Rothbard, Murray. The Mystery of Banking
Shiller, Robert. Irrational Exuberance
Shiller, Robert. The New Financial Order: Risk in the 21st Century
Shiller, Robert and George Akerlof. Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism
Sornette, Didier, Why Stock Markets Crash: Critical Events in Complex Financial Systems
Sowell, Thomas. Basic Economics: A Common Sense Guide to the Economy
Taleb, Nassim Nicholas. Fooled By Randomness.
Taleb, Nassim Nicholas. The Black Swan: The Impact of the Highly Improbable.
Warburton, Peter. Debt and Delusion
Weitzman, Martin. The Share Economy
Wheelan, Charles. Naked Economics
Classics:
Bernstein, Peter. Against the Gods: The Remarkable Story of Risk.
De Soto, Hernando. The Other Path
Friedman, Milton. Capitalism and Freedom
Friedman, Milton and Rose. Free to Choose
Galbraith, John Kenneth. A Short History of Financial Euphoria
Hayek, Friedrich. The Road to Serfdom
Hayek, Friedrich. The Fatal Conceit
Hazlitt, Henry. Economics in One Lesson
Kelso, Louis and Mortimer Adler. The Capitalist Manifesto.
Glossary
Arbitrage
A trading strategy, when two assets are mispriced, to sell the higher priced asset and buy the lower priced asset, yielding a profit when the two prices converge.
Asset
Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset.
Bond
(No, not James Bond.) A debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest and/or to repay the principal at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at fixed intervals.
Bretton Woods System
The international monetary regime established after World War II to manage the finance of international trade, currency exchange, and cross-border investment. The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate by tying its currency to the U.S. dollar and the ability of the IMF to bridge temporary imbalances of payments.
Capital Asset
A factor of production, used to create goods or services in the production process. A capital asset is valued by the return it produces when employed. Since this return is an expected return in the future, capital value is often a function of expectations, infused either with confidence (positive value) or uncertainty (negative value).
Capital Asset Pricing Model (CAPM)
A formulaic model used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset's non-diversifiable risk.
Capital Market
A market for securities (debt or equity), where business enterprises and governments can raise long-term funds.
Collateral
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan. The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation.
Collective Action problem
A situation in which several individuals would all benefit from a certain action, which, however, has an associated cost making it implausible that anyone individually will undertake it. The rational choice is then to undertake this as a collective action the cost of which is shared.
Comparative Advantage
The law of comparative advantage shows that two countries (or other kinds of parties, such as individuals or firms) can both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods. Even if one country is more efficient in the production of all goods, it can still gain by trading with a less-efficient country, as long as they have different relative efficiencies.
Consumption
That proportion of wealth or income that is consumed, as opposed to savings. Consumption is measured in different ways but mostly by the final purchase of goods and services by individuals.
Corporate governance
The set of processes, customs, policies, laws, and institutions affecting the way a corporation is directed, administered or controlled. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed.
Currency or Exchange Rate Regime
There are three basic categories of currency regimes: fixed, pegged, and floating. We currently operate under a floating rate regime, where currencies values are established by foreign exchange market trading. For a fixed regime see Gold Standard. For a pegged regime, see Bretton Woods.
Debt
Debt is a contractual obligation assumed by a borrower to repay the lender according to agreed-upon terms that usually include a regular payment of interest, plus the full principal of the loan to be paid-in-full at some future specified time.
Deflation
A decrease in the general price level of goods and services, occasioned by a decline in the availability of money and credit. Deflation is the opposite of inflation.
Demand
The desire to own anything, the ability to pay for it, and the willingness to pay (see also supply and demand). The term demand signifies the ability or the willingness to buy a particular commodity at a given point of time.
Derivatives, Financial
Financial instruments whose value depends on other, more basic, underlying variables. Such variables can be the price of another financial instrument (the underlying asset), interest rates, volatilities, indices, etc. Derivatives are used to manage risk through hedging.
Diversification
A means to reduce risk by investing in a variety of assets. If the asset values do not move up and down in perfect synchrony, a diversified portfolio will have less risk than the weighted average risk of its constituent assets, and often less risk than the least risky of its constituents.
