Economics of Money and Banking

"Market liquidity" is supplied by dealers who stand ready to absorb temporary imbalances in supply and demand by taking the imbalance onto their own balance sheets, for a price. From this point of view, banks can be considered a special kind of dealer, since they absorb imbalances in payment flows. The first lecture is meant to build intuition by using our familiar balance sheet method to make sense of how this all worked in a system much simpler than our own. The second lecture introduces a formal model of the economics of the dealer function, which we will be using throughout the rest of the course.

Here we adapt the Treynor model to banks, which we conceptualize as dealers in money, specifically term funding. Like Treynor's security dealers, banks supply market liquidity for a price. But sometimes, in a financial crisis, demand for market liquidity overwhelms supply, and that's where the central bank comes in, as dealer of last resort in money markets. And if the crisis is big enough, as 2007-2009, the central bank comes in as dealer of last resort in capital markets as well.

The first twelve lectures have introduced all of the main concepts of the course. The midterm exam gives you a chance to test whether you have mastered these concepts before extending them into new areas in the second part of the course. But before you try the exam, first use the review lecture, and the questions from students, to review the main concepts.

The next four lectures extend the "money view" perspective to the larger world of multiple national monies by thinking about the international monetary system as a payment system, and by thinking of banks as market makers in foreign exchange. The first lecture is introductory and conceptual, while the second builds intuition by "translating" Mundell's account of the development of the international monetary system into money view language (similar to what we did at the beginning of the course for Allyn Young's account of the development of the US monetary system).

The next two lectures use the Treynor model to understand how exchange rates are determined in dealer markets. In the second, we confront directly the puzzle we observed earlier in the course, namely why uncovered interest parity (UIP) fails to hold in real world markets.

The next four lectures extend the money view to the larger financial world of capital markets, where the price of risk is determined in dealer markets for swaps of various kinds. The first lecture is a kind of conceptual introduction, while the second translates the standard finance account of forwards and futures into money view terms, as key building block for what comes after.

In the modern economy, the price of risk is determined in swap markets that distinguish specific forms of risk, most importantly interest rate swaps and credit default swaps. The Treynor model can be adapted to understand how the price of risk is formed in dealer markets.

In this final module, we bring the entire course together. These two lectures build on everything that came before, and show how all the pieces fit together into a unified whole. Specifically, the first lecture uses the conceptual apparatus of the money view to make sense of shadow banking as the quintessential form of banking for the modern financially globalized world. And the second lecture shows how the conceptual apparatus of the money view fits with standard economics view and finance view, by drawing attention to dimensions of the world from which the standard views abstract.

The previous module operated in effect as a review of the entire course, so if you were able to make sense of those lectures, you are ready for the final. But maybe you first want to have a look back at the second lecture, "The Natural Hierarchy of Money", for a high-level summary of the essential concepts of the money view. For almost everybody, the money view is a new and unfamiliar way of thinking about the world, and it takes a while to get used to it. The purpose of this course is to plant the seed, by demonstrating the value of this way of thinking for making sense of real world problems. Once you are done with the final exam, the real work begins, of using the money view to make sense of whatever real world problems confront you in your own daily life.