Friday, August 01, 2008

Marathon S students: The syllabus for the short August semester can now be accessed via the link on the right.

NB: Marathon S begins on August 7. You are expected to begin the reading on that day. Our first class meets on Tuesday, August 12 (in Merrill 261 and at the remote sites) at 6:00. Our first test will be on Wednesday, August 13. I will expect you to have the reading for the first test completed before our first lecture.

Friday, January 04, 2008

Spring 2008 Students:

This class is being taught online this term. The syllabus and other class documents can now be accessed on BlackBoard.

Monday, November 26, 2007

Here is world income and population for the last 2000 years.

Wednesday, November 21, 2007

Here are some practice questions:

1)The British central bank is known as
A)the Bank of London.
B)the British Federal Reserve.
C)the Bank of England.
D)the Bank of the Empire.

2)Which of the following factors contributed to the problems that banks began to face during the 1960s and 1970s?
A)very low interest rates
B)prolonged periods of recession
C)banking regulations enacted during the 1930s
D)very low inflation rates

3)Government regulation of banks in the United States
A)changes slowly over time as knowledge of the best way to organize the system increases.
B)has remained essentially unchanged since the early twentieth century.
C)changes abruptly in response to periodic financial crises.
D)generally increases during election campaigns as politicians exploit the public's hostility toward banks.

4)Congress created the Federal Reserve System
A)to process the receipt of taxes received by the Internal Revenue Service.
B)to provide a source of mortgage loans to the residential housing market.
C)to serve as a lender of last resort.
D)to regulate the value of the U.S. dollar against foreign currencies.

5)The creation of a lender of last resort in the United States
A)occurred in response to the S&L crisis of the 1980s.
B)was mandated in the U.S. Constitution.
C)has been recommended by the Treasury in its report of late 1992.
D)occurred in response to banking panics.

6)Which of the following did NOT occur as a result of the weakness of the Fed's actions during the banking crisis of the early 1930s?
A)A federal system of deposit insurance was introduced.
B)Congress amended the Fed's charter to limit the convertibility of dollars into gold.
C)Congress amended the Fed's charter to broaden the permissible collateral for discount loans.
D)Congress amended the Fed's charter to require it to make discount loans to any banks requesting them.

7)In late 1998, the Fed averted a possible financial panic by
A)using its influence to encourage banks to make loans to broker-dealers in the securities industry.
B)lowering interest rates.
C)using its influence to bring together the creditors of Long-Term Capital Management.
D)raising interest rates.

8)Congress has attempted to reduce competition among banks in order to
A)increase the tax revenues generated from bank profits.
B)lower interest rates charged on bank loans.
C)make the process of check clearing easier.
D)reduce the chance of moral hazard in banks? behavior.

9)Anticompetitive restrictions on banks generally result in
A)the persistence of traditional ways of doing things.
B)a stifling of innovation.
C)a passive attitude on the part of bank managers as they realize attempts to compete vigorously have been closed off.
D)an increase in innovation and competition.

10)The Japanese central bank is known as
A)the Federal Japanese Bank.
B)the Grand Nippon Central Bank.
C)the National Japanese Bank.
D)the Bank of Japan.

11)Which of the following is an asset of the Fed?
A)reserves of banks
B)checkable deposits in commercial banks
C)discount loans to banks
D)currency in circulation

12)Which of the following is a liability of the Fed?
B)U.S. government securities
C)checkable deposits in commercial banks
D)discount loans to banks

13)Banks prefer to hold their liquid balances as
A)mortgage loans. B) required reserves.
C)marketable securities. D) excess reserves.

14)The Fed's portfolio of securities consists principally of
A)U.S. Treasury obligations.
B)corporate bonds.
C)municipal bonds.
D)obligations of foreign governments.

15)What is the most direct method the Fed uses to change the monetary base?
A)changing the level of discount loans
B)changing the federal funds rate
C)open market operations
D)changing the required reserve ratio

16)When banks borrow on the federal funds market,
A)they pay a rate set by the Federal Reserve, rather than one set by market forces.
B)they typically pay a lower interest rate than the discount rate.
C)they borrow funds interest free.
D)they typically pay a higher interest rate than the discount rate.

17)If banks do not hold excess reserves, the multiple deposit expansion process ends when
A)total new reserves equal total checkable deposits created.
B)total reserves equal excess reserves.
C)total loans created equal total checkable deposits created.
D)all excess reserves have been eliminated.

