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Money Banking and Financial


This Obscure marble building located in Washington DC houses the Federal Reserve System.

Review of Macroeconomics: 

Concepts of Macroeconomy:

  1. Unemployment

An economic condition marked by the fact that individuals  actively seeking jobs remain unhired. Unemployment is expressed as a percentage of the total available work force. The level of unemployment varies with economic conditions and other circumstances.

Types of Unemployment

please study the following link about the types of unemployment:

2. Inflation 

For a deep understanding of Inflation, please study the following article:

Inflation and Consumer Price Index

Inflation with Pr Phill Holden 



This video explains what GDP is, and the expenditure approach to GDP

Real GDP

The Interest Rate

An interest rate is the price a borrower pays for the use of money they borrow from a lender

Real vs nominal interest rates

The nominal interest rate is the amount, in money terms, of interest payable.

The real interest rate, which measures the purchasing power of interest receipts, is calculated by adjusting the nominal rate charged to take inflation into account. 

GDP Deflator

What Does GDP Price Deflator Mean?
An economic metric that accounts for inflation by converting output measured at current prices into constant-dollar GDP. The GDP deflator shows how much a change in the base year's GDP relies upon changes in the price level. Also known as the "GDP implicit price deflator".
Investopedia Says
Investopedia explains GDP Price Deflator
Because it isn't based on a fixed basket of goods and services, the GDP deflator has an advantage over the Consumer Price Index. Changes in consumption patterns or the introduction of new goods and services are automatically reflected in the deflator.

The Exchange Rate

In finance, the exchange rates (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies specifies how much one currency is worth in terms of the other. It is the value of a foreign nation’s currency in terms of the home nation’s currency.


Economic Growth


Defining economic growth

Economic growth is best defined as a long-term expansion of the productive potential of the economy. Sustained economic growth should lead higher real living standards and rising employment.  Short term growth is measured by the annual % change in real GDP.

Growth and the Production Possibility Frontier

An increase in long run aggregate supply is illustrated by an outward shift in the PPF.

An increase in long run aggregate supply is illustrated by an outward shift in the PPF

Advantages of Economic Growth

Sustained economic growth is a major objective of government policy – not least because of the benefits that flow from a growing economy.

  • Higher Living Standards – for example measured by an increase in real national income per head of population – see the evidence shown in the chart below
  • Employment effects: Growth stimulates higher employment. The British economy has been growing since autumn 1992 and we have seen a large fall in unemployment and a rise in the number of people employed.
  • Fiscal Dividend: Growth has a positive effect on government finances - boosting tax revenues and providing the government with extra money to finance spending projects
  • The Investment Accelerator Effect: Rising demand and output encourages investment in new capital machinery – this helps to sustain the growth in the economy by increasing long run aggregate supply.
  • Growth and Business Confidence: Economic growth normally has a positive impact on company profits & business confidence – good news for the stock market and also for the growth of small and large businesses alike

Rising national income boosts living standards

And an expanding economy provides the impetus for a rising level of employment and a falling rate of unemployment. This has certainly been the case for the British economy over the last decade.

An expanding economy provides the impetus for a rising level of employment and a falling rate of unemployment. This has certainly been the case for the British economy over the last decade.

Disadvantages of economic growth

There are some economic costs of a fast-growing economy. The two main concerns are firstly that growth can lead to a pick up in inflation and secondly, that growth can have damaging effects on our environment, with potentially long-lasting consequences for future generations.

  • Inflation risk: If the economy grows too quickly there is the danger of inflation as demand races ahead of aggregate supply. Producer then take advantage of this by raising prices for consumers
  • Environmental concerns: Growth cannot be separated from its environmental impact. Fast growth of production and consumption can create negative externalities (for example, increased noise and lower air quality arising from air pollution and road congestion, increased consumption of de-merit goods, the rapid growth of household and industrial waste and the pollution that comes from increased output in the energy sector) These externalities reduce social welfare and can lead to market failure. Growth that leads to environmental damage can have a negative effect on people’s quality of life and may also impede a country’s sustainable rate of growth.  Examples include the destruction of rain forests, the over-exploitation of fish stocks and loss of natural habitat created through the construction of new roads, hotels, retail malls and industrial estates.

Many economists and environmentalists are concerned about the impact that rapid economic growth can have on our limited scarce resources and our environment.

