Monetary Policy and the Stock Market - Dissertation Example

One financial instrument that is normally used by governments is the issuance of treasury bills or government bonds wherein the earning interest rates will generally be followed by the banks of that country. By using the interest rates that will define the treasury-bill holder’s earnings will slowly influence the financial market to adjust its interest rates. In the absence of other economic indicators, the treasury-bill interest rates will not only be adopted by the banks in their own financial transactions but it will also be used as the bench mark for the amount of money that will be available to borrowers.

In theory, if the interest rates are low more people will borrow money from the banks. If the interest rates are high, the theory sustains that little to no borrower will loan money from the banks and most economic activity will be financed from in-house sources. Other instruments or means of conducting monetary policy includes making the government as the lender of last resort wherein the government will be the source of funds that will be available to borrowers normally a function provided by banks and other financial institutions.

Another means of conducting monetary policy includes changing the reserve requirements in banks in order for them to operate. Another is where the government announces its intent to reduce or control inflation or by simply indicating the interest rates it wants for the money it intends to loan out. And last but not the least is moral suasions.. Meanwhile the true value of money is dependent on several factors such as the actual value of the goods that can be bought by the money or its value as compared with other currencies.

However, given that these factors are also dependent on other economic indicators such as inflation and the volume of foreign currency reserve a country has, the correlation of the monetary policy of a country with its interest rates, stock market performance, and inflation will be explored by this paper. Monetary policy is implemented by increasing or decreasing the interest rates that is in theory would be able to inversely increase or decrease the supply of currency in circulation. In fine, the monetary policy of a country controls the amount or volume of currency in circulation to stimulate growth or maintain the stability of its economy.

The primary onus of a government’s monetary authority is to create the optimal monetary policy that will stabilize prices for its basic commodities and encourage investment. The trick however is how to make banks and other financial institutions follow the interest rates the government’s monetary authorities’ desires. One financial instrument that is normally used by governments is the issuance of treasury bills or government bonds wherein the earning interest rates will generally be followed by the banks of that country.

By using the interest rates that will define the treasury-bill holder’s earnings will slowly influence the financial market to adjust its interest rates. In the absence of other economic indicators, the treasury-bill interest rates will not only be adopted by the banks in their own financial transactions but it will also be