Tuesday, November 20, 2007

From Paul Krugman's NYT blog today:
First, we need a model. My starting point is to think of the Fed as setting “the” interest rate (more on that later), and facing two tradeoffs. On one side, the lower the interest rate the higher is employment. On the other side, the lower the interest rate the lower the dollar. In normal times the Fed tries to set the interest rate so as to achieve more or less full employment, and lets the dollar fall where it may.

Now along comes a change in investor expectations that makes the dollar weaker at any given interest rate. This also, with some lag, makes the economy stronger at any given interest rate, because a weaker dollar means stronger exports and less imports.

So what would we expect the effect of changing expectations that weaken the dollar to be? We’d expect it to lead to a weaker dollar (duh) and also higher interest rates — but the latter effect would happen only because the Fed is trying to offset the expansionary effect of that weaker dollar. It shouldn’t depress the economy at all.

OK, so how do we make this story more pessimistic?
Full post here.
These questions pertain to the previous two lectures (November 13 and 20).

Why are a bank's liabilities said to be its sources of funds? Why are a bank's assets said to be its uses of funds?

Why would government regulators and taxpayers like banks to have high net worth?

Describe the types of risk that banks face.

How do banks try to reduce credit risk?

What are floating rate loans? How do they help to reduce the interest rate risk for banks?

What are the major types of off-balance sheet activities in which banks engage? Why have banks been involved in more of these activities recently and less in traditional banking?

Suppose that banks collectively have not managed their exposure to interest rate risk well and that market interest rates increase and become more volatile. What do you predict will happen to the value of the equity capital in the banking industry? To the number of bank failures?

Suppose that Ann, who has an account at First Bank, writes a check for $1000 to Bill, who has an account at Melon Bank. When the check clears, how have the balance sheets of First and Melon been affected?

If you were a banker who believed that interest rates were going to rise, what would you try to do with your bank's portfolio?

What are credit scores and how are they computed?

See this article about the City of Leeds' efforts to obtain a $22.5 million line of credit (from the Jefferson County Commission) to attract a commercial and residential project. The county, which is overextended in such funding for such projects, is likely to reject the request. What would be the advantages and disadvantages if Leeds' accessed funds through the private sector? Is there significant default, credit, and interest rate risk? Which funding source would taxpayers prefer? And, how does the lack of interest on the part of the Jefferson County Commission reflect the opportunity cost of the proposed $1 billion dome project planned for downtown Birmingham?

Explain the US banking system before from 1787 to 1861. Why was the Hamiltonian banking system considered controversial? What type of regulatory structure were free banks subject to? What types of banks received state charters? What is dual banking?

Why was the Secret Service created? What effect on banking in the U.S. did the National Bank Act of 1863 have? What effect on banking did the Federal Reserve Act of 1913 have?

Why was Glass Steagall passed? Did it make the banking system in the US more competitive? What effect did it have on the demand curve for banking services?

What motivated Congress to pass deposit insurance legislation in the 1930s? How much was the original insurance coverage? Was the system intended to operate like an insurance program, with premiums paid by banks?

What was the McFadden Act? What factors contributed to the weakening of this Act? What role was played by holding companies?

Why were banks forbidden from paying interest up until 1970? What problems did this cause the banking industry before the 1970s? How did the government try to rectify these problems?

What is a credit crunch? What is disintermediation?

Why did Congress pass DIDMCA in 1980? What did it do?

What is universal banking? What are some advantages and disadvantages to universal banking? Can the banking system in the US today be characterized by universal banking?

Define: Return on Assets, Return on Equity, and Net Interest Margin? Look at this data on ROA, ROE, and NIM. Why is the significantly ROE larger?

(Here are some examples. Here is a list of average annual return on assets since 1934. Here is a list of bank failures, by year, from 1934 to 2003.)

What are the objectives of bank regulation? How are they contradictory?

How many banks fail each year, on average? Why? Should we conclude that the remaining banks run efficiently?

Here is the FDIC's page on Wal-Mart's application to start a bank from earlier this year. It was eventually rejected. Here and here are articles about the effort.

What is the "too big to fail doctrine"? Here and here are article about this doctrine applied to the case of Continental Illinois (as discussed in class and in our text).

Why were banks easy to blame for the Great Depression?

True, false, and explain: The dominant view today among economists is that the banks caused the Depression.

