Complexities of the U.S. Financial System - Essay Example

Complexities of the U.S. Financial System Answer The US financial markets affect the economy at large as well as the individuals living in the economy. In the securities market equities, commodities and other instruments are traded and the amount of demand existing in the market and the price levels existing affect the economy and the businesses. Since a large amount of the wealth of the people of the United States is invested in the stock markets, an adverse position of the markets will affect the net-worth of the individual.

Thus the investors will tend to cut their spending and this will be reflected in the reduction of the housing investments by the consumers. Since most of the hedge funds and the pension funds make their spending on the stocks, they would suffer a loss due to the fall in the stock markets. This will lead to a reduction in the confidence levels of the consumers. Thus the economy might move towards a situation of recession and lack in the aggregate demand from the individual consumers. This in turn would lead to a fall in the production of the firms and businesses.

Since a lot of foreign investors spend money on the US markets, it will affect the global markets as well. The amount of both domestic and foreign investment will suffer a decline in the economy. Thus the decline in the stock markets would force the consumers to make their investments mostly in the bond markets. Answer 2 The US Federal Reserve is the apex financial institution that acts as the Central Bank of the country and is instrumental in the formulation and implementation of the monetary policy of the United States.

The Board and the Chairman of the Federal Reserve are the chief executives who are appointed by the President of the United States to take the responsibility of the monetary policy of the state. The actions and the speeches of the Chairman and the Board affect the financial markets of the country. The duty of the Federal Reserve is to ensure the proper workings of the economy which includes ensuring macroeconomic stability, containment of inflation and the control of the supply of the money in the economy.

It also acts as the regulatory body for the other banks in the market. Answer 3 Rate of interest is one of the most significant macroeconomic variables and the fluctuations in the rates affect the economy to a large extent. The rate of interest on a certain sum of money or an asset is the cost of capital that the borrower pays the person who lending for allowing him the use of the asset or the money. The rate of interest is generally accrued on an annual basis. This economic variable has a lot of impact on the US financial markets and the other basic characteristics of the economy like the rate of inflation, the amount of liquidity in the economy or the aggregate demand.

The changes in the investor sentiments are caused by the changes in the rates of interest (Blanchard, 2000). The investors generally have two options. They can either park their money with the banks by purchasing bonds or they may invest it in the capital markets by purchasing the equities and commodities. When the Federal Reserve increases the rate of interest the investors prefer to keep their money with the banks because it provides them with a higher rate of return. Thus the investors cut down their spending habits and the aggregate demand will drop.

On the other hand if the investors find that the rate of interest offered by the Fed is low they become optimistic about the stock markets as the return from investment in the equities would provide them with a higher return. Answer 4 The changes in the exchange rate have a large influence on the workings of the businesses. If the value of the currency of a foreign country goes up the imports to the US markets become expensive. Again if the value of the domestic currency goes up the exports become favorable for the home country.

Therefore, the demand for export and import of the foreign products would depend on the exchange rates of the currencies that are existent. Suppose the exchange rate of dollar with respect to Euro increases, it makes the value exports of goods from the United States to any country in the European Union more expensive. Thus with the appreciation of dollars with respect to euro would result in an optimistic position in the balance of payments position of the country. These changes in the rate of exchange also results in the changes of the decision of the firms that have operations across countries.

A producer that has operations both in the United States and Argentina would prefer to set up its production in Argentina because the resources would be available at a cheaper rate if the currency of Argentina depreciates with respect to US dollars. References Blanchard, Olivier (2000). Macroeconomics. Englewood Cliffs: Prentice Hall.