EC/FI 358 - Financial Markets and the Economy

The objective of this course is to deepen students’ understanding of the functions of financial markets in addition to key linkages between the real economy and the financial sector. This requires an understanding of the instruments traded on the key financial markets and their purpose, elements of security pricing, the most important institutions active on those markets and, finally, how governments attempt to steer the economy by means of policy measures which operate via financial markets. In addition, some of the structural weaknesses in the financial system will be explained, which constitute sources of financial and economic instability, and which can result in widespread market failure.

A core message the course will be that a modern economy cannot function without an efficient financial system; equally, the financial system must be tailored to the needs of the real economy and must not be allowed to become self-serving. By means of case studies, the recent experiences of Iceland, Ireland and Austria will be examined, with reference to other countries such as the United Kingdom and Greece.

After considering the structure of an economy and the interactions of its main sectors, attention will focus on how financial markets reconcile the needs of economic agents. Due to the progress of globalisation, money markets are the most highly integrated financial markets, internationally; hence the need to examine the foreign exchange and Eurocurrency markets, in addition to instruments traded on “domestic” markets. Important considerations include payments imbalances, government borrowing and the activities of multinational banks. As the money market is the channel through which monetary policy operates, it assumes special importance in efforts to stabilise the economy.

Capital markets are also considered, emphasising the financing needs of the corporate sector and the government. Innovative activity, from junk bonds to more recent innovation in securitisation, has frequently ended in grief; nevertheless, has to be viewed as an essential development. Markets for derivative securities will not be dealt with extensively, and the emphasis here will be to understand how the growth of credit derivatives in recent years exacerbated a crisis which originated elsewhere.

The course will include a visit to the currency museum of the Austrian Central Bank.