What are central banks and where do they come from?

What are the macroeconomic goals of the U.S. Federal Reserve? Explain in detail the purpose of Humphrey-Hawkins.

Why is price stability considered such an important goal relative to others? How successful has the Fed been in pursuing this goal?

What are the major assets and liabilities of the Federal Reserve System? Describe each briefly.

Explain how the Fed sets the reserve ratio. Are the reserve ratio and the money supply positively or inversely related? Define: excess reserves and fully loaned institution.

What is the money multiplier and how is it related to the money supply and the monetary base?

Define open market operations. How does the Fed know how much money it needs to increase (decrease) the monetary base through open market operations?

If the Fed wants to increase the money supply, should it make an open market purchase or sale? Should it make more discount loans or fewer? If the Fed wants to decrease the money supply, what should it do?

If a bank has $10,000 in excess reserves, what is the most new lending that it should do? Why shouldn't it do more than that amount?

A student remarks, "If any one bank can safely loan only an amount equal to its excess reserves, I don't understand how the banking system as a whole can loan out an amount equal to several times the initial excess reserves in the system." Resolve this seeming paradox.

What are dynamic and defensive transactions in open market operations?

Explain discount policy. What are its advantages (from the point of view of the Fed?)

Explain and give examples of adjustment, seasonal, and extended credits. Explain its use creating announcement effects.

Explain how the Fed uses margin requirements to achieve its goals. (Here is my article comparing asset bubbles in the 1920s and the 1990s.) What is moral suasion?

Friday, November 09, 2007

Greying Japan has a new weapon to scare people into saving for their retirement -- an exploding piggy bank.

The "Savings Bomb," which goes on sale in Japan next week, "explodes" and scatters coins if users fail to save for a long time, toy manufacturer TOMY Co Ltd said Thursday.

The battery-powered toy -- designed as a cartoon-style, ball-shaped black bomb with a skull and crossbones logo -- lights up, makes a noise, shakes violently and scatters coins if it is not topped up for a long time.

"Users must pick up and collect the scattered coins and reflect on their laziness," the Japanese company said.

Thursday, November 08, 2007

Explain the U.S. banking system, in general terms, between 1790 and the Civil War. What are the three parts? How did dual banking emerge from this era? Why were state-chartered private banks more likely to fail than the free banks?

How did this system change (i) during the Civil War, and (ii) after the Civil War?

Define Glass Steagal. Why were banks blamed for the Depression? How does more recent research question that view?

When did deposit insurance start, and what was the initial amount insured?

What are holding companies, and why were they allowed in 1956?

Thursday, November 01, 2007

Define: Bailment. Under what circumstances is fraud in the bailment industry more likely? Explain Jevons' contribution to understanding this industry.

Explain 100 percent warehousing and fractional reserve warehousing.

Why were bailment laws tightened in the grain industry and not in the banking industry in the 19th century? After all, both industries store homogeneous and fungible objects.

Why is fractional reserve banking less likely to be persist for the long run in an economy with a gold standard and competing currencies?

Explain the logic behind the Bretton Woods system. Which two policies discussed in class were especially important in causing the Bretton Woods system to fall apart? Why is Mundell an important economist in relation to the Bretton Woods system and its aftermath?

Tuesday, October 30, 2007

What is the neutrality assumption, and how is it illustrated in the "monetary fables" discussed in class? What is the quantity theory of money?

Explain how new money works it way through the economy. Who benefits from inflation (if anyone)? What is money illusion? What is inflation as a tax?

What is Gresham's Law?

Tuesday, October 23, 2007

How is the PBGC financed? Define defined benefit and defined contribution. What does backloaded mean?

As an employee of a large firm, you are given the choice between a defined benefit pension plan and a defined contribution pension plan. What are the advantages and disadvantages of each?

What are depository institutions and how are they related to the Fed? How were they traditionally segmented, and how are the segmented today?

Is a compulsory government-sponsored Social Security retirement annuity system as subject to adverse selection as a private insurance company that offers individual annuity contracts? Explain.

What is a depression and how it different from a deflation?

What is the neutrality assumption? How is the inflation rate measured?

Thursday, October 18, 2007

What are transaction costs and how can they be reduced by exploiting economies of scale?

Why do higher interest rates increase adverse selection in the loan market?

Distinguish symmetric information with asymmetric information, and state why the distinction is important for the financial system.

