My “Money, Banking, Financial Markets, and Institutions” 2nd edition from Cengage

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When I created this textbook (and the “digital assets” like the ConceptClips and videos that go with it) I wanted to create something that would get the students talking and perhaps even arguing.  So many of the textbooks out there on the topic of money & banking or financial markets are, to me, are either boring as can be or a blur of lines moving around.  I wanted something different. 

So based on how I had taught the class over the last few decades I created something that was designed for today’s student and to be used digitally. You can still get a hardback copy if you want. But, to me, it works best in digital form.  The “chapters” are broken up into smaller subsections that can easily be read on a screen in a few minutes. So, the structure of it is much different than other “books.” But so too is the content.

I tried to write the material in a conversational tone. Thus, the reader is taken on an intellectual journey not bombarded with facts, equations, and graphs that numb the brain.  Yes, there are equations. Yes, there are graphs. But these are used to illustrate and reinforce “the story” that is being told.  And in the process of taking that journey, the reader uses to apply the concepts of economics to money, banking, financial markets and financial institutions. Along the way the reader discovers there is much we do not know about how these markets function.  To paraphrase Socrates:  the more you know, the more you know we don’t know.

Clearly this approach does not work for everyone.  If an instructor is looking for a highly technical textbook with mathematical proofs, this is not the resource for them. But, if someone wants a resource that makes use of technology and has open ended questions at the end of each section designed to spur conversations, discussions, and debates, then this might be useful for them.
One of the key challenges in writing about money, banking, financial markets and institutions is that these markets are constantly Changing.  To me, that is what makes this topic area so much fun. However, I fully understand, that to others this can be a huge challenge if not a headache.

So, to help ease the pain, below I offer some tips on teaching and mastering this material in addition to how things have changed since the most recent version of the book was published.

Here's what is new

June 2022 - Debate over the Fed’s implementation of monetary policy under “ample” bank reserves.

In helping students understand how important central banks are to the functioning of financial markets, and thus the entire economy, teaching economists often explain how central banks conduct monetary policy.  In the United States this discussion focuses on how the Federal Reserve uses its various tools to impact the money supply, and thus market interest rates, most often using open market operations.

This material can be challenging for students to master as they need to first understand how depository institutions function and their need for reserves, they also need to understand the basics of debt markets with the inverse relationship between bond prices and yields, and they need to understand how banks interact with each other and the central bank.

For the last several decades, the traditional approach to address this challenge is, after discussing commercial banks, to have a discussion on what money is, how we measure the money supply, and then examine interest rates as one of the prices of money. This then sets the stage to examine debt markets and the inverse relationship between bond prices and yields.  Once this has been accomplished, the student has the intellectual footing to delve into central bank’s monetary policy including the Fed’s use of Open Market Operations to adjust bank reserves and thus impact the money supply and market interest rates.

Explaining the Monetary Policy to Students

The advantage of this traditional approach is that it focuses the discussion on money and money supply:  what it is, how banks create money, interest rates as the price of money, etc.  The central bank is seen as influencing the money supply in an attempt to make certain the money supply increases fast enough (otherwise the economy can suffer slowdowns and even deflation) but not too fast (otherwise there will be too much money chasing too few goods and thus inflation).

The Fed Changes

But, since the 2007 financial crisis the Fed and other central banks have pursued unprecedented continuously expansionary monetary policy. This has resulted in a period of “ample” (some might say excessive) bank reserves which left the traditional approach to monetary policy ineffective. What happens is with excessive or “ample” reserves the Fed purchasing or selling short term government securities through Open Market Operations is not enough to move market interest rates in a significant way.

