Economics of Money and Banking

About this course: The last three or four decades have seen a remarkable evolution in the institutions that comprise the modern monetary system. The financial crisis of 2007-2009 is a wakeup call that we need a similar evolution in the analytical apparatus and theories that we use to understand that system. Produced and sponsored by the Institute for New Economic Thinking, this course is an attempt to begin the process of new economic thinking by reviving and updating some forgotten traditions in monetary thought that have become newly relevant. Three features of the new system are central. Most important, the intertwining of previously separate capital markets and money markets has produced a system with new dynamics as well as new vulnerabilities. The financial crisis revealed those vulnerabilities for all to see. The result was two years of desperate innovation by central banking authorities as they tried first this, and then that, in an effort to stem the collapse. Second, the global character of the crisis has revealed the global character of the system, which is something new in postwar history but not at all new from a longer time perspective. Central bank cooperation was key to stemming the collapse, and the details of that cooperation hint at the outlines of an emerging new international monetary order. Third, absolutely central to the crisis was the operation of key derivative contracts, most importantly credit default swaps and foreign exchange swaps. Modern money cannot be understood separately from modern finance, nor can modern monetary theory be constructed separately from modern financial theory. That's the reason this course places dealers, in both capital markets and money markets, at the very center of the picture, as profit-seeking suppliers of market liquidity to the new system of market-based credit.

Who is this class for: This course was designed originally for upper level undergraduate economics majors at Barnard and Columbia, in New York City. (The lectures were filmed live in the class I teach there.) But I have found that the course works for a much broader group as well: people who work in banks or finance but have no background in economics or finance (IT folk, lawyers), graduate students in economics and also other social sciences (history, international political economy, anthropology), and adult learners who sense the importance of the subject and want to find out how to think more deeply about it. Because I teach in New York, which is the center of world dollar money markets, the course is focused on those markets, but I have found that it works well even for learners from around the globe, in Europe and Japan, but also in China and India, and everywhere else. The basic concepts and tools that we need to understand dollar money markets work just as well for understanding others, and dollar money markets are at the center of the larger global financial system.

Created by:  Columbia University

Commitment13 weeks of study, 5 hours/week
How To PassPass all graded assignments to complete the course.
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The first two lectures paint a picture of the monetary system as the essential infrastructure of a decentralized market economy. The second lecture, "The Natural Hierarchy of Money", is a kind of high-level overview of the entire course, so don't expect to fully understand it until you look back after completing the rest of the course. Nevertheless it provides essential orientation for what comes after. Lectures notes for these and subsequent lectures may be found in the very first segment of this module.
12 videos2 readings
  1. Reading: Lecture Notes (for download)
  2. Video: The Big Picture
  3. Video: Prerequisites?
  4. Video: What is a Bank, a Shadow Bank, a Central Bank?
  5. Video: Central Themes
  6. Video: Reading: Allyn Young
  7. Reading: Allyn Young
  8. Video: FT: The Eurocrisis, Liquidity vs. Solvency
  9. Video: Hierarchy of Financial Instruments
  10. Video: Hierarchy of Financial Institutions
  11. Video: Dynamics of the Hierarchy
  12. Video: Discipline and Elasticity, Currency Principle and Banking Principle
  13. Video: Hierarchy of Market Makers
  14. Video: Managing the Hierarchy
Introduction, continued
The next two lectures are meant to introduce a key analytical tool, the balance sheet approach to monetary economics, that we will be using repeatedly throughout the course. As inspiration, first I provide a concrete example of how the approach works by "translating" the Allyn Young reading into the balance sheet language. I follow that with a more systematic introduction to this essential tool.