What is the difference between moral hazard and adverse selection? How does each contribute to making information asymmetric?

How is information collection in financial markets is subject to the free rider problem? How do banks overcome the free rider problem?

Explain, verbally and graphically, what the "lemons problem" is. How does the lemons problem lead many firms to borrow from banks rather than from individual investors?

Why might the number of loans that aren't repaid to banks rise as interest rates rise? What might be a better strategy for banks than raising interest rates?

Suppose that a bank makes a loan to a business and that the loan contract specifies that the business is not to engage in certain lines of business. What is this type of provision called? Why would the bank make such a provision?

What is the name of the main problem associated with the separation of ownership and management? What do managers do that owners don't like? What types of solutions are available?

Is a large firm with thousands of shareholders more or less likely to suffer a principal-agent problem than a small firm with just a few shareholders? Explain.

Why don't insurance companies sell income insurance? That is, if a person loses his or her job or doesn't get as big of a raise as anticipated, that person would be compensated under his or her insurance coverage.

Differentiate between investment bankers and securities brokers.

Define contractual saving. How do insurance companies know how high their premiums should be for life and accident insurance? What kinds of problems do they face in assessing risk?

CircleLending is a new Massachusetts-based company that administers loans between family members and friends. The interest rates are lower than the market rates. Listen to this NPR story about the company, and then evaluate its business in terms of transaction and information costs, and default and credit risks. Why is there a disparity between CircleLoan's rates and market interest rates? When might it make sense for a parent to loan money to a child (via CircleLending) even after a bank may have rejected the child's loan application?
Here is The Economist on the 1987 stock market crash.

Tuesday, October 16, 2007

Define adaptive and rational expectations. Give examples of each.

Would a liquid market be an efficient market? Why or why not?

In a market in which investors and traders have rational expectations, what should the price of an asset equal?

Give a concise definition of the efficient markets hypothesis. What assumptions does it require about liquidity and information?

If you believe that the stock market is an efficient market, why would an investment strategy of "buy and hold" be a good idea?

Why are fads inconsistent with the predictions of the efficient market hypothesis? Also define: revert to the mean, circuit breakers, the greater fool theory.

What is program trading? Does it play a significant role in increasing market volatility? What are some of the other problems with EMH discussed in class today? Why would Warren Buffett likely not embrace this hypothesis?

Monday, October 15, 2007

BusinessWeek's cover story this week is on that sinking feeling that happens when housing prices fall. (Read it.) Economists often refer to this as the greater fool theory, and they apply it to assets prices in general (not simply housing).

Tuesday, October 09, 2007

This NPR story from 1999 says that the average college student receives 25 credit card offers each semester.

How did credit cards come about? How did they become a mass consumption good? What is a signature loan?

Explain the relationship between the credit card rate and the federal funds rate.

Why do banks offer credit cards with no fees? What are "deadbeats"?

What are the three defects of debit cards relative to credit cards, as discussed in class?

More credit card data here. (The Discover card comprises 4 percent of the all cards used in the US.)

Monday, October 08, 2007

When Interest Rate Ceilings Lead to Credit Rationing

From the Deseret Morning News:
Utah payday lenders began refusing Monday to make loans to members of the military rather than give them much lower rates mandated by a new federal law.

That new law, which took effect Monday, caps the annual interest on payday, car title or tax refund anticipation loans at 36 percent annually for members of the military and their families....

"At 36 percent annual percent rate, the total fees we could charge are $1.38 per $100 for a two-week loan. That is less than 10 cents a day," Walker said.

"Payroll advance lenders could not even meet employee payroll at that rate, let alone cover other fixed expenses and make a profit," he said.


"The protection the regulation offers is not a wall preventing a service member from getting assistance, rather it is more like a flashing sign pointing out danger and directing the borrower to a safer way of satisfying immediate financial need," said Leslye A. Arsht, deputy undersecretary of defense for military community and family policy.

He said financial help for members of the military is available through a member's chain of command, legal assistance office or military aid society.
In other words, this is another case of unintended consequences resulting from intervening in market forces. (Read the full article here.)

Friday, October 05, 2007

How the economy could handle oil at $100 a barrel--from the WSJ. Question: Would a significant increase in the price of oil be an example of inflation?

What are the two conditions necessary for capital formation to set in and continue?

What are the external and biological time preference factors? Why does it matter for these factors to be expected? What role is played by nutrition and health care?

