Microeconomics of Banking or Macroeconomics

Microeconomics of Banking

Author: Xavier Freixas

Over the last thirty years, a new paradigm in banking theory has overturned economists' traditional vision of the banking sector. The asymmetric information model, extremely powerful in many areas of economic theory, has proven useful in banking theory both for explaining the role of banks in the economy and for pointing out structural weaknesses in the banking sector that may justify government intervention. In the past, banking courses in most doctoral programs in economics, business, or finance focused either on management or monetary issues and their macroeconomic consequences; a microeconomic theory of banking did not exist because the Arrow-Debreu general equilibrium model of complete contingent markets (the standard reference at the time) was unable to explain the role of banks in the economy. This text provides students with a guide to the microeconomic theory of banking that has emerged since then, examining the main issues and offering the necessary tools f or understanding how they have been modeled.

This second edition covers the recent dramatic developments in academic research on the microeconomics of banking, with a focus on four important topics: the theory of two-sided markets and its implications for the payment card industry; "non-price competition" and its effect on the competition-stability tradeoff and the entry of new banks; the transmission of monetary policy and the effect on the functioning of the credit market of capital requirements for banks; and the theoretical foundations of banking regulation, which have been clarified, although recent developments in risk modeling have not yet led to a significant parallel development of economicmodeling.

Table of Contents:

