Econ 654 Syllabus:
Financial Markets and Monetary Theory II
Last Updated: 19 February 1996
Course Instructor:
Professor Leigh Tesfatsion
- Address:
-
Department of Economics
Iowa State University
Ames, Iowa 50011-1070
Telephone: (515) 294-0138
Email:
tesfatsi@iastate.edu
WWW: http://www.econ.iastate.edu/tesfatsi/
S96 Office Hours: Tuesday and Thursday, 1-2:30,
and by appointment
Date of Course Offering: Spring Semester 1996
- Credits: 3 credits
- Meeting Time/Place: Tues/Thurs, 11-12:30, Ross 25
- Prerequisites: Econ 604 and Econ 607 (the
Ph.D. micro and macro theory sequences).
- Grading: Grades for the course will be based on one
midterm exam (70 points), one final exam (100 points), and an
article critique
(30 points). Contributions to class
discussion will count for extra credit in case of a borderline
grade.
COURSE OBJECTIVES:
Econ 654 will use recent developments in economic and
financial theory to analyze the potential effects of financial
markets and monetary policy instruments on the consumption and
investment decisions of households and firms over time. Article
reading will be stressed.
OUTLINE OF TOPICS AND REQUIRED READINGS
A #double# asterisk ** means that a reading contains basic
#required# material for answering exam questions and a #single#
asterisk * means that a reading contains #highly recommended#
material of a more general contextual nature that may be useful
for answering some exam questions as well as for preparing your
article critique. All readings with double and single asterisks
are listed in a suggested reading order, from simplest to most
advanced, and copies of these readings are on closed reserve in
the Econ/Soc Reading Room, Third Floor, Heady Hall, Room 368.
Recommended readings for more advanced specialized study are also
listed. Additional required and recommended readings may be
added at a later time in accordance with student backgrounds and
interests.
The selection and ordering of course topics roughly follow
the selection and ordering of topics of the following
undergraduate/masters level text by Campbell and Kracaw (CK),
placed on closed reserve:
Tim S. Campbell and William A. Kracaw, #Financial Institutions
and Capital Markets#, Harper-Collins, 1994.
All students---particularly those in need of a background
introduction or review of the topics covered in the course---are
urged to read the appropriate CK chapters, indicated below for
each section of the course, prior to tackling the more difficult
required reading assignments.
I. INTRODUCTION
* CK, Chapter 1, pp. 1-16. CLOSED RESERVE
** Gertler, M., "Financial Structure and Aggregate Economic
Activity: An Overview," Journal of Money, Credit, and
Banking 20 (1988), pp. 559-588. CLOSED RESERVE
Bhattacharya, S. and G. M. Constantinides, Eds., #Frontiers of
Modern Financial Theory,# Vol. 1: Theory of Valuation, and
Vol. 2: Financial Markets and Incomplete Information, Rowman and
Littlefield, 1989. [Edited volumes of readings with discussion.]
Friedman, B. M., and F. H. Hahn, Handbook of Monetary Economics,
North-Holland, New York, 1990.
Huang, C., and R. Litzenberger, Foundations for
Financial Economics, North-Holland, Amsterdam, 1988.
Ingersoll, J., Theory of Financial Decision-Making, Rowman
and Littlefield, New Jersey, 1987.
Jarrow, R., Finance Theory, Prentice-Hall, New Jersey, 1988.
Malliaris, A., Stochastic Methods in Economics and Finance,
North-Holland, Amsterdam, 1982.
Mayer, Colin, and Xavier Vives, Capital Markets and
Financial Intermediation, Cambridge University Press, 1993.
Mishkin, F., The Economics of Money, Banking, and
Financial Markets, Scott, Foresman, Boston, 1989.
Ohlson, J. A., The Theory of Financial Markets and Information,
North Holland, New York, 1987.
Sharpe, W. F., Investments, Prentice-Hall, New Jersey, 1981.
II. SAVINGS, WEALTH, AND THE VALUATION OF RISKY ASSETS
#Primary Topics#: Time preference; present value; intertemporal
optimization; dynamic programming treatment of
stochastic dynamic asset-allocation problems.