Do you think that members of the military more likely or less likely to have high time preferences?

Why are property rights violations harmful to capital formation? What were the examples given in class? Can you think of others?

In this academic article, Robert F. Mulligan of Western Carolina University examines the relationship between property rights and time preferences.

Thursday, October 04, 2007

Questions for today's lecture will be posted soon. In the meantime, read this article on the Great French Inflation.

Tuesday, October 02, 2007

N.B.: Quiz on Thursday.

What is the term structure of interest rates?

According to the expectations theory of the term structure of interest rates, what happens to long-term interest rates when short-term interest rates are expected to fall in the future?

Define: segmented markets, expectations, and preferred habitat theories. When does the yield curve slope upward, according to the expectations theory? According to the segmented markets theory? According to the preferred habitat theory?

Why is the interest rate on a U.S. Treasury bond usually less than that on a corporate bond?

Does a taxable bond or a tax-free bond pay a higher before-tax interest rate?

Countries with lower real interest rates have more development in those things that require long-term commitments. Would Bohm-Bawerk agree? Explain.

Define time preference, high time preference, low time preference, and time preference rate.
TheStreet's Philip van Doorn notes that NetBank's failure is proof that ratings matter:
No depositor ever wants to be in the position of hoping to get money back after a bank failure. In the case of NetBank (formerly a unit of NetBank (NTBK) ,'s financial strength ratings provided five years of warnings, with ratings of D (weak financial strength) or below. NetBank's rating was downgraded to D- in December 2006, E (very weak) in March 2007 and finally E- in June 2007.

After NetBank's deal to be acquired by EverBank fell through, the Office of Thrift Supervision closed down NetBank on Friday, and named the Federal Deposit Insurance Corp. as receiver. The FDIC then issued a statement saying that NetBank's insured deposits had been acquired by ING Bank, FSB (a unit of ING Group).

ING Bank did not acquire NetBank's $109 million in deposit accounts that exceeded FDIC insurance limits. Customers with uninsured deposits will receive immediate payment of 50% of their uninsured balances. These customers will become creditors to the receivership for the remaining 50%. This means that $54.5 million in deposits may never be recovered by these customers.
You could face major risk if the bank servicing your mortgage fails. If you got your mortgage from a bank, chances are the loan was sold to Fannie Mae or Freddie Mac, or was securitized and sold to another investor. This process was probably invisible to you, and your loan may still be serviced by the original bank.

If the bank servicing your mortgage were to fail, the owner of the loan would need to take over the servicing or find another servicer. If your mortgage is escrowed for taxes and insurance and the troubled bank fails to deliver the loan files to the new servicer quickly, the insurance premium and property tax payments that your bank normally makes could be made late, or not at all. Freddie Mac recently faced this problem, when American Home Mortgage Investment Corp. (a nonbank loan servicer) went bankrupt and failed to quickly deliver loan files to Freddie Mac.

It can only help to monitor the rating of the bank or thrift servicing your mortgage. If the institution has a very low rating, contact them. Make sure they are paying any insurance premiums and property taxes on time. You should try to find out who ultimately holds the mortgage and who to contact if the servicing is transferred to another institution.
Read the full article here.

Question: Does financial regulation encourage such monitoring? Why do we tend to see more monitoring by the private sector in the bond industry than among banks?

Tuesday, September 25, 2007

Why is the interest rate on a U.S. Treasury bond usually less than that on a corporate bond? What factors affect the interest rate paid on a bond?

Define: default risk, default premium, liquidity risk, and liquidity premium. During the late 1970s, Michael Milken convinced many investors that the yields on junk bonds more than compensated for their higher default risk. What do you think happened to the liquidity of these bonds as a result?

At the start of the recession in 2000, interest rates on lower-rated corporate bonds rose relative to the interest rate on Treasury bonds. Why did this happen? Why did it happen? What is this phenomenon called?

Explain the significance of Moody's, MorningStar, and Standard & Poors to the financial system. How are they related to Underwriters Laboratories?

The yield curve over time:

Friday, September 21, 2007

Look at the question raised today by Greg Mankiw, regarding an exchange between Greenspan and Jon Stewart that occurred on The Daily Show (which I mentioned in class on Thursday).

Thursday, September 20, 2007

From The Economist: A Very British Banking Crisis.

When a bond is exchanging hands in the bond market, we are seeing two goods being exchanged: the bond and the use of funds. Explain.