Figures
Preface
1 General Introduction
1.1 What Is a Bank, and What Do Banks Do?
1.1.1 Liquidity and Payment Services
1.1.2 Asset Transformation
1.1.3 Managing Risk
1.1.4 Monitoring and Information Processing
1.1.5 The Role of Banks in the Resource Allocation Process
1.2 Banking in General Equilibrium Theory
1.2.1 The Consumer
1.2.2 The Firm
1.2.3 The Bank
1.2.4 General Equilibrium
Notes
References
2 Why Do Financial Intermediaries EXist?
2.1 Transaction Costs
2.1.1 Economies of Scope
2.1.2 Economies of Scale
2.2 Liquidity Insurance
2.2.1 The Model
2.2.2 Autarky
2.2.3 Market Economy
2.2.4 Optimal Allocation
2.2.5 Financial Intermediation
2.3 Information Sharing Coalitions
2.3.1 A Basic Model of Capital Markets with Adverse Selection
2.3.2 Signaling Through SelfFinancing
2.3.3 Coalitions of Borrowers
2.3.4 Related Justifications of FIs with Asymmetric Informa tion
2.4 Financial Intermediation as Delegated Monitoring
2.5 CoeXistence of Direct and Intermediated Lending
2.5.1 A Simple Model of the Credit Market with Moral Hazard
2.5.2 Monitoring and Reputation (adapted from Diamond, 1991)
2.5.3 Monitoring and Capital (adapted from Holmström and
Tirole, 1993)
2.5.4 Related Contributions
2.6 Problems
2.6.1 Economies of Scale in Information Production
2.6.2 Monitoring as a Public Good and Gresham's Law
2.6.3 Intermediation and Search Costs (adapted from Gehrig, 1993)
2.7 Solutions
2.7.1 Economies of Scale in Information Production
2.7.2 Monitoring as a Public Good and Gresham's Law
2.7.3 Intermediation and Search Costs
Notes
References
3 The IndustrialOrganization Approach to
Banking
3.1 A Model of Perfect Competition in the Banking Sector
3.1.1 The Model
3.1.2 The Standard Approach: The Credit Multiplier
3.1.3 The Behavior of Individual Banks in a Competitive Ba nking Sector
3.1.4 The Competitive Equilibrium of the Banking Sector
3.2 The MontiKlein Model of a Monopolistic Bank
3.2.1 The Original Model
3.2.2 The Oligopolistic Version
3.2.3 Empirical Evidence
3.3 Analyzing the Impact of Deposit Rate Regulation
3.4 Double Bertrand Competition
3.5 Monopolistic Competition
3.5.1 Does Free Competition Lead to the Optimal Number of Banks?
3.5.2 The Impact of Deposit Rate Regulation on Credit Rates
3.5.3 Bank Network Compatibility
3.6 Branch versus Unitary Banking
3.7 AppendiX 1: Empirical Evidence
3.8 AppendiX 2: Measuring the Activity of Banks
3.8.1 The Production Approach
3.8.2 The Intermediation Approach
3.8.3 The Modern Approach
3.9 Problems
3.9.1 EXtension of the MontiKlein Model to the Case of Risky
Loans (adapted from Dermine, 1986)
3.9.2 Compatibility between Banking Networks (adapted from Matutes
and Padilla, 1994)
3.10 Solutions
3.10.1 EXtension of the MontiK lein Model to the Case of
Risky Loans
3.10.2 Compatibility between Banking Networks
Notes
References
4 The LenderBorrower Relationship
4.1 Why Risk Sharing Does Not EXplain All the Features of Bank
Loans
4.1.1 Optimal Contracts When Cash Flows Are Observable
4.1.2 EXtensions and Applications of the RiskSharing Paradigm
4.2 Costly State Verification
4.2.1 Incentive Compatible Contracts
4.2.2 Efficient Incentive Compatible Contracts
4.2.3 Efficient FalsificationProof Contracts
4.2.4 Dynamic Debt Contracts with Costly State Verification
4.3 Incentives to Repay
4.3.1 Threat of Termination
4.3.2 Strategic Debt Repayment: The Case of a Sovereign Debtor
4.3.3 Private Debtors and the Inalienability of Human Capital
4.4 Moral Hazard
4.5 The Incomplete Contract Approach
4.5.1 Delegated Renegotiation
4.5.2 The Efficiency of Bank Loan Covenants
4.6 Collateral and Loan Size as Devices for Screening Heterogenous
Borro wers
4.6.1 The Role of Collateral
4.6.2 Loans with Variable Size
4.7 Problems
4.7.1 Optimal Risk Sharing with Symmetric Information
4.7.2 Optimal Debt Contracts with Moral Hazard (adapted from Innes, 1987)
4.7.3 The Optimality of Stochastic Auditing Schemes
4.7.4 The Role of Hard Claims in Constraining Management (adapted
from Hart and Moore, 1995)
4.7.5 Collateral and Rationing (adapted from Besanko and Thakor, 1987)
4.7.6 Securitization (adapted from Greenbaum and Thakor, 1987)
4.8 Solutions
4.8.1 Optimal Risk Sharing with Symmetric Information
4.8.2 Optimal Debt Contracts with Moral Hazard
4.8.3 The Optimality of Stochastic Auditing Schemes
4.8.4 The Role of Hard Claims in Constraining Management
4.8.5 Collateral and Rationing
4.8.6 Securitization
Notes
References
5 Equilibrium and Rationing in the Credit
Market
5.1 Definition of Equilibrium Credit Rationing
5.2 The Backward Bending Supply of Credit
5 .3 How Adverse Selection Can Lead to a Backward Bending Supply
of Credit
5.3.1 The Model of Stiglitz and Weiss (1981)
