(Edited with Donald D. Hester) This monograph is one of three (Monographs 19, 20, and 21) that bring together nineteen essays on theoretical and empirical monetary economics written by recent Yale graduate students and staff members of the Cowles Foundation. Seven of these are based on doctoral dissertations approved by the Yale Economics Department, supervised by Cowles Foundation staff members and other members of the Department.
The subjects of Monograph 21, Financial Markets and Economic Activity, are macroeconomic. They concern the conditions of equilibrium in economy-wide financial markets. The microeconomic principles discussed in the first two monographs are assumed to guide the behavior of individual economic units, including financial intermediaries, in demanding and supplying assets and debts in these markets. But the main focus is on the adjustment of interest rates and other yields to create equilibrium in various financial markets simultaneously. From this standpoint, the quantity of money as conventionally defined is not an autonomous variable controlled by governmental authority but an endogenous or “inside” quantity reflecting the economic behavior of banks and other private economic units. Commercial banks are seen to differ from other financial intermediaries less basically in the nature of their liabilities than in the controls over reserves and interest rates to which they are legally subject. Models of financial market equilibrium can be used to analyze a wide variety of questions about the behavior of financial markets. The theoretical studies in Monograph 21 apply this framework to investigate the consequences of various institutions and regulations for the effectiveness of monetary control. In addition some empirical findings on the structure of interest rates by maturity and by risk category are reported.