What factors affect bond demand and supply? Why does the bond supply curve slope up and the bond demand curve slope down in the bond market diagram?

How is the bond market related to the loanable funds market? If bond prices are currently above equilibrium, what can we infer about the pressure on interest rates in the loanable fund market? Why?

Wednesday, September 19, 2007

Regulatory differences between the U.S. and Great Britain means that U.S. bank runs are unlikely, writes the Associated Press.

Tuesday, September 18, 2007

In inflation-adjusted (real) terms, here are the richest Americans of all time. (Bill Gates comes in at number 13.)
Differentiate between Treasury Bills, Treasury Bonds, Treasury Notes, and Treasury Auctions.

Differentiate between a simple loan, a discount loan, a fixed payment loan, and a coupon bond.

How does a discount bond differ from a simple loan? What is the main difference between a coupon bond and a fixed payment loan?

Define: nominal yield, current yield, and yield to maturity.

Define nominal and real interest rates. Why might the actual real interest rate differ from the expected real interest rate? Would this possible difference be of more concern to you if you were considering making a loan to be paid back in one year or a loan to be paid back in 10 years?

Consider Irving Fisher. (Literally.) Explain the Fisher Hypothesis. Under what circumstances would the lender benefit in terms of purchasing power when interest rates and inflation rates differ?

What is the Prime Rate and the London Interbank Offer Rate.

Friday, September 14, 2007

Real money demand: Bloomberg on a bank run today in London. An excerpt:
Hundreds of Northern Rock Plc customers crowded into branches in London today to pull out their savings after the mortgage-loan provider sought emergency funding from the Bank of England.

``It's scary,'' said Peter Pye, 60, a retired university lecturer standing in a line of about 30 people outside the Moorgate branch in the financial district. ``I have my life's savings in Northern Rock.'' He said he would withdraw a ``six- figure'' sum and leave 5,000 pounds in the account.

The Bank of England said it will provide emergency cash to Northern Rock, Britain's third-largest mortgage provider, in the nation's biggest bailout of a financial institution in 30 years. The rising cost of credit left the lender unable to make new loans and stoked concern among customers about their money.

Read the whole article. This is the scenario that central bankers and banking regulators are trying to avert in the wake of the subprime lending crisis and its attendant credit crunch. Banks ensure (in part) that they have enough cash to satisfy withdrawals through their lending activities. If this activity slows as interest rates rise--think of that loanable funds supply curve shifting to the left--and if depositors perceive that certain banks are becoming insolvent as a result, how are (i) depositors, (ii) investors, and (iii) regulators likely to respond? I'd expect the Fed to increase the monetary base relative to the monetary measures.

Thursday, September 13, 2007

Define: auction markets, over-the-counter markets, capital and derivative markets. See this article about Southwest's use of the derivative market to protect itself from risk.

Why do firms use derivative markets?

Why are money market assets typically more liquid than capital market assets? Does the relative illiquidity of capital market assets have any consequences for the banking system?

What factors explain the need for financial markets? (We discussed four today.) Who is more likely to use a stock broker (ceteris paribus): an active college professor in Alabama or a retired college professor in Florida? Why?

What are the benefits to savers and borrowers if financial markets communicate all available information about financial instruments via their prices?

Here is an interesting recent story about moral hazard. How does U.S. foreign aid promote moral hazard? What are some ways that ailing countries can be helped without creating it? Also, here is the story about the doctor's strike in Israel and its effect on death rates. How can a doctor's strike promote moral hazard?

Here is Sam Peltzman on seat belts and moral hazard. Don Cherry noted that when hockey players were forced to wear face masks, there was a higher incidence of high sticking and slashing calls. Explain how possible moral hazard problems can result from (i) financial regulation, (ii) general insurance, and (iii) deposit insurance.