5.3.2 Risk Characteristics of Loan Applicants
5.4 Collateral as a Sorting Device
5.5 Credit Rationing Due to Moral Hazard
5.5.1 Nonobservable Technology Choice
5.5.2 Nonobservable Capacity to Repay
5.6 Problems
5.6.1 The Model of Mankiw (1986)
5.6.2 Efficient Credit Rationing (adapted from De Meza and Webb, 1992)
5.6.3 Too Much Investment (adapted from De Meza and Webb, 1987)
5.7 Solutions
5.7.1 The Model of Mankiw (1986)
5.7.2 Efficient Credit Rationing
5.7.3 Too Much Investment
Notes
References
6 The Macroeconomic Consequences of Financial
Imperfections
6.1 A Short Historical Perspective
6.2 The Transmission Channels of Monetary Policy
6.2.1 The Money Channel
6.2.2 Credit View
6.2.3 Credit View versus Money View: Relevance of the Assumptions
and Empirical Evidence
6.2.4 Endogenous Money
6.3 The Fragility of the Financial System
6.3.1 Financial Collapse Due to Adverse Selection
6.3.2 Financial Fragility and Economic Performance
6.4 Financial Cycles and Fluctuations
6.4.1 Bankruptcy Constraints
6.4.2 Credit Cycles
6.5 The Real Effects of Financial Intermediation
6.6 Financial Structure and Economic Development
Notes
References
7 Individual Bank Runs and Systemic Risk
7.1 Banking Deposits and Liquidity Insurance
7.1.1 A Model of Liquidity Insurance
7.1.2 Autarky
7.1.3 The Allocation Obtained When a Financial Market Is Opened
7.1.4 The Optimal (Symmetric) Allocation
7.2 A Fractional Reserve Banking System
7.3 The Stability of the Fractional Reserve System and Alternative
Institutional Arrangements
7.3.1 The Causes of Instability
7.3.2 A First Remedy to Instability: Narrow Banking
7.3.3 Regulatory Responses: Suspension of Convertibility or
Deposit Insurance
7.3.4 Jacklin's Proposal: E quity versus Deposits
7.4 Efficient Bank Runs
7.5 Interbank Markets and the Management of Idiosyncratic Liquidity
Shocks
7.5.1 The Model of Bhattacharya and Gale (1987)
7.5.2 The Role of the Interbank Market
7.5.3 The Case of Unobservable Liquidity Shocks
7.6 Aggregate Liquidity Shocks
7.6.1 The Model of Hellwig (1994)
7.6.2 Efficient Risk Allocation
7.6.3 Second Best Allocations under Asymmetric Information
7.7 Systemic Risk and the Lender of Last Resort: A Historical
Perspective
7.7.1 Four Views of the LLR Role
7.7.2 The Effect of LLR and Other Partial Arrangements
7.7.3 The Moral Hazard Issue
7.8 Problems
7.8.1 Different Specifications of Preferences in the
DiamondDybvig Model
7.8.2 InformationBased Bank Runs (adapted from Postlewaite and
Vives, 1987)
7.8.3 Banks' Suspension of Convertibility (adapted from Gorton,
1985)
7.9 Solutions
7.9.1 Different Specifications of Preferences in the
DiamondDybvi g Model
7.9.2 InformationBased Bank Runs
7.9.3 Banks' Suspension of Convertibility
Notes
References
8 Managing Risks in the Banking Firm
8.1 Default Risks
8.1.1 Institutional ConteXt
8.1.2 Evaluating the Cost of Default Risks
8.1.3 EXtensions
8.2 Liquidity Risk
8.2.1 Reserve Management
8.2.2 Introducting Liquidity Risk in the MontiKlein Model
8.2.3 The Bank as a Market Maker
8.3 Market Risk
8.3.1 Modern Portfolio Theory: The Capital Asset Pricing Model
8.3.2 The Bank as a Portfolio Manager: The Pyle (1971) and
HartJaffee (1974) Approach
8.3.3 An Application of the Portfolio Model: The Impact of Capital
Requirements
8.4 AppendiX: Institutional Aspects of Credit Risk
8.4.1 Interest Rate and Rate of Return
8.4.2 Collateral
8.4.3 Endorsement and Insurance
8.4.4 Loan Covenants
8.4.5 Information Costs
8.4.6 Accounting
8.4.7 Bankruptcy
8.4.8 Fraud
8.5 Problems
8.5.1 The Model of Prisman, Slovi n, and Sushka (1986)
8.5.2 The Risk Structure of Interest Rates (adapted from Merton, 1974)
8.5.3 Using the CAPM for Loan Pricing
8.6 Solutions
8.6.1 The Model of Prisman, Slovin, and Sushka
8.6.2 The Risk Structure of Interest Rates
8.6.3 Using the CAPM for Loan Pricing
Notes
References
9 The Regulation of Banks
9.1 Regulation Theory and Banking Theory
9.1.1 The Justification of Regulation
9.1.2 The Scope of Banking Regulation
9.1.3 Regulatory Instruments
9.2 Why Do Banks Need a Central Bank?
9.2.1 The Monopoly of Money Issuance
9.2.2 The Fragility of Banks
9.2.3 The Protection of Depositors
9.3 Portfolio Restrictions
9.4 Deposit Insurance
9.4.1 The Moral Hazard Issue
9.4.2 RiskRelated Insurance Premiums
9.4.3 Is FairlyPriced Deposit Insurance Possible?
9.4.4 The Effects of Deposit Insurance on the Banking Industry
9.5 Solvency Regulations
9.5.1 The Portfolio Approach
9.5.2 The Incentive Approach< br>9.5.3 The Incomplete Contract Approach
9.6 The Resolution of Bank Failures
9.6.1 Resolving Banks' Distress: Instruments and Policies
9.6.2 Who Should Decide on Banks' Closure?
9.6.3 Can Banks Be "Too Big to Fail"?
9.7 Complements
Notes
References
IndeX