Equilibrium
A state of the world where economic forces are balanced and in the absence of external influences the (equilibrium) values of economic variables will not change. It is the point, and price, at which quantity demanded and quantity supplied are equal.
Equity
Equity (or stock) represents the residual claim or ownership interest of the most junior class of investors in assets, after all liabilities and debts are paid. Stock shareholders bear more risk than bondholders because bondholders are paid first. When a company succeeds and the value of its stock rises, shareholders gain investment returns from dividends and capital gains.
Externalities
A cost or benefit, not transmitted through prices, incurred by a party who did not agree to the action causing the cost or benefit. A benefit in this case is called a positive externality or external benefit, while a cost is called a negative externality or external cost.
Factors of Production
Any commodities or services used to produce goods and services. 'Factors of production' may also refer specifically to the primary factors, which are land, labor, and capital goods applied to production.
Federal Reserve
The central banking system of the United States. It was created in 1913 with the enactment of the Federal Reserve Act, largely in response to a series of financial panics, particularly a severe panic in 1907. Over time, the roles and responsibilities of the Federal Reserve System have expanded and its structure has evolved. Its duties today, according to official Federal Reserve documentation, are to conduct the nation's monetary policy, supervise
and regulate banking institutions, maintain the stability of the financial system and provide financial services to depository institutions, the U.S. government, and foreign official institutions.
Federal Reserve Discount Rate
The interest rate charged to banks for borrowing short-term funds directly from the Federal Reserve, also called the discount window.
Federal Reserve Funds Rate
The interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions, usually overnight. It is the interest rate banks charge each other for loans.
Fiat Currency
A fiat currency is a currency issued by the state and declared to be legal tender. It is not redeemable or convertible into any other commodity, such as gold or silver, and thus it holds no intrinsic value.
Fiscal Policy
Government economic policies that consist of expenditures and revenue collection through taxation.
Foreign exchange market (also forex, FX, or currency market)
The foreign exchange market is a worldwide decentralized financial market for the trading of currencies.
Fractional-reserve banking
Fractional reserve banking is best defined with a brief explanation. When a bank receives a $100 deposit it is required to hold a small reserve, roughly 10%, or $10 in our example, and then it is allowed to lend out the other 90%. This is repeated throughout the system, meaning the actual liquidity of the financial system is exponentially greater than the physical supply of the currency. This allows the money supply to be elastic in response to demand for capital, but at a cost. The Federal Reserve controls the reserve ratios for member banks, but unregulated, non-depositary banks such as investment banks were able to leverage up their credit instruments to as much as 40 to 1. A highly leveraged system is very sensitive to small changes in expectations, meaning the risk of real losses, or even a loss of confidence, is greatly increased. This is why we have bank runs.
General Equilibrium Theory (GE)
An economic theory that seeks to explain the behavior of supply, demand and prices in a whole economy with several or many markets, by seeking to prove that equilibrium prices for goods exist and that all prices are at equilibrium, hence general equilibrium.
Gold Standard
A monetary system in which the standard economic unit of account is a fixed weight of gold.
Inflation
A rise in the general price level of goods and services. Occasioned by an increase in the supply of money and credit.
Insurance
A form of risk management primarily used to diversify or hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment.
Interest rate
The rate at which interest is paid by a borrower for the use of money that they borrow from a lender. There are many different interest rates that vary according to risk and liquidity. There are two basic components of the interest rate: the risk premium and the time premium. The first compensates the lender for the risk of loss is the loan is not repaid. The second compensates the lender for the time value of money.
Investment
The commitment of money or capital to the purchase of financial instruments or other assets so as to gain profitable returns in the form of interest, dividends, or appreciation of the value of the instrument (capital gains).
Labor
A measure of the work done by human beings. It is conventionally contrasted with other factors of production such as land and capital. The skill component of labor, such as that imparted by education or training, is often classified as human capital.
Liability
An obligation of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future.
Loss Aversion
People's tendency to strongly prefer avoiding losses to acquiring gains. Some studies suggest that losses are twice as powerful, psychologically, as gains. Loss aversion was first convincingly demonstrated by Amos Tversky and Daniel Kahneman, for which he won the Nobel Prize in economics.
Macroeconomics
The branch of economics dealing with the performance, structure, behavior, and decision-making of the entire economy.