Wednesday, September 12, 2007

Here is a new academic paper (by Livshits, MacGee, and Tertilt, "Accounting for the Rise in Consumer Bankruptcies") that ties increasing consumer bankruptcies with credit market innovations that have come about since 1970. Here's the abstract:
Personal bankruptcies in the United States have increased dramatically, rising from 1.4 per thousand working age population in 1970 to 8.5 in 2002. We use a heterogeneous agent life-cycle model with competitive financial intermediaries who can observe households' earnings, age and current asset holdings to evaluate several commonly offered explanations. We find that increased uncertainty (income shocks, expense uncertainty) cannot quantitatively account for the rise in bankruptcies. Instead, the rise in filings appears to mainly reflect changes in the credit market environment. We find that credit market innovations which cause a decrease in the transactions cost of lending and a decline in the cost of bankruptcy can largely accounting for the rise in consumer bankruptcy. We also argue that the abolition of usury laws and other legal changes are unimportant.
Question: Why would decreased transaction costs in loan contracts result in increased consumer bankruptcies? There is an adverse selection argument here (we have not yet covered adverse selection in class), but it seems weak in this case. (Note that in the early 2000s, former Fed Chairman Alan Greenspan encouraged the use of the subprime market.) One point we will discuss later in class is the lag between technological innovations and regulatory adjustment. Regulations are created to fit a specific banking environment, and when the environment changes, the regulations are often not adjusted until after a crisis of some sort develops. Also, the argument here is that lowered transaction costs leave lenders with decreased incentives to maintain minimum lending standards. Do you agree? Can you think of other likely--perhaps more likely--candidates for he increase in bankruptcies?

We'll discuss this in more detail in class. Also, here are some links to the full paper.

Tuesday, September 11, 2007

Define the loanable funds market and the production possibilities frontier as discussed today in class. What happens to each if (for instance) an economy is characterized with many productive baby boomers entering retirement?

Why do financial markets exist? What are financial instruments? Explain financial markets role in providing risk sharing, liquidity, and increases in information. Why are risk sharing, liquidity, and information valued by savers and borrowers?

Do banks and other financial intermediaries like high interest rates? Why or why not?

Differentiate between the primary and secondary, money and capital, and cash and derivative ways to analyze financial markets. What goods are associated with each?

The sound you here coming from Miami is of the condo crash. One advantage of a credit crunch is that those who have saved can now find good deals on housing. Consider the situation of the condo market in Miami, which rivaled Shanghai and Dubai in terms of new construction during the boom.

"It's painful and scary," Natalie Luongo, 31, said. "We saw the frenzy, and we bought in. Now we're paying the consequences."

Just how many other speculators face the same dilemma in the nation's most glutted condo market will become clear during the next two years. That is when 25,000 new condo units, most of them rising in or near Miami's downtown, will flood an area already saturated with 23,000 condos listed for sale. An additional 40,000 units have been approved, but analysts doubt the majority will break ground. (See map with condo locations.)

Orlando and other Florida cities -- Naples, Fort Myers, Tampa and Sarasota among them -- also have huge condo gluts. With 4,440 condos listed for sale, Orlando has an unprecedented 29-month supply, and last month sales plummeted 64 percent lower than a year ago.
[Full article here.]

Monday, September 10, 2007

See this short video from 1967 that predicts that by 1999, we will be shopping at home from our own computers. We'll also be paying our bills, accessing bank statements, and reading electronic mail. These are very interesting--and generally correct--musings from a time in which most transactions were conducted in cash, the dollar was weakly tied to gold, the euro existed only in theory, and banks earned money via fees from checking accounts and interest on commercial loans.

Thursday, September 06, 2007

Why do governments create fiat currencies? Do they help promote an optimal amount of money? Explain.

Define price. Explain the price system that exists under barter and why it is problematic. How does the emergence of a money commodity from barter improve the market system?

Why do economists study the money supply? (Discuss the four reasons covered in class.)

Define: C, M1, M2, M3, and L. How are they related in terms of aggregation and in terms of liquidity?

Define liquidity. Rank the following assets in terms of liquidity, from most to least liquid: money market mutual fund, demand deposit, corporate stock, dollar bill, house, gold, checkable deposit.

How is income related to saving and investment?
The Credit Crunch of 2007?

The Economist discusses the strains on the banking industry resulting from the subprime mortgage mess.

“NOT only is there no God,” said Woody Allen, “but try getting a plumber on weekends.” That just about sums up the problems of today's financial markets. The plumbing is badly blocked, and nobody seems able to fix it, not even the central banks, the market's immortals.

The problem is the apparent reluctance of banks to lend to each other, particularly over three months. That problem arises, in part, from uncertainty about who will pay the bill for America's subprime-mortgage collapse. But it also results from the need for banks to protect their own balance-sheets in the face of some unexpected claims on their capital.

Read the full article here.

Tuesday, September 04, 2007

What is money? Explain the four definitions of money discussed in class.