** Distributed lecture notes
* Varian, H., "Time," Chapter 18, pp. 358-367, in #Microeconomic
Analysis#, W. W. Norton and Co., Third Edition, 1992, BOOK ON
CLOSED RESERVE
Fisher, I., The Theory of Interest, Macmillan, New York, 1930.
Foley, D., "On Two Specifications of Asset Equilibrium in
Macroeconomic Models, Journal of Political Economy 83 (April
1975), pp. 303-324, plus comments by J. Turnovsky and E.
Burmeister, by W. Buiter and C. Woglom, and by D. Foley,
Journal of Political Economy 85 (April 1977), pp. 379-393,
395-400, and 401-402, respectively.
Hicks, J. R., Value and Capital, Clarendon Press, Oxford, 1946.
Hirshleifer, J., Investment, Interest, and Capital, Prentice-Hall,
Inc., New Jersey, 1970.
III. INFORMATION AND FINANCIAL MARKETS
#Primary Topics#: Ex ante versus ex post measures of information
value; Information signalling through price systems;
adverse selection; moral hazard; monitoring and
evaluation costs.
A. Measuring the value of information
** Distributed lecture notes
** Hirshleifer, J., and J. Riley, "The Analytics of Uncertainty
and Information: An Expository Survey," Journal of Economic
Literature 17 (1979), pp. 1384-1389, 1393-1403. CLOSED RESERVE
** Gale, Douglas, #Money in Equilibrium#, Cambridge University Press,
New York, 1982, Chapter 2 ("Informational Efficiency and Economic
Efficiency"), especially pp. 59-68. BOOK ON CLOSED RESERVE
B. Problems with Asymmetric Information
** Distributed lecture notes
** Hirshleifer, J., and J. Riley, "The Analytics of Uncertainty
and Information: An Expository Survey," Journal of Economic
Literature 17 (1979), pp. 1389-1393, 1406-1421. CLOSED RESERVE
** Varian, H., "Information," Chapter 25, especially pp. 466-471,
in #Microeconomic Analysis#, W. W. Norton and Co., Third Edition,
1992. BOOK ON CLOSED RESERVE
* Akerlof, G. A., "The Market for Lemons," Quarterly Journal of
Economics 84 (August 1970), 488-500. [Classic study of adverse
selection.] CLOSED RESERVE
Additional Suggested Readings:
Grossman, S., and J. Stiglitz, "On the Impossibility of
Informationally Efficient Markets," American Economic Review
70 (1980), 393-408. [Argues private traders can benefit from
inside information in a noisy rational expectations equilibrium.]
Grossman, S., and J. Stiglitz, "Information and Competitive
Price Systems," American Economic Review (May 1976), 611-628.
Hubbard, G. (ed.), Asymmetric Information, Corporate
Finance, and Investment, University of Chicago Press (for
the NBER), 1990.
McCall, J., ed., The Economics of Uncertainty and Information,
University of Chicago Press, Chicago, 1982.
Nermuth, M., Information Structures in Economics: Studies in the
Theory of Markets with Imperfect Information, Springer-Verlag,
New York, 1982.
Ohlson, J. A., The Theory of Financial Markets and Information,
North Holland, New York, 1987.
Ross, S., "The Economic Theory of Agency: The Principal's Problem,"
The American Economic Review 63 (May 1973), 134-139.
IV. CONTEMPORARY THEORIES OF FINANCIAL INTERMEDIATION AND MONEY
A. Overview
#Primary Topics#: Major types of players in financial markets;
alternative types of financial market structures;
key services provided by financial intermediaries;
what (if anything) makes "money" distinctive from
financial assets or real goods?
