Money, Banking & Interest Rates

In this chapter we started by defining what a global financial system is, which has been defined as comprised by a set of market-related institutions that includes financial markets, financial institutions, laws, procedures and regulations, as well as the set of techniques through which securities of all types of financial products and/or services are bought and sold (e.g., bonds, stocks, futures, options, and other hybrid securities are some of the most commonly exchanged financial products).

Of course, in studying the global financial system we the sub-categories within financial markets.  The section explores the global financial system as marketplace for the demand and supply of capital. In order to understand the importance of the credit channel, we study the global financial system and the occurrence of market failures. It should be observed that financial markets are periodically prone to market failures, insofar as the events (however extreme) occurring within the financial industry might also have important repercussions on the overall health of the global economy. The credit channel which is a shock transmission mechanism is then looked at in a bit more detail.

Inevitably, because there are distinct segments of the financial markets that serve the global financial system, they are classified in multiple forms. In section 1.3 we explore four major categorisations. These are: Money markets vs Capital markets, Open markets vs Negotiated markets, Primary markets vs Secondary markets, and Spot markets vs Futures, forward, or options markets. This chapter also highlights the global financial system as the marketplaces for savings and investment.

In order to determine the market equilibrium between the demand and supply of money, we first look at the demand for money and supply of money separately. In studying the demand for money, this chapter investigates some of the reasons for holding money. It is here that the Quantity theory of money is stated.  To better understand this concept, a simple curve depicting the relationship between money and interest rate can be drawn based on the negative association between these variables. Accordingly, the curve representing the money demand curve depicts the negative relationship between the interest rate offered by the financial markets and the quantity of money demanded by economic agents. Lastly, in this sub-section, we studied the shift in the money curve.

Following on from this, there is great exposition of the supply of money. It is important to also focus on the different types of money namely Monetary base, M1 and M2. Of course, in studying the supply of money, inevitably we have to examine the creation of money.

Another common growth theory covered in this chapter is the endogenous growth theory which suggests that knowledge, innovation, increases in personal productivity through education and perfection of technological skills or processes are significant contributors to economic growth. Of course, it is here that we discuss the most common endogenous model which is the ‘AK model.’ Likewise, we explored the implications of the AK model for economic growth. There have been some augmentations/advances in endogenous growth theory. This chapter will focus on the merger with the theory of entrepreneurship.

The other factors which affect economic development are studied briefly including trade openness, inequality and economic freedom amongst others. As entrepreneurship is key to economic growth, this is further explored in section 5.0 of this chapter. As with most ideas, concepts and information in economics, it is important that we consider both the benefits and the costs of economic growth to get a well-informed overall picture. A definition of economic welfare is provided (which essentially, is a more extensive measure of well-being. The chapter closes with a brief study of the developed versus undeveloped countries terminologies.


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