What makes a dollar bill money? What makes a personal check money? What factors, if changed, would affect your willingness to accept a dollar bill or a check as money?

What is barter? Explain the double coincidence of wants problem that exists in barter.

Explain the six stages of money's evolution. What is the relationship between use and exchange value as money evolves?

Define: commodity money, commodity standard, and fiat money.

What are the "money-ish" qualities of gold and silver?

Explain how the modern banking developed during the time of the goldsmith bankers. Why would some goldsmith bankers engage in fraud?

Why might a $20 Federal Reserve Note be more desirable as a form of money than a $20 gold coin from the point of view of an individual? How about from the point of view of the government?

Define seigniorage. How can it be increased?

Explain the U-shaped cost of exchange curve.

Thursday, May 31, 2007

Note to Summer 1 Students

The class syllabus is now updated and can be accessed via the link on the right.

Wednesday, December 13, 2006

Note to Spring 2007 students:

This is a compressed video class, and students are welcome to take the class in room 115 of the Bevil Center in Gadsden, even if they are registered for the Jacksonville section. I will only require attendance in Jacksonville on test days, which you can see in the syllabus (the link to which is on the right). As usual, I encourage you to try to order the book early over the Internet, using the ISBN number on the syllabus.

Thursday, November 30, 2006

Yesterday's London Telegraph: "US Setbacks See Dollar Plunge to Near 15-year Low":

The dollar tumbled to a near 15-year low against sterling yesterday on fresh signs of economic trouble in the United States.

An 8.3pc crash in US industrial orders and an admission by the Federal Reserve chairman that Washington does not know how bad housing really is set off another day of wild gyrations on the currency markets.


The dollar continued its slide against the euro, dropping to $1.3194 after the Federal Reserve chairman, Ben Bernanke, said the housing slump "would be a drag on economic growth into next year". Mr Bernanke said official figures did not pick up the "sharp increase" in cancellations on house deals and might understate the inventory glut.

"Any significant effect on consumer spending arising from further weakness in housing would have important implications for the economy," he said.


The OECD club of rich nations gave warning yesterday in its bi-annual economic outlook that the world's second-biggest economy was still too fragile after years of debt deflation to risk a rapid rise in rates from 0.25pc.

"The return to price stability is proving longer and less assured than expected. Further monetary tightening should wait until a fully-fledged exit from deflation finally materialises," it said.

The OECD downgraded its global growth forecast for the 30 leading economies from 2.9pc to 2.5pc in 2007, and said the US might need to start cutting interest rates next year.

Chief economist Jean-Philippe Cotis said there was no cause for alarm, arguing that the US would achieve the "soft-landing" it eluded after the dotcom bubble in 2000. "What the world may be facing is a rebalancing of growth," he said. "In the euro area, recent hard data suggest that a solid upswing may be under way. Growth should remain buoyant in China, India, Russia and other emerging economies."

In a rare piece of good news that helped calm Wall Street after the equity rout on Monday, Mr Bernanke said inflation had been "somewhat better behaved of late".
Reading Assignment

P. 495, Case Study: “Is Inflation Targeting a Good Idea?

Q1: What are the four points some economists argued for inflation targeting?

Q2: What are the four points economists argued against inflation targeting?

Wednesday, November 29, 2006

(These questions are for Tuesday, Nov. 28.)

What are the four ways that Fed organization can be divided?

What are the Board of Governors' duties and responsibilities with regard to monetary policy?

Where does most of the Fed's income come from? What features of the Fed help to make it independent of political pressure? How does the U.S. Constitution protect the Fed?

How many Federal Reserve banks are there? Where are they located?

Who guides the open market operations of the Fed?

Why do Federal Reserve districts cut across some state lines, and why do the directors of the district banks represent business, banking, and the general public?

What are the duties of Federal Reserve banks?

"It is impossible to know where the true power and authority in an organization lie just from examining the formal structure of the organization." Does this observation apply to the Federal Reserve System? Explain.

Evaluate: The Federal Reserve System is independent of the political process in the United States.

Evaluate: To conduct monetary policy in the national interest, the Federal Reserve System should be made independent of the political process in the United States.

Wednesday, November 15, 2006

Here is the optional assignment to be completed in lieu of class Thursday, Nov. 16. Please turn this in to me in class on Nov. 28 (or email it to me, in Word format, as an attached file).