* CK, Part I: Survey of Financial Institutions and Markets,
Chapters 2-4 (pp. 18-114), CLOSED RESERVE
B. Selected Readings on the Modelling of Financial Intermediation
** Bhattacharya, S., and A. Thakor, "Contemporary Banking Theory,"
Journal of Financial Intermediation 3 (1993), 2-50. [A
review of contributions to the theory of financial
intermediation over the past fifteen years. See in particular
pp. 1-28 and 31-38, which focus on some of the topics/readings
assigned below.] CLOSED RESERVE
** Diamond, D. W., "Financial Intermediation and Delegated Monitoring,"
Review of Economic Studies 51 (July 1984), 393-414. [Intermediary
structure modelled as arising in response to agency problems]
CLOSED RESERVE
** Williamson, S. D., "Recent Developments in Modelling Financial
Intermediation," Quarterly Review, Federal Reserve Bank of
Minneapolis, Summer 1987, pp. 19-29. [Develops a model in which
intermediaries arise due to principal-agent problems.] CLOSED
RESERVE.
** (ADDITIONAL REQUIRED READINGS MAY BE ASSIGNED)
C. Selected Readings on the Modelling of Money
** Hoover, K., #The New Classical Macroeconomics#, Basil
Blackwell, 1988 (issued in paperback 1991,1992), Chapter 5:
"The New Monetary Economics" (pp. 87-110). [What constitutes
an adequate microfoundations for monetary theory? What, if
anything, distinguishes "money" from real goods or from
financial assets?] CLOSED RESERVE.
** Hoover, K., #The New Classical Macroeconomics#, op. cit.,
Chapter 6: "Formal Models of Monetary Economies" (pp. 111-137).
[Surveys work on monetary overlapping generations economies and
finance-constrainedf (e.g., cash-in-advance) models.] CLOSED
RESERVE.
** Kiyotaki, N., and R. Wright, "A Contribution to the Pure Theory
of Money," Journal of Economic Theory 53 (1991), 215-235.
[Analyzes a general equilibrium model with search frictions and
differentiated commodities that permits a medium of exchange
role for money.] CLOSED RESERVE
* Kiyotaki, N., and R. Wright, "A Search-Theoretic Approach to
Monetary Economics," American Economic Review (1993), 63-77.
[Simplified treatment, with extended discussion, of Kiyotaki
and Wright, JET 1991, op. cit.] CLOSED RESERVE
** R. Marimon, E. McGrattan, and T. J. Sargent, "Money as a Medium
of Exchange in an Economy with Artificially Intelligent Agents,"
Journal of Economic Dynamics and Control 14 (1990), 329-373.
CLOSED RESERVE.
** (ADDITIONAL REQUIRED READINGS MAY BE ASSIGNED)
Additional Suggested Readings:
Barnett, W., and K. Singleton, eds., New Approaches to Monetary
Economics, Cambridge University Press, Cambridge, 1987.
Bernanke, B., and M. Gertler, "Agency Costs, Net Worth, and
Business Fluctuations, American Economic Review (March 1989),
14-31.
Bester, H., "Screening vs. Rationing in Credit Markets with
Imperfect Information," American Economic Review (September
1985), pp. 850-855.
Boyd, J. H., and E. Prescott, "Financial Intermediary-Coalitions,"
Journal of Economic Theory 38 (April 1986), 211-232.
Gale, Douglas, Money: In Equilibrium, Cambridge University
Press, New York, 1982.
Gale, Douglas, Money: In Disequilibrium, Cambridge University
Press, New York, 1983.
Havrilesky, T. M., "Theory-of-the-Firm Models of Bank Behavior,"
pp. 5-26 in T. M. Havrilesky, R. Schweitzer, and J. T. Boorman,
Dynamics of Banking, Harlan Davidson, 1985.
Jacklin, C., "Demand Deposits, Trading Restrictions, and Risk
Sharing," in E. C. Prescott and N. Wallace, eds., Contractual
Arrangements for Intertemporal Trade, Minnesota Studies in
Macroeconomics, Vol. 1, University of Minnesota Press, 1987.
McCandless, G. T., jr., with N. Wallace, Introduction to
Dynamic Macroeconomic Theory: An Overlapping Generations
Approach, Harvard University Press, Cambridge, 1991.
