulting decrease in lending
activity. This shock led to a decrease in the availability of credit and a reduction in spending and investment.
Impact on Economic Activity: The decrease in the money supply had severe repercussions on economic activity. With
less money available for spending and investment, aggregate demand fell sharply. This decline in demand led to
widespread unemployment, decreased production, and a general economic downturn.
Government Steps In; To fix things, the government created programs like the FDIC to make people trust banks again.
They also tried to inject more money into the economy to get people spending again.
Slow Recovery: Even with these efforts, it took a long time for the economy to recover fully from the Great Depression.
KEY POINTS
- There are three players in the money supply process: the central bank, banks (depository institutions), and
depositors
- The monetary base consists of currency in circulation and reserves.
Many factors affect a country’s monetary base, such as holdings of securities and investments, advances,
foreign currency assets, securities purchased under resale agreements, currency outstanding, other assets,
government deposits, securities sold under repurchase agreements.
- Central banks control the monetary base through open market operations and reserves.
- A single bank can make loans up to the amount of its excess reserves, thereby creating an equal amount of
deposits.
- The money supply is positively related to the non-borrowed monetary base (open market operations) and the
level of borrowed reserves from central banks
- The money supply process takes into account the behaviour of all three players in the market
1. the central bank through open market operations and lending
2. depositors through their decision about their holding of currency;
3. banks through their decisions about desired reserves, which are also influenced by depositors decisions
about deposit outflows.
Money supply;
- Entire stock of currency and other liquid instruments circulating in a country's economy as of a particular time.
- Can include cash, coins, and balances held in checking and savings accounts, and other near money substitutes
- Economists analyze the money supply as a key variable to understanding the macroeconomy and guiding
macroeconomic policy
Monetary Base
- Total amount of a currency that is either in general circulation in the hands of the public or in the commercial
bank deposits held in the central bank's reserves
- This measure of the money supply typically only includes the most liquid currencies; it is also known as the
"money base.”
LESSON 8. Money and Inflation

Inflation refers to the general increase in prices of goods and services over time.
It represents a decrease in the purchasing power of money, meaning that each unit of currency buys fewer goods and
services.
- Inflation is often measured by the Consumer Price Index (CPI) or the Producer Price Index (PPI), which track
the changes in the prices of a basket of goods and services over time.
- It can be caused by various factors including increased demand, supply shortages, expansionary monetary
policies (printing more money), rising production costs, or external factors such as changes in exchange rates
or commodity prices.
- Moderate inflation is considered healthy for an economy as it encourages spending and investment, but high
or hyperinflation can lead to economic instability, erode savings, and reduce the standard of living.
Central banks often aim to maintain low and stable inflation rates through monetary policy tools such as interest
rate adjustments and open market operations.
Quantity Theory of Money
Increases in the quantity of money tend to create inflation, and vice versa
→ For example, if the Federal Reserve or European Central Bank (ECB) doubled the supply of money in the
economy, the long-run prices in the economy would tend to increase dramatically
This is because more money circulating in an economy would equal more demand and spending by
consumers, driving prices north.
The most important feature of this theory is that it suggests that interest rates have no effect on the demand for
money
Velocity of Money and Equation of Exchange
→ A measurement of the rate at which money is exchanged in an economy
Velocity of money is the average number of times per year that a dollar is spent in buying the total amount of goods
and services produced in the economy
If people use accounts and credit cards to conduct their transactions and consequently use money less often when
making purchases, less money is required to conduct the transactions generated by nominal income, and velocity
will increase.
Inflation can take three different shapes
- Demand-Pull inflation
When demand for goods/services exceeds production capacity
- Cost-Push inflation
When production costs increase prices
- Built-In inflation
When prices rise, wages rise too, in order to maintain living costs
Is inflation bad?
For a market: pros and cons
POSITIVE NEGATIVE
- Promotes investments, both by business and - May limit spending
individuals
- Expected better returns than inflation - Decreased money circulation will slow overall
economic activities
- Promote spending to a certain extent instead of - Negative or uncertain value of inflation
saving negatively impacts an economy
- May lead to unemployment
- International ramification
-
DEFLATION
General decline in prices for goods and services, typically associated with a contraction in the supply of money and
credit in the economy
- During deflation, the purchasing power of currency rises over time

- Deflation is usually associated with a contraction in the supply of money and credit, but prices can also fall
due to increased productivity and technological improvements
LESSON 9. International markets