Interesting textbook: The Career Fitness Program or Management

Macroeconomics

Author: Olivier Blanchard

Blanchard presents a unified and global view of macroeconomics, enabling students to see the connections between the short-run, medium-run, and long-run.

Technological problems and growth, financial markets and expectations, the goods market in an open economy, monetary policy, and fiscal policy.

 For business professionals seeking to understand the macroeconomic picture of corporate businesses.

 

Booknews

A book/CD-ROM text providing an integrated view of macroeconomics, featuring boxes on current macroeconomic events. Material is built around an underlying model that concentrates on the implications of equilibrium conditions in the goods, financial, and labor markets. This second edition is reorganized in a core section on the short, medium, and long run, and a set of three major extensions examining the role of expectations, implications of openness, and pathologies. Includes key points and terms and exercises. The CD-ROM contains a series of 48 interactive graphs. The author teaches economics at Massachusetts Institute of Technology. Annotation c. Book News, Inc., Portland, OR (booknews.com)

Table of Contents:

193< TD WIDTH="20%">23-2

	Preface	xvii
	Introduction	1
Chapter 1	A Tour of the World	3
1-1	The United States	4
1-2	The European Union	8
1-3	Japan	13
1-4	Looking Ahead	16
Appendix	Where to Find the Numbers?	19
Chapter 2	A Tour of the Book	21
2-1	Aggregate Output	22
2-2	The Other Major Macroeconomic Variables	26
2-3	A Road Map	34
Appendix	The Construction of Real GDP, and Chain-Type Indexes	40
	The Core	43
	The Short Run	43
Chapter 3	The Goods Market	45
3-1	The Composition of GDP	46
3-2	The Demand for Goods	48
3-3	The D etermination of Equilibrium Output	51
3-4	Investment Equals Saving: An Alternative Way of Thinking About Goods-Market Equilibrium	58
3-5	Is the Government Omnipotent? A Warning	60
Chapter 4	Financial Markets	65
4-1	The Demand for Money	66
4-2	The Determination of the Interest Rate. I	69
4-3	The Determination of the Interest Rate. II	75
4-4	Two Alternative Ways to Think About the Equilibrium	81
Chapter 5	Goods and Financial Markets: The IS-LM Model	87
5-1	The Goods Market and the IS Relation	88
5-2	Financial Markets and the LM Relation	93
5-3	Putting the IS and the LM Relations Together	96
5-4	Using a Policy Mix	101
5-5	How Does the IS-LM Model Fit the Facts?	102
	The Medium Run	111
Chapter 6	The Labor Market	113
6-1	A To ur of the Labor Market	114
6-2	Movements in Unemployment	116
6-3	Wage Determination	120
6-4	Price Determination	124
6-5	The Natural Rate of Unemployment	125
6-6	Where We Go from Here	129
Appendix	Wage- and Price-Setting Relations Versus Labor Supply and Labor Demand	132
Chapter 7	Putting All Markets Together: The AS-AD Model	135
7-1	Aggregate Supply	136
7-2	Aggregate Demand	139
7-3	Equilibrium in the Short Run and in the Medium Run	141
7-4	The Effects of a Monetary Expansion	144
7-5	A Decrease in the Budget Deficit	149
7-6	Changes in the Price of Oil	152
7-7	Conclusions	156
Chapter 8	The Natural Rate of Unemployment and the Phillips Curve	161
8-1	Inflation, Expected Inflation, and Unemployment	162
8-2	The Phillips Curve	163
8-3	A Summary and Many Warnings	169
Appendix	From the Aggregate Supply Relation to a Relation Between Inflation, Expected Inflation, and Unemployment	179
Chapter 9	Inflation, Activity, and Nominal Money Growth	181
9-1	Output, Unemployment, and Inflation	182
9-2	The Medium Run	186
9-3	Disinflation	188
9-4	Expectations, Credibility, and Nominal Contracts
9-5	The U.S. Disinflation, 1979-1985	196
	The Long Run	201
Chapter 10	The Facts of Growth	203
10-1	Growth in Rich Countries Since 1950	204
10-2	A Broader Look Across Time and Space	208
10-3	Thinking About Growth: A Primer	212
Chapter 11	Saving, Capital Accumulation, and Output	219
11-1	Interactions Between Output and Capital	220
11-2	Implications of Alternative Saving Rates	223
11-3	Getting a Sense of Magnitudes	230
11-4	Physical Versus Human Capital	236
Appendix	The Cobb-Douglas Production Function and the Steady State	240
Chapter 12	Technological Progress and Growth	243
