ANSWERS TO QUESTIONS

Answers to End-of-Chapter Questions and Problems The Economics of Money, Banking, and Financial Markets, 13e Frederic Mishkin (Solutions Manual All Chapters, 100% Original Verified, A+ Grade) 1 / 4

Mishkin • Instructor’s Manual for The Economics of Money, Banking, and Financial Markets, Thirteenth Edition 51 Copyright © 2022 by Pearson Education, Inc. All rights reserved.Chapter 1

ANSWERS TO QUESTIONS

• What is the typical relationship among interest rates on three-month Treasury bills, long-

term Treasury bonds, and Baa corporate bonds?The interest rate on three-month Treasury bills fluctuates more than the other interest rates and is lower on average. The interest rate on Baa corporate bonds is higher on average than the other interest rates.

• What effect might a fall in stock prices have on business investment?

The lower price for a firm’s shares means that it can raise a smaller amount of funds, so investment in facilities and equipment will fall.

• Explain the main difference between a bond and a common stock.

A bond is a debt instrument, which entitles the owner to receive periodic amounts of money (predetermined by the characteristics of the bond) until its maturity date. A common stock, however, represents a share of ownership in the institution that has issued the stock. In addition to its definition, it is not the same to hold bonds or stock of a given corporation, since regulations state that stockholders are residual claimants (i.e., the corporation has to pay all bondholders before paying stockholders).

• Explain the link between well-performing financial markets and economic growth. Name one

channel through which financial markets might affect economic growth and poverty.Well-performing financial markets tend to allocate funds to its more efficient use, thereby allowing the best investment opportunities to be undertaken. The improvement in the allocation of funds results in a more efficient economy, which stimulates economic growth (and thereby poverty reduction).

• What was the main cause of the recession that began in 2007?

The U.S. economy was hit by the worst financial crisis since the Great Depression. Defaults in subprime residential mortgages led to major losses in financial institutions, producing not only numerous bank failures but also the demise of two of the largest investment banks in the United States. These factors led to the “Great Recession” that began late in 2007.

• Can you think of a reason why people in general do not lend money to one another to buy a

house or a car? How would your answer explain the existence of banks?In general, people do not lend large amounts of money to one another because of several information problems. In particular, people do not know about the capacity of other people of repaying their debts, or the effort they will provide to repay their debts. Financial intermediaries, in particular commercial banks, tend to solve these problems by acquiring information about potential borrowers and writing and enforcing contracts that encourage lenders to repay their debt and/or maintain the value of the collateral. 2 / 4

Mishkin • Instructor’s Manual for The Economics of Money, Banking, and Financial Markets, Thirteenth Edition 52 Copyright © 2022 by Pearson Education, Inc. All rights reserved.

• What are the other important financial intermediaries in the economy, besides banks?

Savings and loan associations, mutual savings banks, credit unions, insurance companies, mutual funds, pension funds, and finance companies.

• Can you date the latest financial crisis in the United States or in Europe? Are there reasons

to think that these crises might have been related? Why?The latest financial crisis in the United States and Europe occurred in 2007–2009. At the beginning, it hit mostly the U.S. financial system, but it then quickly moved to Europe, since financial markets are highly interconnected. One specific way in which these markets were related is that some financial intermediaries in Europe held securities backed by mortgages originated in the United States, and when these securities lost their a considerable part of their value, the balance sheet of European financial intermediaries was adversely affected.

• Has the inflation rate in the United States increased or decreased in the past few years?

What about interest rates?Since 2015, inflation has been around 2%, with some brief dips in 2015 and 2020. In 2015, the interest rate on three-month Treasury bills was near zero, and it then rose to just over 2% in 2019, only to fall back near to zero in 2020.-

• If history repeats itself and we see a decline in the rate of money growth, what might you

expect to happen to

• real output?
• the inflation rate?
• interest rates?

The data in Figures 3, 5, and 6 suggest that real output, the inflation rate, and interest rates would all fall.

• When interest rates decrease, how might businesses and consumers change their economic

behavior?Businesses would increase investment spending because the cost of financing this spending is now lower, and consumers would be more likely to purchase a house or a car because the cost of financing their purchase is lower.

• Is everybody worse off when interest rates rise?

No. It is true that people who borrow to purchase a house or a car are worse off because it costs them more to finance their purchase; however, savers benefit because they can earn higher interest rates on their savings.

• Why do managers of financial institutions care so much about the activities of the Federal

Reserve System?Because the Federal Reserve affects interest rates, inflation, and business cycles, all of which have an important impact on the profitability of financial institutions. 3 / 4

Mishkin • Instructor’s Manual for The Economics of Money, Banking, and Financial Markets, Thirteenth Edition 53 Copyright © 2022 by Pearson Education, Inc. All rights reserved.

• How does the current size of the U.S. budget deficit compare to the historical budget deficit

or surplus for the time period since 1950?The deficit as a percentage of GDP expanded dramatically in 2007 but improved starting in 2010; in 2009, the deficit to GDP ratio was 9.8%, and in 2016 was 3.2%,. However, by 2019 it increased to 4.6%, then sharply increased further in 2020 as a result of the coronavirus pandemic, and still above the historical average of around 2% since 1950.

• How would a fall in the value of the pound sterling affect British consumers?

It makes foreign goods more expensive, so British consumers will buy fewer foreign goods and more domestic goods.

• How would an increase in the value of the pound sterling affect American businesses?

It makes British goods more expensive relative to American goods. Thus, American businesses will find it easier to sell their goods in the United States and abroad, and the demand for their products will rise.

• How can changes in foreign exchange rates affect the profitability of financial institutions?

Changes in foreign exchange rates change the value of assets held by financial institutions and thus lead to gains and losses on these assets. Also changes in foreign exchange rates affect the profits made by traders in foreign exchange who work for financial institutions.

• According to Figure 8, in which years would you have chosen to visit the Grand Canyon in

Arizona rather than the Tower of London?In the mid-to-late 1970s, the late 1980s to early 1990s, and 2008 to 2015, the value of the dollar was low, making travel abroad relatively more expensive; thus, it was a good time to vacation in the United States and see the Grand Canyon. With the rise in the dollar’s value in the early 1980s, late 1990s, and after 2015, travel abroad became relatively cheaper, making it a good time to visit the Tower of London. This was also true, to a lesser extent, in the early 2000s.

• When the dollar is worth more in relation to currencies of other countries, are you more

likely to buy American-made or foreign- made jeans? Are U.S. companies that manufacture jeans happier when the dollar is strong or when it is weak? What about an American company that is in the business of importing jeans into the United States?When the dollar increases in value, foreign goods become less expensive relative to American goods; thus, you are more likely to buy French-made jeans than American-made jeans. The resulting drop in demand for American-made jeans because of the strong dollar hurts American jeans manufacturers. On the other hand, the American company that imports jeans into the United States now finds that the demand for its product has risen, so it is better off when the dollar is strong.

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