What is a market?
- A market is a place where two parties can gather to facilitate the exchange of goods and services
- The parties involved are usually buyers and sellers
Technically speaking, a market is any place where two or more parties can meet to engage in an economic
transaction.
A market transaction may involve goods, services, information, currency, or any combination of these that pass
from one party to another.
What is a financial market?
Any marketplace where the trading of securities occurs, including the stock market, bond market,forex market
and derivative markets
- They are essential for the smooth functioning of capitalist economies by allocating resources and creating
liquidity.
- Well-functioning financial markets contribute to high economic growth.
- Poorly performing financial markets can hinder development in many countries.
Types of markets
- OTC markets (over the counter: stocks)

- Bond markets
- Money markets
- Derivatives market
- Forex market
Bond A fixed-income instrument that represents a loan made by investor to a borrower

(typically corporate or governmental)
Capital market The venues where funds are exchanged between buyers (capital supplier) and sellers in
the form of equity securities, bonds or other financial assets
Derivative market A type of financial contract whose value is dependent on an underlying asset, group of
assets or benchmark
Forex market Where banks, funds, and individuals can buy or sell currencies for hedging and speculation
LESSON 10. International financial institutions

An international financial institution (IFI) is a financial institution that has been established by more than one country
- Main International Organizations:
1. International Monetary Fund (IMF):
Purpose: Facilitates international monetary cooperation, promotes exchange rate stability, balanced trade, and
economic growth, and provides financial assistance to member countries facing economic difficulties.
- Cases: IMF intervention in countries like Argentina, Greece, and Ukraine during economic crises to provide
financial aid and implement structural adjustment programs.
2. World Bank Group:
Purpose: Aims to reduce poverty and support sustainable development by providing loans, grants, and technical
assistance for development projects in middle-income and low-income countries.
- Cases: Funding infrastructure projects, poverty alleviation programs, and educational initiatives in
countries such as India, Brazil, and Kenya.
3. General Agreement on Trade and Tariffs (GATT)
Agreement(s) to apply the multilateral principles of non-discrimination and reciprocity to matters of trade
Requirement that each country had to concede most favoured nation status to all trading partners.
- Basic principles
1. A trading system should be discrimination-free
2. A trading system should be more free where there should be little trade barriers
3. A trading system should be predictable to foreign companies and governments
4. A trading system should be more competitive.
5. A trading system should be more accommodating for less developed countries
- Main functions : reducing tariffs on manufactured goods ◦ eliminating non-tariff barriers and other
impediments to international trade, and ◦ acting as an arbiter in case of trade disputes between members
4. World Trade Organization (WTO):
Purpose: Facilitates trade negotiations, resolves trade disputes, monitors trade policies, and promotes the
liberalization of international trade.
- Cases: Adjudicating disputes between member states over issues like tariffs, subsidies, and intellectual
property rights, such as disputes involving the United States, European Union, and China.
ORIGIN
Just before the end of WWII, global leaders convened at Bretton Woods in 1944 to address post-war economic
stability.
Key actors included Harry D. White (US) and J.M Keynes (UK). They aimed to prevent economic instability and chaos
of the interwar period, focusing on unemployment and economic insecurity. The consensus was to establish a
framework of norms and rules. The resulting Bretton Woods system created three institutions: the IMF, World Bank,
and later the WTO.
Key principles included stable exchange rates to foster trade and some flexibility to accommodate full employment
concerns.
→ Bretton Woods
Countries worked together to make the world economy stable after World War II. Everyone agreed to use similar rules
for their money.
They created groups to lend money to countries that needed it to get back on their feet after the war. They wanted to
make sure money values stayed the same, so businesses and countries could plan better.
How it worked?
The Bretton Woods system worked by establishing fixed exchange rates between currencies, with each currency
pegged to the US dollar, which was in turn tied to gold. Here's how it worked:
1. Fixed Exchange Rates: Under the Bretton Woods system, countries agreed to fix the value of their currencies
in terms of the US dollar. For example, one British pound might be worth $2.80.
2. Pegging to Gold: The US dollar was convertible to gold at a fixed rate of $35 per ounce. This meant that other
currencies were indirectly linked to gold through their fixed exchange rates with the dollar.
3. Role of the IMF: The International Monetary Fund (IMF) was created to oversee the functioning of the Bretton
Woods system. It provided financial assistance to member countries experiencing balance of payments
problems and monitored exchange rate policies to ensure they were consistent with the agreed-upon rules.
4. Trade Balances: The system relied on countries maintaining balanced trade and payments. If a country
consistently ran large trade surpluses or deficits, it could put pressure on the fixed exchange rate system.
Three pillars of the system; 1. The International Monetary Fund to maintain order in the
international monetary system
- Exchange rate stability
- Recovery and development 2. The World Bank group to promote economic development
- Liberalization of international 3. The General Agreement on Trade and Tariffs (GATT) to promote
trade the world trading system
LESSON 11. The European Central Bank and the Economic and Monetary Union (EMU)
Origins
 The fixed exchange rate system from Bretton Woods ended in 1971.
 To reduce currency fluctuations, the European Monetary System (EMS) was created in March 1979.
 EMS introduced a reference currency called the European Currency Unit (ECU), made up of currencies from
member states.
What is the Economic and Monetary Union?
The Economic and Monetary Union (EMU) is a framework established by the European Union (EU) with the goal of
creating closer economic integration among its member states. Its main features include:
1. Single Currency: Introduction of the euro as the common currency for participating member states.
2. Monetary Policy: Centralization of monetary policy under the European Central Bank (ECB) to maintain price
stability.
3. Coordination of Economic Policies: Member states align fiscal policies and structural reforms to promote
economic stability and convergence.
4. Stability and Growth Pact: Establishment of rules to ensure fiscal discipline and maintain the stability of the
euro.
5. Common Institutions: Creation of common institutions like the Eurogroup and the Euro Summit to coordinate
economic and monetary policies among member states.
6. Economic Integration: Aim to foster closer economic integration among member states through the EMU
framework.
The 12 countries which introduced the Euro in 2001:
Austria ,Belgium ,Finland, France, Germany ,Greece ,Italy , Ireland ,Luxembourg ,Netherlands ,Portugal and Spain
→ Euro’s benefits
- International trade is facilitated
- Inflation remains low and stable
- European Central Bank keeps price inflation low so interest rates also remain low
- Currency exchange costs are eliminated
- Travelling is made easier
- Comparing prices is made simpler
EUROPEAN CENTRAL BANK (ECB)