12-1	Technological Progress and the Rate of Growth	244
12-2	The Determinants of Technological Progress	251
12-3	The Facts of Growth Revisited	254
12-4	Epilogue: The Secrets of Growth	258
Appendix	Constructing a Measure of Technological Progress	265
Chapter 13	Technological Progress, Wages, and Unemployment	267
13-1	Productivity, Output, and Unemployment in the Short Run	268
13-2	Productivity and the Natural Rate of Unemployment	272
13-3	Technological Progress and Distribution Effects	278
	Extensions	287
	Expectat ions	287
Chapter 14	Expectations: The Basic Tools	289
14-1	Nominal Versus Real Interest Rates	290
14-2	Expected Present Discounted Values	293
14-3	Nominal and Real Interest Rates, and the IS-LM Model	298
14-4	Money Growth, Inflation, and Nominal and Real Interest Rates	299
Appendix	Deriving the Expected Present Discounted Value Using Real or Nominal Interest Rates	308
Chapter 15	Financial Markets and Expectations	311
15-1	Bond Prices and Bond Yields	312
15-2	The Stock Market and Movements in Stock Prices	320
15-3	Bubbles, Fads, and Stock Prices	326
Appendix	Arbitrage and Stock Prices	332
Chapter 16	Expectations, Consumption, and Investment	335
16-1	Consumption	336
16-2	Investment	342
16-3	The Volatility of Consumption and Investment	349
App endix	Derivation of the Expected Present Value of Profits Under Static Expectations	353
Chapter 17	Expectations, Output, and Policy	355
17-1	Expectations and Decisions: Taking Stock	356
17-2	Monetary Policy, Expectations, and Output	360
17-3	Deficit Reduction, Expectations, and Output	364
	The Open Economy	371
Chapter 18	Openness in Goods and Financial Markets	373
18-1	Openness in Goods Markets	374
18-2	Openness in Financial Markets	383
18-3	Conclusions and a Look Ahead	390
Chapter 19	The Goods Market in an Open Economy	395
19-1	The IS Relation in the Open Economy	396
19-2	Equilibrium Output and the Trade Balance	399
19-3	Increases in Demand, Domestic or Foreign	400
19-4	Depreciation, the Trade Balance, and Output	405
19-5	Looking at Dynamics: The J-Curve	408
19-6	Saving, Investment, and the Trade Balance	412
Appendix 1	Multipliers--Belgium Versus the United States	415
Appendix 2	Derivation of the Marshall-Lerner Condition	416
Chapter 20	Output, the Interest Rate, and the Exchange Rate	417
20-1	Equilibrium in the Goods Market	418
20-2	Equilibrium in Financial Markets	419
20-3	Putting Goods and Financial Markets Together	422
20-4	The Ef fects of Policy in an Open Economy	423
20-5	Fixed Exchange Rates	426
Appendix	Fixed Exchange Rates, Interest Rates, and Capital Mobility	433
Chapter 21	Exchange Rate Regimes	437
21-1	Fixed Exchange Rates and the Adjustment of the Real Exchange Rate in the Medium Run	438
21-2	Exchange Rate Crises Under Fixed Exchange Rates	444
21-3	Exchange Rate Movements under Flexible Exchange Rates	448
21-4	Choosing Between Exchange Rate Regimes	451
Appendix	The Real Exchange Rate, and Domestic and Foreign Real Interest Rates	458
	Pathologies	461
Chapter 22	Depressions and Slumps	463
22-1	Disinflation, Deflation, and the Liquidity Trap	464
22-2	The Great Depression	471
22-3	The Japanese Slump	477
Chapter 23	High Inflation	489
23-1	Budget Deficits and Money Creation	490
Inflation and Real Money Balances	492
23-3	Deficits, Seignorage, and Inflation	494
23-4	How Do Hyperinflations End?	499
23-5	Conclusions	501
	Back to Policy	507
Chapter 24	Should Policy Makers Be Restrained?	509
24-1	Uncertainty and Policy	510
24-2	Expectations and Policy	514
24-3	Politics and Policy	518
Chapter 25	Monetary Policy: A Summing Up	529
25-1	The Optimal Inflation Rate	530
25-2	The Design of Monetary Policy	535
25-3	The Fed in Action	542
Chapter 26	Fiscal Policy: A Summing Up	549
26-1	The Government Budget Constraint	550
26-2	Four Issues in Fiscal Policy	558
26-3	The U.S. Budget	563
	Epilogue	571
Chapter 27	Epilogue: The Story of Macroeconomics	571
27-1	Keynes and the Great Depression	572
27-2	The Neoclassical Synthesis	572
27-3	The Rational Expectations Critique	575
27-4	Current Developments	579
27-5	Common Beliefs	581
Appendix 1	An Introduction to National Income and Product Accounts	1
Appendix 2	A Math Refresher	6
Appendix 3	An Introduction to Econometrics	12
	Glossary	1
	Index	1