Pingle, M., and L. Tesfatsion, "Overlapping Generations,
Intermediation, and the First Welfare Theorem," Journal of
Economic Behavior and Organization 15 (1991), 325-345.
Pingle, M., and L. Tesfatsion, "Active Intermediation in a Monetary
Overlapping Generations Economy," ISU Economic Report No. 32,
Revised Feb 1995.
Prescott, E., and N. Wallace, Contractual Arrangements for
Intertemporal Trade, University of Minnesota Press, Mpls., 1987.
Shubik, M., "The Game Theoretic Approach to the Theory of Money
and Financial Institutions," Chapter 5 in Handbook of Monetary
Economics, ed. by B. M. Friedman and F. H. Hahn, North-Holland,
N.Y., 1990.
Stiglitz, J. E., and A. Weiss, "Credit Rationing in Markets
with Imperfect Information," American Economic Review 71
(June 1981), 393-410.
Tirole, J., "Asset Bubbles and Overlapping Generations,"
Econometrica 53 (1985), pp. 1499-1528.
Weil, P., "Confidence and the Real Value of Money in an
Overlapping Generations Economy," Quarterly Journal of
Economics 102 (February 1987), pp. 1-22.
Williamson, S., "Costly Monitoring, Financial Intermediation,
and Equilibrium Credit Rationing," Journal of Monetary Economics
18 (1986), pp. 159-179.
Williamson, S., "Financial Intermediation, Busines Failures, and
Real Business Cycles," Journal of Political Economy (December
1987), 1196-1216.
V. THE OPERATION AND REGULATION OF BANKING INSTITUTIONS
A. Rationales for the Regulation of Banking Activity
#Primary Topic#: the deposit insurance crisis
* CK, Chapters 5-7 (pp. 115-170), CLOSED RESERVE
** Diamond, D. W., and P. H. Dybvig, "Bank Runs, Deposit Insurance,
and Liquidity," Journal of Political Economy 91 (1983), 401-419.
[This famous seminal paper explores the idea that liquidity
considerations might justify the types of interventions in
commercial banking currently in effect, such as FDIC insurance.]
CLOSED RESERVE
** Temzelides, T., "Evolution, Coordination, and Banking Panics,"
Working Paper, Fed Reserve Bank of Philadelphia, October 1995.
[Studies equilibrium selection via an evolutionary process for
a repeated game version of the model by Diamond-Dybvig (1983).
CLOSED RESERVE.
** (ADDITIONAL REQUIRED READINGS MAY BE ASSIGNED)
* Symposium on Federal Deposit Insurance, Journal of Economic
Perspectives 3 (Fall 1989), pp. 3-47. (Articles by D. M.
Jaffee, L. J. White, and E. J. Kane.) CLOSED RESERVE
B. Credit vs. Monetarist Views on Monetary Transmission
** Green, E. J., and Soo Nam Oh, "Can a 'Credit Crunch' Be
Efficient?", Quarterly Review, Federal Reserve Bank of
Minneapolis, (Fall 1991), pp. 3-17. CLOSED RESERVE
** (ADDITIONAL REQUIRED READINGS MAY BE ASSIGNED)
* Bernanke, B. S., "Credit in the Macroeconomy," Quarterly
Review, Federal Reserve Bank of New York, Spring 1992-1993.
CLOSED RESERVE.
Additional Suggested Readings on Banking, Money, and Credit
Bernanke, B., "Non-Monetary Effects of the Financial Collapse
in the Propagation of the Great Depression," American Economic
Review 73 (June 1983), pp. 257-276.
Bernanke, B., and M. Gertler, "Banking and Macroeconomic
Equilibrium," pp. 89-111 in W. Barnett and K. Singleton, eds.,
New Approaches to Monetary Economics, Cambridge University
Press, 1987.
Bryant, J., "Bank Collapse and Depression," Journal of Money,
Credit, and Banking 13 (1981), pp. 454-464.
Bryant, J., "Banking, Recession, Depression, and Government
Expenditure," Journal of Banking and Finance 6 (1982), pp.