The European Central Bank (ECB) took over from the European Monetary Institute (EMI) in 1998 and is responsible for
the monetary policy of the European Union (EU). It operates as a collegial system with the Governors of the Central
Banks of member states.
- Formed by: The ECB is comprised of decision-making bodies including the Executive Board and the
Governing Council, which consists of the ECB's President and Vice-President, along with the Governors
of the national central banks of eurozone countries.
- Governed by: The ECB is governed by the Treaty on the Functioning of the European Union (TFEU) and
the Statute of the European System of Central Banks (ESCB).
Its three main functions are:
1. Setting and implementing monetary policy to maintain price stability within the Eurozone.
2. Conducting foreign exchange operations and managing the official foreign reserves of the Eurozone countries.
3. Promoting smooth operation of payment systems within the Eurozone.
And is unique in the world because: It is the only central bank in the world that is responsible for a multinational
currency, the euro, without being the central bank of a single country.
LESSON 12. Financial crisis

→ A situation where assets drop sharply in value, businesses and consumers struggle to pay their debts,
and liquidity dries up.
In a financial crisis, asset prices see a steep decline in value, business and consumers are unable to pay their
debts, and financial institutions experience liquidity shortages.
A financial crisis is often associated with a panic or a bank run during which investors sell off assets or
withdraw money from savings accounts because they fear that the value of those assets will drop if they
remain in a financial institution.
Triggering effect:
- assets are overvalued, and can be exacerbated by irrational or herd-like (como rebaño) investor behavior.
- For example, a rapid string (net) of selloffs can result in lower asset prices, prompting individuals to dump
assets or make huge savings withdrawals when a bank failure is rumored
Financial crisis Economic crisis

