Econ 311 Fall 2023

STUDY GUIDE

1.)How would you explain or motivate the observed positive relationship between financial intermediation and economic growth over time and across countries? Your explanation must refer to and utilize the functions of the financial system.

2.)What do we mean by "perfect information" in the financial markets? Imagine a world where information is perfect. Characterize demand, supply, and equilibrium in the credit market in that world.

3.)What do we mean by "imperfect information" in the financial markets? What are the consequences of information imperfections in the financial markets for the behavior of lenders and borrowers? Describe the role of the interest rate in such an environment.

4.)Provide a graphical illustration of the credit market in the context of imperfect markets. Discuss how 'credit rationing' arises and what it means. What would cause the 'equilibrium' supply of credit in the market to increase under market imperfection?

5.)Compare debt finance and equity finance in a world with imperfect information. Describe the relative advantages and disadvantages of the two alternative modes of financing business activities.

6.)What can be done to alleviate (minimize) the problems of adverse selection and moral hazard in the financial markets.

7.)What factors determine the profitability of a commercial bank?

8.)What are the main risks faced by a commercial bank? What can be done to alleviate

those risks?

9.)The US banking industry is a complex web composed of a very large number small

entities and a very small number of very large entities ('too big to fail'). How did this structure evolve? Did this structure emerge because of or despite of regulation? What challenges can such a banking structure pose?

10.)What are the key functions that government-sponsored enterprises play in the banking sector? Are they needed? Do they add value to the sector? What could be some arguments against (counter-arguments to) the existence of GSEs in the banking sector?

11.)Describe the "regulatory dilemma" that the government faces in dealing with the financial system. How does the dilemma emerge? How does the government (the regulator) address the dilemma?

12.)What are the key tools utilized to regulate the US banking system? What are the key challenges faces by the regulator in today's innovation-driven and open (integrated) economy?

13.)What is "the mission" of the central bank (Fed)? How is the central bank equipped to accomplish the mission and how does it go about doing it? How are the goals of monetary policy linked to the tools of monetary policy? In other words, what is the transmission mechanism of monetary policy?

14.)What are the key elements that make money creation through credit expansion possible? How does the behavior of the non-bank public, commercial banks, and the central bank influence credit expansion? Refer to the money multiplier in your explanations.

15.)What motivated the use of monetary aggregates in the conduct of monetary policy aimed at controlling inflation? What motivated the gradual shift away from such approach to monetary policy towards inflation targeting since the 1990s?

16.)Some people may see the mandate of a Central Bank with a "dual mandate" to pursue at the same time an inflation objective and an employment (growth) objective as "mission impossible". Why? Explain conceptually and formulate the "impossible mission" in analytical (mathematical) form.

17.)What are the challenges of operationalization of the Taylor rule in conducting monetary? What are the conditions for effectiveness of a policy framework utilizing the Taylor rule?

18. What are the limitations and challenges faced by inflation targeting as a framework for monetary policy? How do they affect the performance of the framework? How can they be overcome?