20 videos1 reading1 practice quiz
  1. Video: FT: Quantitative Easing and the Fed
  2. Video: Allyn Young: Money and Economic Orthodoxy
  3. Video: National Banking System Before the Fed
  4. Video: Civil War Finance, Bonds, and Loans
  5. Video: Civil War Finance, Legal Tenders
  6. Video: National Banking System, Origins
  7. Video: National Banking System, Instability
  8. Video: Federal Reserve System, Plan
  9. Video: Federal Reserve System, Actual
  10. Video: FT: Dealer of Last Resort
  11. Video: Reading: Hyman Minsky
  12. Video: Sources and Uses Accounts
  13. Video: Payments: Money and Credit
  14. Video: Payments: Discipline and Elasticity
  15. Video: The Survival Constraint
  16. Reading: Hyman Minsky
  17. Video: Payment Example: Money and Credit
  18. Video: Flow of Funds Accounts
  19. Video: The Survival Constraint, Redux
  20. Video: Liquidity, Long and Short
  21. Video: Financial Fragility, Flows and Stocks
  22. Practice Quiz: Introduction
Banking as a Clearing System
In the next four lectures, we build intuition by viewing banking as a payments system, in which every participant faces a daily settlement constraint (a survival constraint). From this point of view, the wholesale money market plays a key role by allowing banks to relax the discipline of a binding settlement constraint, delaying final payment by putting settlement off until a later date. The relative importance of the various money markets has changed since the 2008 crisis--Fed Funds is now less important--but the conceptual framework remains valid, indeed not only for dollar money markets but also for non-dollar money markets.
20 videos1 reading1 practice quiz
  1. Video: FT: Martin Wolf on QE3
  2. Video: One Big Bank
  3. Video: Multiple Banks, A Challenge
  4. Video: Reading: Charles F. Dunbar
  5. Reading: Dunbar
  6. Video: Correspondent Banking, Bilateral Balances
  7. Video: Correspondent Banking, System Network
  8. Video: Clearinghouse, Normal Operations
  9. Video: Clearinghouse, Private Lender of Last Resort
  10. Video: Central Bank Clearing
  11. Video: Central Bank Cooperation
  12. Video: FT: European Bank Deleveraging
  13. Video: What are Fed Funds?
  14. Video: Payment Settlement versus Required Reserves
  15. Video: Payment Elasticity/Discipline, Public and Private
  16. Video: The Function of the Fed Funds Market
  17. Video: Payment versus Funding: An Example
  18. Video: Brokers versus Dealers
  19. Video: Payments Imbalances and the Fed Funds Rate
  20. Video: Secured versus Unsecured Interbank Credit
  21. Video: Required Reserves, Redux
  22. Practice Quiz: Banking as a Clearing System
Banking as a Clearing System, continued
The next two lectures extend the payments system frame to non-banks by bringing in repo markets, and to the international monetary system by bringing in Eurodollar markets. Here, as in the previous two lectures, the emphasis is on settlement, and so implicitly on so-called "funding liquidity". The last three segments of the Eurodollar lecture, on the failure of two seemingly obvious arbitrage conditions, are meant to motivate the shift to market-making and "market liquidity" in the next module.
20 videos1 reading
  1. Video: FT: The Impact of QE3
  2. Video: Money Market Interest Rate Patterns
  3. Video: What is Repo?
  4. Video: Repo in Balance Sheets
  5. Video: Comparison with Fed Funds
  6. Video: Legal Construction of Repo
  7. Video: Security Dealers Balance Sheet
  8. Video: Repo, Modern Finance, and the Fed
  9. Reading: Bagehot
  10. Video: Interest Rate Spreads: Before the Crisis
  11. Video: Interest Rate Spreads: After the Crisis
  12. Video: FT: Ring-fencing and the Volcker Rule
  13. Video: The Eurodollar Market in Crisis
  14. Video: What are Eurodollars?
  15. Video: Why is There a Eurodollar Market?
  16. Video: Eurodollar as Global Funding Market
  17. Video: Liquidity Challenge of Eurodollar Banks
  18. Video: FRA as Implicit Swap of IOUs
  19. Video: Forward Parity, Interest Rates, EH
  20. Video: Forward Parity, Exchange Rates, UIP
  21. Video: Forward Rates are NOT Expected Spot Rates
Graded: Banking as a Clearing System, continued
Banking as Market Making
"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.