Thus, in 2008 the Fed announced that instead of relying on Open Market Operations as its key monetary policy tool it would switch to using its new policy of paying interest on bank reserves as its main tool. This is referred to as either IOR (interest on reserves) or IORB (interest on reserve balances). Under this approach the discount rate functions as interest rate ceiling in the market for bank reserves, the overnight repo rate functions a floor.  The Fed then adjusts the IOR up or down to steer the effective fed funds rate into the desired range.  Through the creation of arbitrage opportunities between the fed funds rate and the IOR the fed funds rate adjusts as the Fed wishes.  So, in this approach the focus is not on money or money supply it is on interest rates and changes in interest rates.

The Powell Fed doubled down on this ample reserves approach in 2019[1] when it announced that it would continue to use interest on bank reserves in the future to be the Fed’s main tool in conducting monetary policy.

Recently two non-teaching economists, Jane Ihrig at the Fed’s Board of Governors and Scott Wolla at the St. Louis Fed, have criticized teaching economists (and authors of Principles textbooks) for not fully rejecting the traditional explanation in favor of the “ample” reserves approach. In addition to penning an article for the Journal of Economic Education[2] in 2022,  Ihrig and Wolla have created PPTs and lecture notes for faculty to use in making changes to how they discuss the implementation of monetary policy.

So Why Not Change? 

When Ihrig and Wolla were asked why[3] they thought so many teaching economists have not embraced the new “ample” reserves approach in their teaching, one of them argued that those who teach economics are some combination of uninformed, outdated, and/or do not think for themselves relying instead of textbooks from which they teach.  

But before faculty members run out and make significant changes to how they discuss the implementation of monetary policy with their students, they might want to consider one question:  will these changes stick?

What I mean by this, is far too often in policy circles (this also happens in the business world) there are “fads” or “hot new ideas” that after implemented fail to live up their hype and eventually fade into obscurity. For those of us old enough to remember President Nixon’s Wage and Price Controls or President Ford’s Whip Inflation Now, or even the “monetary rule” we know there have been monetary “fads” that come and go.

So, let’s ponder for a moment how will history view the current Powell Fed and its policies? At the time of this writing in the summer of 2022, things do not look very promising for the legacy of the Powell Fed.  The current flare up in the rate of inflation, which the Powell Fed reassured us would only be “transitory” appears to have the Fed back on its heels. Some critics are pointing out that this increase the rate of inflation is a direct result of the Fed allowing the money supply to grow dramatically in the wake of 2007 crisis and in reaction to the COVID pandemic.  

Other Fed critics argue that the Powell Fed should have should have started to unwind quantitative easing and return to back to “normal” in 2018. Instead, it is argued, the Powell Fed worried mostly about insuring a rising stock market, keeping market interest rates and thus corporate borrowing costs low, and for several years keeping the occupant of the Oval Office happy.  As a result, these critics argue, the Powell Fed took its “eye” off the ball when it came to money supply growth which is the main fuel for inflation.

What then if the legacy of the Powell Fed will be to reinforce the dangers of a politically driven monetary policy that allows for run ups in asset prices and downplays the dangers of excessive money supply growth?  Will the ample reserves approach to monetary policy go the way disco music and tail fins on automobiles?  If so, then will a post-Powell Fed see a return to the traditional use of monetary policy tools?

If this is how things do turn out, the “ample” reserves approach to monetary policy may turn out to be just another one of those “fads” that are a mere footnote in the study of monetary policy. Thus, it may be perfectly rational for teaching economists to want to take a “wait and see” approach before they undertake a major overhaul of how they teach the implementation of monetary policy.

[1] See the Statement Regarding Monetary Policy Implementation and Balance Sheet Normalization https://www.federalreserve.gov/newsevents/pressreleases/monetary20190130c.htm

[2] Jane Ihrig & Scott Wolla (2022) “Let’s close the gap: Updating the textbook treatment of monetary policy” The Journal of Economic Education, DOI: 10.1080/00220485.2022.2075509

[3] Wolla: “…many educators are simply unaware. Right? So, they’re relying on what their textbooks say and what they learned in college.” https://www.stlouisfed.org/timely-topics/teaching-about-new-monetary-policy-tools

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