Many economists and environmentalists are concerned about the impact that rapid economic growth can have on our limited scarce resources and our environment.

The trend rate of economic growth

Another way of thinking about the trend growth rate is to view it as a safe speed limit for the economy. In other words, an estimate of how fast the economy can reasonably be expected to grow over a number of years without creating an increase in inflationary pressure.

  • Above trend growth – positive output gap: If the economy grows too quickly (much faster than the trend) – then aggregate demand will eventually exceed long-run aggregate supply and lead to a positive output gap emerging (excess demand in the economy). This can lead to demand-pull and cost-push inflation.
  • Below trend growth – negative output gap: If the economy experiences a sustained slowdown or recession (i.e. growth is well below the trend rate) then output will fall short of potential GDP leading to a negative output gap. The result is downward pressure on prices and rising unemployment because of a lack of aggregate demand.

Demand and supply factors influence growth of GDP

Many factors influence the rate of economic growth. Some factors, such as changes in consumer and business confidence, aggregate demand conditions in the UK’s trading partners, and monetary and fiscal policy, tend to have a mainly temporary effect on growth. Other factors, such as the rates of population and productivity growth, have more enduring effects, and help to determine the economy’s average growth rate over long periods of time.

Adapted from a Treasury paper

The importance of the supply-side of the economy

The trend rate of growth is determined mainly by the supply-side capacity of a country – i.e. the extent to which LRAS increases year-on-year to meet a higher level of demand for goods and services. Potential output in the long run depends on the following factors

  • The trend growth of the working population i.e. the size of the active labour supply (e.g. those people able available and willing to find paid employment)
  • The growth of the nation’s stock of capital – driven by the level of capital investment in new buildings, machinery, plant and technology
  • The trend rate of growth of factor productivity (including labour productivity) – a measure of gains in factor efficiency
  • Technological improvements driven by innovation and invention which reduce the costs of supplying goods and services and which lead to an outward shift in a country’s production possibility frontier

Long Run Aggregate Supply and the Trend Rate of Growth

The effects of an increase in long run aggregate supply are traced in the diagram below. An increase in LRAS allows the economy to operate at a higher level of aggregate demand – leading to sustained increases in real national output.


Long Run Aggregate Supply and the Trend Rate of Growth

Potential output in the long run depends on the following factors

(1) The growth of the labour force e.g. those people able available and willing to find employment

If the government can increase the number of people willing and able to actively seek paid employment, then the employment rate increases leading to a higher output of goods and services. The Government has invested heavily in a number of employment schemes designed to raise employment including New Deal and reforms to the tax and benefit system. Changes in the age structure of the population also affect the total number of people seeking work. And we might also consider the effects that migration of workers into the UK from overseas, including the newly enlarged European Union, can have on our total labour supply

(2) The growth of the nation’s stock of capitaldriven by the level of fixed capital investment.

A rise in capital investment adds directly to GDP in the sense that capital goods have to be designed, produced, marketed and delivered. Higher investment also provides workers with more capital to work with. New capital also tends to embody technological improvements which providing workers have sufficient skills and training to make full and efficient use of their new capital inputs, should lead to a higher level of productivity after a time lag.

(3) The trend rate of growth of productivity of labour and capital. For most countries it is the growth of productivity that drives the long-term growth. The root causes of improved efficiency come from making markets more competitive and achieving better productivity within individual plants and factories.  Increased investment in the human capital of the workforce is widely seen as essential if the UK is to improve its long run productivity performance – for example – increased spending on work-related training and improvement in the UK education system at all levels.

(4) Technological improvements are important because they reduce the real costs of supplying goods and services which leads to an outward shift in a country’s production possibility frontier

The current growth phase for the UK is the longest period of continuous growth for over forty years.

Author: Geoff Riley, Eton College, September 2006

This article was taken from :


The Federal Reserve System


Before talking about the Monetary policy, let's first talk about the maker of this monetary policy which is the Federal Reserve System

Monetary Policy 

Fiscal Policy 


Creating Money 

Quantity Theory of Money

 Reem Heakal

The concept of the Quantity Theory of Money (QTM) began in the 16th century. As gold and silver inflows from the Americas into Europe were being minted into coins, there was a resulting rise in inflation. This led economist Henry Thornton in 1802 to assume that more money equals more inflation and that an increase in money supply does not necessarily mean an increase in economic output. Here we look at the assumptions and calculations underlying the QTM, as well as its relationship to monetarism and ways the theory has been challenged. 