16 videos1 reading
  1. Video: FT: Depreciation of Iran's Currency
  2. Video: Reading: John Hicks
  3. Reading: Hicks
  4. Video: Bagehot's World, Wholesale Money Market
  5. Video: Economizing on Notes: Deposits, Acceptances
  6. Video: Managing Cash Flow: Discount, Rediscount
  7. Video: Market Rate of Interest
  8. Video: Central Bank and Bank Rate
  9. Video: The Bagehot Rule, Origin of Monetary Policy
  10. Video: Limits on Central Banking: Internal vs. External Drain
  11. Video: FT: Asymmetric Credit Growth in Europe
  12. Video: Market Liquidity, Dealers, and Inventories
  13. Video: Two-Sided Dealer Basics
  14. Video: Economics of the Dealer Function: the Treynor Model
  15. Video: Leveraged Dealer Basics
  16. Video: Real World Dealers
  17. Video: Arbitrage and the Assumption of Perfect Liquidity
Graded: Banking as Market Making
Banking as Market Making, continued
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.
16 videos1 reading
  1. Video: FT: Money Market Mutual Funds
  2. Video: Banks as Money Dealers, a Puzzle
  3. Video: Security Dealers as Money Dealers, Matched and Speculative Book
  4. Video: Adapting Treynor to Liquidity Risk
  5. Reading: Treynor
  6. Video: Digression: Evolution of American Banking
  7. Video: The Fed in the Fed Funds Market
  8. Video: Return to the Initial Puzzle
  9. Video: FT: Citibank and the SIVs
  10. Video: The Art of Central Banking
  11. Video: Evolution of Monetary Policy: 1951-1987
  12. Video: The Taylor Rule: 1987-2007
  13. Video: Monetary Transmission Mechanism
  14. Video: Anatomy of a Normal Crisis
  15. Video: Anatomy of a Serious Crisis
  16. Video: Should the Fed Intervene or Not?
  17. Video: The Fed as Dealer of Last Resort: 2007-2009
Graded: Banking as Market Making, continued
Midterm review and exam
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.
10 videos
  1. Video: FT: Trade Credit and the Eurocrisis
  2. Video: Inspiration: The Origin of the Fed
  3. Video: Central Bank Operations, Normal Times
  4. Video: Central Bank Operations, Crisis Times
  5. Video: Settlement Risk, Payments, and Market-making
  6. Video: Q: Standard and Subordinate Coin
  7. Video: Q: War Finance as Financial Crisis
  8. Video: Q: Forward Parity
  9. Video: Q: Payments, CHIPS and Fedwire
  10. Video: Q: Fed Balance Sheet Operations
Graded: Midterm
International Money and Banking
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).
18 videos1 reading
  1. Video: FT: Autonomy of Bank of Japan
  2. Video: Key Currencies as a Hierarchical System
  3. Video: What is Money? Chartalism versus Metallism
  4. Video: Chartalism as a Theory of Money
  5. Video: Quantity Theory of Money
  6. Video: Purchasing Power Parity
  7. Video: Metallism as a theory of money
  8. Video: A Money View of International Payments, FX Dealers
  9. Video: Chartallism, Metallism, and the Money View Compared
  10. Video: Private and Public Money: A Hybrid System
  11. Video: Hybridity in FX Market-making
  12. Video: FT: Costs of Japan's Monetary Policy
  13. Video: Reading: Robert Mundell
  14. Reading: Mundell
  15. Video: Act 1 (1900-1933): Confrontation of the Fed with the Gold Standard
  16. Video: Act 2 (1934-1971): Contradiction Between Keynesian National Management and the Bretton Woods Fixed Rate System
  17. Video: The Dollar System
  18. Video: Act 3 (1972-1999): Flexible exchange, Learning from Experience
  19. Video: Act 4: Global Financial Crisis, Limits of Central Bank Cooperation
Graded: International Money and Banking
International Money and Banking, continued
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.