Financial assets’ value fall rapidly in an economy A county experiences a sudden downturn due to a
financial crisis
= economic instability = depression or a recession
Contributing factors to a financial crisis include:
→ systemic failures
→ unanticipated or uncontrollable human behavior,
→ incentives to take too much risk,
→ regulatory absence or failures, or
→ contagions that amount to a virus-like spread of problems from one institution or country to the
→ next.
If left unchecked, a crisis can cause an economy to go into a recession or depression
- Even when measures are taken to avert (avoid) a financial crisis, they can still happen, accelerate, or deepen.
RECESSION: a significant and prolonged downturn in economic activity
➢ The great depression: the greatest and longest economic recession in modern worlds history that ran between
1929 and 1941
RECESSION DEPRESSION
Is generalized economic decline that last for at least 6 It is more severe decline that last for several years. (more
months sever than recession)
Negative impact on the economy, but generally less Severe and widespread economic hardship
severe
THE EURO DEBT CRISIS

A period of economic uncertainty int the Eurozone that began in 2009 and was triggered by high levels of public debt
- The crisis began in 2008 with the collapse of Iceland's banking system, spreading primarily to Portugal, Italy,
Ireland, Greece, and Spain by 2009, earning them the moniker "PIIGS." This led to a loss of confidence in
European businesses and economies.
- European countries and the IMF intervened with financial guarantees to prevent the collapse of the euro and
financial contagion, but rating agencies downgraded several Eurozone countries' debts, with Greece's debt
even reaching junk status. Bailout recipients were required to implement austerity measures to reduce public-
sector debt growth.
Further Effects:
Ireland, Portugal, and Spain required bailouts in subsequent years, with Italy and Spain also vulnerable. Although these
countries saw improvement by 2014 due to fiscal reforms and austerity measures, the path to full economic recovery
was longer than expected, especially considering challenges like
- the banking crisis in Italy

- potential instabilities triggered by Brexit
- economic impact of the COVID-19 outbreak.
What can IFIs do?
WB, ECB and international banks were questioned
The relevance of the IMF to global finance was fiercely criticised
Today, its influence is evident in both developed-and developing-country settings as world leaders respond to a
global economic crisis.
Three main tenets
→ forecasting the crisis (A)

→ acting as lender of last resort (AA+)
→ providing expertise in designing and supervising macroeconomic reforms (AAA)

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International Financial Institutions and Markets

LESSON 1. Introduction to Money and Banking

There are three types of banks:

The relevance of monetary policy

LESSON 2. THE FUNCTIONS OF MONEY

Money has three primary functions in any economy:

Medium of exchange Unit of account Store of value.

1. It must be easily standardized, making it simple to ascertain its value;

2. it must be widely accepted;

3. it must be divisible so that it is easy to make change;

4. it must be easy to carry; and

5. it must not deteriorate quickly

→ BARTER ECONOMY (trueque)

Money is therefore essential in an economy:

- it is a spillover allowing the economy to run more smoothly

Development as Economic Growth

Measured by GDP, GNP, GDP per capita, and growth rate..

- Many such assets have advantages over money as a store of value

Liquidity is highly desirable in any economic system

Another key idea: the value of money

- Typical: high inflation periods increase price level rapidly

Evolution of the payment system

The payments system is the method of conducting transactions in the economy.

- Readiness, movement of the economy

- Much lighter than coins or precious metal

Major drawbacks of paper currency and coins are that

- They are easily stolen or counterfeited.

- All the paper shuffling required to process cheques is costly. (Paperwork)

The first form of e-money was the debit card.

Stored-value cards: Simplest form is prepaid like phone cards.

E-cash: Used online, transferred from bank account to merchant electronically.

Potential for a cashless society with widespread electronic payment adoption.

How reliable are money data?

 Money defined: Accepted payment for goods/services, repayment of debts.

LESSON 3. Banking industry. Structure and competition

- State banks chartered and regulated under state laws

Bank of the United States.

Money Market Mutual Fund? MMMF

A money market fund is a kind of mutual fund that invests only in

- highly liquid instruments such as cash, cash equivalent securities,

How does a Money Market Fund Work?

- Bankers' Acceptances (BA)—short term debt guaranteed by a commercial bank

LESSON 4. Understanding central banks

- Central banks are inherently non-market-based or even anticompetitive institutions.

- The critical feature of a central bank is its privilege to issue cash

How a central bank works

1. Control and manipulate the national money supply

2. Regulate member banks

Monetary policy – set interest rates

Central Banks and the Economy

Central banks have other actions at their disposal

History of Central Banks

CENTRAL BANKS AND DEFLATION

- Deflation: The decline in prices for goods and services

ECB (European Central Bank)

Results of Deflation-Fighting Efforts

QE could lead to a covert currency war:

Modern central bank issues