549-559.
Cukierman, Alex, #Central Bank Strategy, Credibility, and
Independence#, MIT Press, 1992.
Dewatripont, M., and J. Tirole, #The Prudential Regulation
of Banks#, The MIT Press, Cambridge, MA, 1994.
Dunbar, C. F., "Free Banking," p. 417 in #The New Palgrave#, ed.
by J. Eatwell, M. Milgate, and P. Newman, W. W. Norton, N.Y.,
1987. CLOSED RESERVE
Fama, E., "What's Different About Banks?," Journal of Monetary
Economics 15 (1985), pp. 29-39.
Friedman, M., and A. Schwartz, A Monetary History of the
United States, 1867-1960, Princeton University Press,
Princeton, 1963.
Friedman, M., "The Quantity Theory of Money," pp. 1-40 in #The
New Palgrave: Money#, ed. by J. Eatwell, M. Milgate, and P.
Newman, W. W. Norton, N.Y., 1989.
Goodhart, C., The Evolution of Central Banks, MIT Press,
Cambridge, 1988.
Goodhart, C., "Game Theory for Central Bankers: A Report to
the Governor of the Bank of England," Journal of Economic
Literature 32 (March 1994), 101-114.
Gorton, G., "Banking Theory and Free Banking History: A Review
Essay," Journal of Monetary Economics 17 (1985), pp. 267-276.
Green, R., "Real Bills Doctrine," pp. 310-315 in #The New Palgrave:
Money#, ed. by J. Eatwell, M. Milgate, and P. Newman, W. W.
Norton, N.Y., 1989.
Haraf, W. S., and R. Kushmeider, eds., #Restructuring Banking and
Financial Services in America#, American Enterprise Institute,
Washington, D. C., 1988.
Havrilesky, T. M., R. Schweitzer, and J. T. Boorman, Dynamics
of Banking, Harlan Davidson, 1985, Part I: Bank Management,
Part IV: Constraints on Geographic and Product-Line Expansion
by Financial Services Firms, and Part VI: Supervisory and
Regulatory Reform.
Havrilesky, T. M., ed., Modern Concepts in Macroeconomics,
Harlan Davidson, Illinois, 1985, Part IV: Monetary Policy.
Hubbard, G., Financial Markets and Financial Crises, The
University of Chicago Press, Chicago, 1991.
Jacklin, C., and S. Bhattacharya, "Distinguishing Panics and
Information-Based Bank Runs: Welfare and Policy Implications,"
Journal of Political Economy 96 (June 1988), 568-592.
Kahn, J., "Another Look at Free Banking in the United States,"
American Economic Review 75 (September 1985).
Kane, E., The Gathering Crisis in Federal Deposit Insurance,
Cambridge: MIT Press, 1985.
Kiyotaki, N., and R. Wright, "On Money as a Medium of Exchange,"
Journal of Political Economy (August 1989), 927-954.
Laidler, D., "Misconceptions about the Real Bills Doctrine: A
Comment on Sargent and Wallace," Journal of Political Economy
92 (Feb 1984), 149-155.
Mishkin, F., "Anatomy of a Financial Crisis," NBER Working Paper
No. 3934, December 1991. [Provides an asymmetric information
framework for understanding the nature of financial crises.]
Rolnick, A., and W. Weber, "The Causes of Free Bank Failures: A
Detailed Examination," Journal of Monetary Economics 14 (1984),
267-292.
Rose, P., The Changing Structure of American Banking,
Columbia University Press, New York, 1987.
Sargent, T., and N. Wallace, "The Real Bills Doctrine vs. the
Quantity Theory of Money: A Reconsideration," Journal of
Political Economy 90 (December 1982), 1212-1236.
A. Schwartz, "Banking School, Currency School, Free Banking
School," pp. 41-49 in #The New Palgrave: Money#, ed. by J.
Eatwell, M. Milgate, and P. Newman, W. W. Norton, N.Y., 1989.
Tobin, J., "A Case for Preserving Regulatory Distinctions,"
Challenge 30 (November-December 1987), 10-27.