15 videos1 reading
  1. Video: FT: European Money Market Funds Shifting to Asia and European Core Countries
  2. Video: International Transactions under the Gold Standard
  3. Video: Dealer Model for Foreign Exchange
  4. Video: Central Banking, Defense of Domestic Exchange
  5. Video: Bank of England, Defense Against External Drain
  6. Video: Toward a Theory of Exchange, Without the Gold Standard
  7. Video: FT: High Frequency Trading
  8. Video: Uncovered Interest Parity (UIP) and the Expectations Hypothesis of the Term Structure (EH)
  9. Video: FX Dealers Under the Gold Standard, Redux
  10. Video: Private FX Dealing System
  11. Video: Economics of the Dealer Function, Speculative Dealer
  12. Video: Economics of the Dealer Function, Matched-book Dealer
  13. Video: Digression: Why do UIP and EH Fail?
  14. Video: Central Bank as FX Dealer of Last Resort
  15. Video: Reading: McCauley on Internationalization of Renminbi
  16. Reading: Kindleberger
Graded: International Money and Banking, continued
Banking as Advance Clearing
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.
19 videos1 reading
  1. Video: FT: Shadow Banking
  2. Video: Bagehot's World: Separation of Money Markets and Capital Markets
  3. Video: The New World: Integration of Money Markets and Capital Markets
  4. Video: Funding Liquidity Versus Market Liquidity
  5. Video: Digression: Schumpeter on Banking and Economic Development
  6. Video: Payment Versus Funding
  7. Video: Reading: Gurley and Shaw
  8. Reading: Gurley and Shaw
  9. Video: Financial Evolution: Indirect Finance to Direct Finance
  10. Video: Banking Evolution: Loan-based Credit to Market-based Credit
  11. Video: Preview: Central Banking and Shadow Banking
  12. Video: FT: Argentina in Court to Fight Debt Ruling
  13. Video: Banking as Advance Clearing
  14. Video: Forwards versus Futures
  15. Video: Forward Contracts, Fluctuations in Value and Final Cash Flow
  16. Video: Futures Contracts, Fluctuations in Value and Daily Cash Flows
  17. Video: Cash and Carry Arbitrage, Defined
  18. Video: Cash and Carry Arbitrage, Explained as Liquidity Risk
  19. Video: Cash and Carry Arbitrage, Explained as Counterparty Risk
  20. Video: Cash and Carry Arbitrage, as a Natural Banking Business
Graded: Banking as Advance Clearing
Banking as Advance Clearing, continued
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.
19 videos1 reading
  1. Video: FT: Sovereign Debt Crises
  2. Video: Reading: FOMC Report (1952)
  3. Reading: FOMC
  4. Video: Treasury-swap Spread, a Puzzle
  5. Video: What is a Swap?
  6. Video: Why swap? An Example from Stigum
  7. Video: Market Making in Swaps
  8. Video: Money Market Swaps, Example
  9. Video: Life in Arbitrage Land
  10. Video: Treasury-swap Spread, Liquidity Risk or Counterparty Risk?
  11. Video: FT: Internationalization of the Euro
  12. Video: Credit Indices
  13. Video: Fischer Black (1970), Risk-free Security
  14. Video: What is a Credit Default Swap (CDS)?
  15. Video: Corporate Bonds
  16. Video: CDS Pricing
  17. Video: Market Making in CDS
  18. Video: Example: Negative Basis Trade and Liquidity Risk
  19. Video: Example: Private backstop of Marketmaking in CDS
  20. Video: Example: Synthetic CDO as Collateral Prepayment
Graded: Banking as Advance Clearing, continued
Money in the Real World
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.
17 videos1 reading
  1. Video: FT: Regulation of Shadow Banking
  2. Video: Shadow Banking vs Traditional Banking
  3. Video: Liquidity and Solvency Backstops
  4. Video: Global Dimension
  5. Video: Evolution of Modern Finance
  6. Video: What is Shadow Banking?
  7. Reading: Shadow Banking
  8. Video: Backstopping the Market Makers
  9. Video: Regulation of Systemic Risk
  10. Video: Regulation of Collateral and Payment Flows
  11. Video: Private Backstop and Public
  12. Video: FT: Future of Banking
  13. Video: Three World Views
  14. Video: Economics View: Commodity Exchange
  15. Video: Finance View: Risk
  16. Video: The Education of Fischer Black
  17. Video: Steps From the Finance View to the Money View
  18. Video: A Money View of Economics and Finance
Graded: Money in the Real World
Final Exam
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.
Graded: Final Exam
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