Microeconomics
The branch of economics that studies the behavior of how the individual modern household and firms make decisions to allocate limited resources.
Modern Monetary Theory (MMT)
Not really a theory, MMT is an analytical framework for understanding monetary phenomena under a fiat currency regime, such as the U.S. dollar. In effect, MMT recognizes that the currency issuer (the Fed and U.S. Treasury/Federal government) can create money from credit at will and thus is unconstrained by sovereign debt burdens. A country like Greece, as part of the European Monetary Union, cannot issue its own currency; to fund deficits it must borrow from the international government debt market. Thus, Greece, like you or me, is a currency user, not issuer, and must pay its debts or go bankrupt. The U.S. government is not constrained by the need to pay off its debts. The more serious issue is whether the pay-offs will be worth anything in the future. That depends on the overall productivity of the U.S. economy.
Modern Portfolio Theory
A theory that demonstrates a risk diversification strategy where assets that fluctuate in price independently can be combined in a single investment portfolio to reduce overall risk.
Moral hazard
Moral hazard occurs when a party insulated from risk behaves differently than it would behave if it were fully exposed to the risk. This is an asymmetric informational problem that exists in all insurance pooling that is often controlled by behavior monitoring. Moral hazard also afflicts the principal-agent relationship.
Principal-Agent problem
The principal–agent problem or agency dilemma treats the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent, such as the problem of potential moral hazard and conflict of interest, in as much as the principal is hiring the agent to pursue the principal's interests.
Quantitative Easing
Quantitative easing (QE) is a central bank policy of directly buying bonds from the U.S. Treasury or government-backed mortgages, essentially injecting new funds into the financial system and providing a price floor under distressed financial assets. This is accomplished by the Fed purchasing U.S. Treasury debt with newly created credits. The Fed has also used these credits to buy toxic mortgage debt. By these methods, the central bank can provide funds at lower than zero interest rates in order to increase the monetary supply and combat deflationary forces. In essence, the Fed is monetizing the debt and increasing the money supply.
Rational Expectations Theory
A hypothesis in economics which states that agents' predictions of the future value of economically relevant variables are not systematically wrong in that all errors are random.
Risk
A state of uncertainty where some possible outcomes have an undesired effect or significant loss. Exposure to the possibility of loss, injury, or other adverse or unwelcome circumstance; a chance or situation involving such a possibility. Financial risk is defined by the variability of expected outcomes times the maximum loss exposure.
Risk-Adjusted Rate of Return
The rate of return on an investment asset that is adjusted for the level of risk. Finance theory shows by the security market line that there is one universal theoretical risk-adjusted rate of return to which all returns revert. This is like the odds ratios on the roulette table. This relationship between risk and return is represented mathematically by the Sharpe ratio.
Saving
Income not spent, also known as deferred consumption.
Security
market line (SML)
The graphical representation of the Capital asset pricing model. It displays the expected rate of return of an individual security as a function of systematic, or non-diversifiable market risk.
Securitization
The financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said debt as bonds, pass-through securities, or collateralized mortgage obligations to various investors. The strategy is to increase diversification of the ‘portfolio’ of assets and lower risk. Securitization assumes independence among the various assets that are securitized, a condition that broke down during the worldwide housing bubble.
Shadow Banking system
The shadow banking system consists of non-depository banks and other financial entities (e.g., investment banks, hedge funds, money market funds and insurers) that grew in size dramatically after the year 2000. These entities, not regulated like commercial banks, play an increasingly critical role in lending businesses the money necessary to operate. Also unlike commercial banks, they are able to speculate in financial markets.
Social Choice
Social choice is any process by which we make decisions in the collective. The process of voting is the most common case, but exchange markets are also social choice mechanisms where we “vote” with our demand and payment for certain goods and services.
Supply
The amount of product producers are willing and able to sell at a given price, all other factors being held constant (see also supply and demand).
Systemic Risk
In finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system.
Taxes
Does anyone really need a definition of taxes? However, there are various forms of taxation that affect economic behavior differently. There are taxes on production that are levied on capital and labor, as well as personal and business income. There are taxes on consumption, such as retail sales and value-added taxes. And there are wealth taxes levied on real property or inheritances. In general, the levy of a tax on an activity or entity tends to reduce that activity or lower the value of the entity.
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