Wachtel, P., ed., Crises in the Economic and Financial
Structure, D. C. Heath, Lexington, l982.
Wallace, N., "Another Attempt to Explain an Illiquid Banking
System: The Diamond and Dybvig Model with Sequential Service
Taken Seriously," Quarterly Review, Federal Reserve Bank of
Minneapolis, Fall 1990.
White, E., Crises and Panics: The Lessons of History, Dow
Jones-Irwin, Homewood, 1989.
White, L., "The Debacle of the S&Ls in the United States: Some
Cautionary Lessons for the Regulation of Financial Institutions,"
Working Paper EC-90-10, Stern School of Business, New York
University, December 1990.
Williamson, S., "Liquidity, Banking, and Bank Failures,"
International Economic Review 29 (1988), pp. 25-43. [Critique
of Diamond-Dybvig]
Williamson, S., "Restrictions on Financial Intermediaries and
Implications for Aggregate Fluctuations: Canada and the United
States 1870-1913," Staff Report 119, Federal Reserve Bank of
Minneapolis, April 1989.
VI. GLOBAL FINANCIAL MARKETS
#Primary Topics#: The global integration of financial markets;
strengths and weaknesses in the current global
financial regulatory system; the reform of global
financial regulatory policies.
* CK, Part II, Chapters 9-12 (pp. 240-319), CLOSED RESERVE.
** REQUIRED READINGS WILL BE ASSIGNED IF TIME PERMITS.
Bryant, R. C., International Financial Intermediation, Studies
in International Economics Series, Brookings Institution,
Washington, D.C., 1987.
Bullow, J., and K. Rogoff, "Sovereign Debt: Is to Forgive to
Forget?," American Economic Review (March 1989), 43-50.
Crane, D., and S. Hayes, III, "The Evolution of International
Banking Competition and its Implications for Regulation,"
Journal of Bank Research (Spring 1983), pp. 39-48.
Dean, J. W, and I. H. Giddy, "Old and New Proposals for
International Banking Safety," pp. 342-355 in Havrilesky, T.
M., R. Schweitzer, and J. T. Boorman, eds., The Dynamics of
Banking, Harlan Davidson, Inc., 1985.
Dornbusch, R., and A. Giovannini, "Monetary Policy in the Open
Economy," Chapter 23 in the Handbook of Monetary Economics, ed.
by B. M. Friedman and F. H. Hahn, North-Holland, New York, 1990.
Feldstein, M., "Distinguished Lecture on Economics in Government:
Thinking About International Economic Cooperation," Journal of
Economic Perspectives 2 (Spring 1988), pp. 3-13.
Fieleke, N. S., "International Lending on Trial," pp. 314-327
in Havrilesky, T. M., R. Schweitzer, and J. T. Boorman, eds.,
The Dynamics of Banking, Harlan Davidson, Inc., 1985.
Havrilesky, T. M., Modern Concepts in Macroeconomics, Harlan
Davidson, Illinois, 1984, Part V: International Aspects of
Monetary and Fiscal Policy.
McKinnon, R. I., "Monetary and Exchange Rate Policies for
International Financial Stability: A Proposal," Journal of
Economic Perspectives 2 (Winter 1988), pp. 83-103, followed by
comments by R. Dornbusch, pp. 105-112, and J. Williamson, pp.
113-119.
Pardee, S. E., "Internationalization of Financial Markets,"
Economic Review, Federal Reserve Bank of Kansas City, Feb.
1987, pp. 3-7.
Stockman, A., "On the Role of International Financial Markets
and Their Relevance for Policy," Journal of Money, Credit, and
Banking 20 (August 1988, Part 2), pp. 531-558, followed by
comments by P. Kehoe and J. David Germany.
Walter, I., "Country Risk, Portfolio Decisions, and Regulation
in International Bank Lending," pp. 328-341 in Havrilesky, T.
M., R. Schweitzer, and J. T. Boorman, eds., The Dynamics of
Banking, Harlan Davidson, Inc., 1985.