Impact of US Financial Markets on Economy as a Whole - Research Paper Example

? The U.S. financial system and its many complexities College Teacher Finance 2nd May Impact of U.S. Financial Markets on Economy as a Whole The well-developed financial markets which are effortlessly operating, plays vital role in the progress of health and effectiveness of the economy. There is quite a strong constructive relationship between economic growth and development of financial market. For instance, Kunt and Levine stated that, “researchers have offered additional conclusions on finance-growth and have put forward an appraisal of the relationship; which suggests that financial development put forth a positive impact on the growth of economy”. The Federal Reserve situates the monetary policy of the nation in order to encourage the stable prices, objectives of highest employment, and reasonable interest rate for long-term basis. The biggest challenge for all the policy makers, is that pressure among the set goals might take place in short run as well as the information with respect to economy is accessible only with a delay and chances are that it might be inadequate. Financial markets assist in effectively directing the flow of investments and savings within the economy which facilitates the growth of capital along with production of products and services in different ways. The ideal blend of strong institutions and financial markets as well as different range of financial instruments and products, perfectly fits with the lenders and borrowers’ need and hence the entire economy. Financial Markets and Institutions A financial market includes bonds or trade stocks, an instrument includes derivatives and bank CDs and institutions includes banks, insurance companies and funds. They all offer opportunities to investors so that they can specialize in diversify risks, specific market and/or services, or both and can exchange financial assets (Fabozzi, 2002). How Economy is affected by Monetary Policy? The preliminary connection in the chain among the economy and monetary policy is market for stability which takes place at Federal Reserve Banks. At reserve banks, depository institutions have their accounts, and they vigorously trade the balances which are kept in the accounts with an interest rate termed as federal funds rate. Federal Reserve has control on federal funds rate with an influence on demand and supply at Reserve Banks. Any change in expectation or in the rate of federal funds can affect other short and long term rate of interest, stock price and the value of dollar with respect to foreign exchange. This in turn affects spending decision of business and households which ultimately distress growth in the economy and aggregate demand. In Federal Reserve Act, the targets of monetary policy are shared which states that the Committee of Federal Open Market and the Board of Governors must look forward to encourage effectively the targets of highest employment rate along with stable prices and interest rates. When the prices are constant or stable and are expected to remain the same, inflation has no effect on the process of services, goods, labor and materials and thus helps in contributing in higher living standard. This also helps in capital formation by helping in saving because when threat of attrition of asset values minimized, business got the opportunity to invest more whereas households are encouraged for more saving. Influence of Interest Rate on U.S. and Global Financial Environment Interest rates are always been proposed as policy guide, not only they serve the role of spending decisions also because interest rates information is accessible on the basis of real-time. The proper level of rate of interest will differ with fiscal policy stance, changes in spending pattern of business and household, global economic development and productivity growth. Modifications in interest rate on long-term basis will affect on stock prices, which will create a remarkable effect on the wealth of household. Investors keep in line both their investment returns on bonds and on stocks. For instance, if there is a decline in interest rates for long term period, then everything thing remain constant, return on stocks shall surpass returns on bonds while encouraging other investors to bid high and to purchase stocks so that the expectation on return are aligned once again. On the other hand, lower rate of interest may encourage investors that there will be strong economy with high profits in future, which ultimately results in the increase of equity prices. Impact of Exchange Rate on the Decision of Business’s to operate in Foreign Markets The main risk of an exchange rate with respect to an investment or operation is that profits recognized will partially be reduced as soon as it is exchanged with domestic currency whether it is US dollars or the euro or any other currency (Cypher and Dietz, 2009). The risk of exchange rate affects a company’s price competitiveness with respect to goods and services when it is offered in foreign currency by the competitor. If the currency of competitor weakens, the cost will decline but its competitive position will improves since they will be able to capture market on large scale. There is an easy way to evade the risk caused by rate of exchange rates that is one should not do business internationally or abroad. It will be like not moving on for further business whether the company is small size or large size. The practical approach is to understand what are the risks associated with exchange rate. It will be wise enough if advisers are chosen wisely who have full command on the subject and make great use of their findings and counsel wisely. This is quite complex and sophisticated that have been used for more than decade. Although interest rates have significant impact on rate of exchange however, one needs to be cautious in order to verify additional conditions. Reference Cypher, J. M., & Dietz, J. L. (2009). The process of economic development. New York: Routledge. Demirgu?c?-Kunt, A., & Levine, R. (2001). Financial structure and economic growth: A cross-country comparison of banks, markets, and development. Cambridge, Mass: MIT Press. Fabozzi, F. J. (2002). Foundations of financial markets and institutions. Upper Saddle River, N.J: Prentice Hall. Read More