QTM in a Nutshell
The Quantity Theory of Money states that there is a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold. According to QTM, if the amount of money in an economy doubles, price levels also double, causing  inflation (the percentage rate at which the level of prices is rising in an economy). The consumer therefore pays twice as much for the same amount of the good or service. 

Another way to understand this theory is to recognize that money is like any other commodity: increases in its supply decrease marginal value (the buying capacity of one unit of currency). So an increase in money supply causes prices to rise (inflation) as they compensate for the decrease in money’s marginal value.  

The Theory’s Calculations
In its simplest form, the theory is expressed as:
MV = PT (the Fisher Equation)

Each variable denotes the following:
M = Money Supply
V = Velocity of Circulation (the number of times money changes hands)
P = Average Price Level
T = Volume of Transactions of Goods and Services  

The original theory was considered orthodox among 17th century classical economists and was overhauled by 20th-century economists Irving Fisher, who formulated the above equation, and Milton Friedman.

It is built on the principle of "equation of exchange": 

Amount of Money x Velocity of Circulation = Total Spending

Thus if an economy has US$3, and those $3 were spent five times in a month, total spending for the month would be $15.    

QTM Assumptions
QTM adds assumptions to the logic of the equation of exchange. In its most basic form, the theory assumes that V (velocity of circulation) and T (volume of transactions) are constant in the short term. These assumptions, however, have been criticized, particularly the assumption that V is constant. The arguments point out that the velocity of circulation depends on consumer and business spending impulses, which cannot be constant.  

The theory also assumes that the quantity of money, which is determined by outside forces, is the main influence of economic activity in a society. A change in money supply results in changes in price levels and/or a change in supply of goods and services. It is primarily these changes in money stock that cause a change in spending. And the velocity of circulation depends not on the amount of money available or on the current price level but on changes in price levels.  

Finally, the number of transactions (T) is determined by labor, capital, natural resources (i.e. the factors of production), knowledge and organization. The theory assumes an economy in equilibrium and at full employment.  

Essentially, the theory’s assumptions imply that the value of money is determined by the amount of money available in an economy. An increase in money supply results in a decrease in the value of money because an increase in money supply causes a rise in inflation. As inflation rises, the purchasing power, or the value of money, decreases. It therefore will cost more to buy the same quantity of goods or services.  

Money Supply, Inflation and Monetarism
As QTM says that quantity of money determines the value of money, it forms the cornerstone of monetarism.   

Monetarists say that a rapid increase in money supply leads to a rapid increase in inflation. Money growth that surpasses the growth of economic output results in inflation as there is too much money behind too little production of goods and services. In order to curb inflation, money growth must fall below growth in economic output.  

This premise leads to how monetary policy is administered. Monetarists believe that money supply should be kept within an acceptable bandwidth so that levels of inflation can be controlled. Thus, for the near term, most monetarists agree that an increase in money supply can offer a quick-fix boost to a staggering economy in need of increased production. In the long term, however, the effects of monetary policy are still blurry. 

Less orthodox monetarists, on the other hand, hold that an expanded money supply will not have any effect on real economic activity (production, employment levels, spending and so forth). But for most monetarists any anti-inflationary policy will stem from the basic concept that there should be a gradual reduction in the money supply. Monetarists believe that instead of governments continually adjusting economic policies (i.e. government spending and taxes), it is better to let non-inflationary policies (i.e. gradual reduction of money supply) lead an economy to full employment.  

QTM Re-Experienced
John Maynard Keynes challenged the theory in the 1930s, saying that increases in money supply lead to a decrease in the velocity of circulation and that real income, the flow of money to the factors of production, increased. Therefore, velocity could change in response to changes in money supply. It was conceded by many economists after him that Keynes’ idea was accurate.  

QTM, as it is rooted in monetarism, was very popular in the 1980s among some major economies such as the United States and Great Britain under Ronald Reagan and Margaret Thatcher respectively. At the time, leaders tried to apply the principles of the theory to economies where money growth targets were set. However, as time went on, many accepted that strict adherence to a controlled money supply was not necessarily the cure-all for economic malaise.

by Reem Heakal


Chapter 1: Why Study Money, Banking, and Financial Markets?



