Class Materials for Lecture 4

Brief Outline of Topics Covered in Lecture 4

Chapter 12 Structure of Central Banks and the Federal Reserve System

Informal Structure of the Federal Reserve System

• How Power Has Been Centralized Over Time

How Independent is the Fed?

Should The Fed Be Independent?

• The Case for Independence
• The Case Against Independence

Chapter 13 Multiple Deposit Creation and the Money Supply Process

Four Players in the Money Supply Process

The Fed’s Balance Sheet

• Liabilities
• Assets

Control of the Monetary Base

• Open Market Operations with Bank
• Open Market Operations with an Individual and shifts between Currency and Deposits

Materials from class:

Central Bank Independence and Inflation

From "Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence," by Alberto Alesina and Lawrence H. Summers, Journal of Money, Credit and Banking, Vol. 25, No. 2. (May, 1993), pp. 151-162  (the link will work on UO net, but I don't expect you to read the paper as it is a bit technical):

This has changed with the adoption of inflation targeting by central banks. Note also that Adam Posen casts doubt on whether causality runs from central bank independence to improved macroeconomic performance in Central Bank Independence and Disinflationary Credibility: A Missing Link?, NY Fed Staff Report, May 1995.

Video:

Lecture 4 [Google video] - Fall 2007
Lecture 4 [Media Player] - Fall 2007

 

Economics 470 Lecture 4 (Google chooses the fixed frame...)

Previous (these were taped outside of class):
Lecture 4 - Chapter 12,  pgs. 321-330; Chapter 13, pgs. 333-340
Google Video

Lecture 4 Wiki

This is an area you can edit as you wish [edit password=lecture4].

Additional Reading:

• Dodd to Keep Fed Short-Handed - WSJ Economics Blog
• Securitisation: life after death - Martin Wolf
• What makes an economist? - Free Exchange
• In the Lap of the Gods - Richard Fisher - FRB Dallas
• In a Primitive Tool, Evidence of Trading in the Pacific - New York Times
• A Few Days in the South of Ethiopia… - Stiglitz - New York Times

Application:

On global finance:

Financial Globalization's New Power Source, by David Wessel, WSJ: In the blizzard of headlines about borrowing by private-equity firms, rising oil prices and accumulating hoards of cash at Asian central banks, it's hard to tell if this is part of the same old story of money sloshing around the globe, or if something big is happening.

Pension funds, mutual funds and insurers still hold a bigger chunk of the world's financial assets ($59.4 trillion) than more recent pools of capital. But four newcomers are gaining rapidly: Asian central banks, hedge funds, private-equity funds and petrodollar investors, the ones pocketing the proceeds from $80-a-barrel oil.

Together the four hold $8.4 trillion, excluding overlap, roughly $1 of every $20 in the global financial system. Their assets have tripled since 2000.

Even if oil prices fall back to $50 a barrel, China's giant trade surplus shrinks and growth in private-equity and hedge funds slows, McKinsey Global Institute, the think-tank arm of the big consulting firm, projects the assets of these Big Four will double by 2012.

Their rise amounts to a new phase in the globalization of financial markets. They are one important way in which economic earthquakes spread from one country to another. Europe's economy is shuddering not because the U.S. is importing fewer Mercedes or bottles of French wine, but because financial shock waves from defaults on subprime mortgages in Detroit are jolting banks in Düsseldorf.

"The new power brokers represent a structural shift in global capital markets," McKinsey says in a 174-page analysis out today. Their growth, the analysts add, is "mutually reinforcing" as oil barons put their petrodollars in hedge funds, and so on.

How big is big? The carefully researched report, "The New Power Brokers," is studded with morsels like these:

At $70 a barrel, oil producers have nearly $2 billion of petrodollars to invest every day. Saudi Prince Alwaleed bin Talal's investments are valued at around $50 billion (including significant stakes in both Citigroup and in News Corp., which is buying the publisher of this newspaper), putting his wealth up there with Warren Buffett's. Between a fifth and a quarter of all petrodollars are owned by very wealthy individuals.

The Chinese central bank, with $1.1 trillion in assets, is the world's fifth-largest asset manager; its assets are three-quarters the size of the hedge-fund industry before accounting for hedge-fund borrowing.

The five largest hedge funds each have at least $30 billion in assets. Taking leverage into account, each of them command around $100 billion. Hedge funds account for 30% to 50% of the trading in U.S. and U.K. equity and bond markets.

So what? We won't know for years, but here are three implications:

• So much of this money flows to the U.S. that these new pools of liquidity hold down U.S. long-term interest rates. Asian central banks and petrodollars alone reduce U.S. rates by about three-quarters of a percentage point. That helped fuel a debt binge in the U.S. that pushed up home and stock prices.

McKinsey sides with those who pronounce stock prices to be reasonable based on price/earnings ratios (we'll see about that), but it blames these entities for contributing to a global real-estate bubble, and perhaps an art bubble, too.

In years to come, more of this money will go to Asia, the Middle East, even Africa and other emerging markets, a reminder of why the U.S. needs to wean itself of its addiction to foreigners' savings and save more itself.

• Reversing a long trend, private markets are getting a lot of the action. Last year, for instance, about $256 billion was raised in global initial public offerings (private companies going public), but private-equity firms took $525 billion worth of public companies private.

How this will affect the dynamics of capitalism isn't entirely clear: It might allow companies to invest for the longer term. It might create new forms of productivity-enhancing shareholder activism.

It also might make companies less sensitive to public and political pressure to do their part to address problems ranging from global warming to the backlash against globalization. And it might be temporary, as recent events remind private-equity investors and hedge funds of the advantages of public markets: their liquidity and capacity to price assets.

• At the same time, financial clout of overseas governments is growing, as reflected by the rise of sovereign wealth funds financed by central-bank holdings (Asia) or oil (the Mideast and Norway).

This raises the possibility of investments made with political, mercantilist or military motives, even though most of these funds' investing looks more like the Harvard endowment's than the financial equivalent of nuclear weapons -- so far. But risk looms and, perhaps just as serious, the anxiety about the risk is contributing to a backlash against globalization.