Why Study Financial Markets?

Financial markets are markets in which funds are transferred from people who have an excess of available funds to people who have a shortage.

Example of financial markets: Bond markets, and stock markets.

A security is a claim on the issuer’s future income or assets. Assets are any financial claim or piece of property that is subject to ownership.

A bond is a debt that promises to make payments periodically for a specified period of time. The bond market is important to economic activity because it enables corporations and governments to borrow to finance their activities and because it is where interest rates are determined.

An interest rate is the cost of borrowing or the price paid for the rental of funds.

Example of interest rates: mortgage interest rates, car loan rates.

High interest rates can deter people in general from borrowing money from financial institutions such as banks. In this case, due to the high interest rates of loans, the cost of financing the loan to buy a house or a car is high. On the other hand, high interest rates ought to encourage people in saving their money in order for them to earn more interest income.

On a more general level, increased interest rates would inevitably affect businesses’ investment decisions. High interest rates might cause a corporation to postpone building a new plant that would ensure more jobs.

The Stock Market

A common stock (a stock) represents a share of ownership in a corporation. It is a security that is a claim on the earnings and assets of the corporation.

Issuing stock and selling it to the public is a way for corporations to raise funds to finance their activities.

The stock market in which shares of stock are traded is the most widely followed financial market in America.

The stock market is also an important factor in business investment decisions, because the price of shares affects the amount of funds that can be raised by selling newly issued stock to finance investment spending. A higher price for a firm’s shares means that it can raise a larger amount of funds, which can be used to buy facilities and equipment.

The Foreign Exchange Market

The foreign exchange market is the place where one currency, say $dollars$, is converted to another currency, say €Euros€.

The foreign exchange rate is the price of one country’s currency in terms of another’s.

A change in the exchange rate has a direct effect on American consumers because it affects the cost of imports. When the exchange rate of the dollar falls, importing foreign goods becomes more expensive, and thus, consumers tend to shift their consumption to domestic products. For example, instead of acquiring French wine, Americans would choose to buy domestic-branded wine, because it is cheaper than the French wine. On the other hand, a strong dollar means that U.S. goods exported abroad would cost more, and hence foreigners would buy less of them.

A strong dollar benefited American consumers by making foreign goods cheaper but hurt American businesses.

A relatively weak dollar makes foreign goods more expensive, but makes American businesses more competitive.

Why Study Banking and Financial Institutions?

Banks and other financial institutions are what make financial markets work.

Structure of the Financial System

The financial system is complex and comprised of many private financial institutions.

Examples of financial institutions: banks, insurance companies, finance companies, investment banks.

If an individual wants to provide a loan to a corporation, he does not simply go to the CEO of the company and asks to give him a loan. Accordingly, he consults one of financial intermediaries.


Banks and Other Financial Institutions

Financial intermediaries are institutions that borrow money from people who save and in turn and make loans to others.

Banks are financial institutions that accept deposits and make loans.

Other financial institutions that are encompassed under the term bank: commercial banks, mutual savings banks, credit unions, savings and loan associations.

Financial Innovation

New means of delivering financial services electronically have come to surface, such as e-finance.

Money and Business Cycles

Unemployment rate: the percentage of the available labor force unemployed.

Business Cycles: the upward and downward movement of aggregate output produced in the economy. Business cycles affect all of us; when output is rising, for example it is easier to find a job; when output is falling a good job might be difficult to find.

Recessions: periods of decline in aggregate output.

*       Before every decline in real output, there is a decline in the rate of money growth!


Monetary Theory: the theory that relates changes in the quantity of money to changes in aggregate economic activity and the price level.

Money and Inflation

Aggregate price level: the average price of goods and services in an economy.

Inflation: a continual increase in the price level.

*       A continuing increase in the money supply might be an important factor in causing the continuing increase in the price level that we call inflation!

Inflation rate: the rate of change of the price level, usually measured as a percentage change per year.


Conduct of Monetary Policy

Monetary policy: the management of money and interest rates.

Central bank: the organization responsible for the conduct of a nation’s monetary supply.

Federal Reserve System: the United States’ central bank.

Fiscal Policy and Monetary Policy

Fiscal policy: involves decisions about government spending and taxation.

Budget deficit: the excess of government expenditures over tax revenues for a particular time period, typically a year.

Budget surplus: arises when tax revenues exceed government expenditures.