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

Complexities of the U.S Financial System How the U.S. financial markets impact the economy, businesses, and individuals The term financial market may be simply defined as the place where different companies find capital that they use to expand their operations. It also provides investors with the opportunities to specialize in various market forms, and diversify their risks accordingly. It may be presumed to have a meaning similar to the stock or bond markets or the idea of hedging of risks by companies.

The dynamics for the operation of financial markets are quite complex and entailing (Pozen, 2010). However, in this study, I seek to express the impacts of the same in U.S to individuals, businesses and the economy in general. A well developed financial market that smoothly operates can be of great significance to the economy by contributing towards its efficiency and health. A strong positive relationship exists between the economic growth rate and the development of financial markets. To the economy of U.

S, the development of strong financial markets that have then continued to exert huge positive pressure that have greatly impacted on the economy. Specifically, the growth of financial markets has efficiently aided the direct flow of investments and savings in the economy. As a result of this, there has been huge accumulation of capital in the economy, as well as the enhancement of production of goods and services in the country. A good combination of flourishing financial market, diverse array of financial instruments and products and well developed financial institutions also attracts more borrowers and suits the lenders’ needs hence, positively impacting on the economy.

Furthermore, the financial markets in U.S due to their efficiency have lowered the economy’s search and transaction costs (Norton & Melicher, 2013). However, the activities of financial markets largely depend on factors such as inflation. For instance, during times of depression, the capital levels decline as a result of low savings and investments: hence, further impacting on the economy negatively. To the businesses and individuals, the financial markets have greatly provided them with more liquidity especially when the market is large.

This has then enhanced the number of participants and securities available to businesses, as well as enhancing the trading opportunities available to them. Consequently, the financial markets have also led to accumulation of capital by businesses and enhanced their production capacities. Other than this, the prices of the instruments and credit offered in the financial market acts as a signal to the producers on how to price their commodities too. These signals also help in directing funds from households and other businesses to the other consumers, businesses and the government or investors who would like to borrow the same (Norton & Melicher, 2013).

The role of U.S Federal Reserve The Federal Reserve System in the U.S (formed in December 23, 1913) is the central system of banking, and plays a crucial role in the maintenance of the economy. Generally, it may be referred to as the bank of the USA government. Initially formed to provide responses to the financial panics that gripped the country around the year 1907, its roles have greatly expanded and its structure evolved. Its key objectives under the Federal Reserve Act are to ensure maximum employment, ensure the stability of prices and to moderate the long term interest rates in the economy.

Other duties currently performed by it includes supervision and regulation of the activities of banking institutions, monitoring of the country’s monetary policy, maintaining stability of the financial system, as well as provision of financial services to depository institutions, other foreign financial institutions and the USA government (Norton & Melicher, 2013). Functions/roles of the Federal Reserve Chairman The Chairman (appointed by the President) is tasked with the duty to control the Federal Reserve.

It does this by being the spokesman of the Federal Reserve (central bank). Consequently, he is tasked with negotiating with the USA President and the Congress on financial matters that might affect the country. He also controls the agenda of the Federal Reserve Board (FRB) and those of the Federal Open Market Committee (FOMC) (Choudhry & Beehler, 2011). The role of the Federal Reserve Board The main role of the Board is to supervise the Federal Reserve System through the making of monetary policies for the government.

For instance, according to the Monetary Control Act (1980), the board is authorized to set an 8% to 14% reserve requirement on transaction deposits. Other than this the Board (appointed by the US President) supervises the work that the other Federal Reserve Banks all over the country do. In line with this, it supervises the banking industry by examining the depository institutions for soundness and safety and compliance with the regulations and laws. Consequently, the Board issues various consumer-credit and banking regulations that are practiced in country, and also approves the discount rate of Federal Reserve Banks.

Finally, the Board publishes statistics and information about the U.S economy and the Federal Reserve (Choudhry & Beehler, 2011). How interest rates influence the U.S. and universal financial environment Interest rates can easily influence the economy and in various ways. When there are high interest rates, few people will want to take loans from banks due to the difficulties they fear might hinder them from paying back those loans. Consequently, other items like cars and homes in terms of purchases will go down as there will be low disposable income among consumers.

However, when interest rates are low, consumers benefit since they are likely to take more loans from banks so as to purchase homes or cars. This is because the market for such items becomes strong hence, their prices decreases. Additionally, investors are also likely to benefit more from the low interest rates as they will not pay more when repaying. Therefore, low interest rates encourage investments but discourage savings. However, when the interest rates increases, foreign direct investments will increase as foreign investors will require large returns, which they can only get in a country where there are high interest rates.

As a result of this, the demand for dollars in the market increases hence, its value too in the international market will increase. Interest rates also have an effect in the inflation and depression in the country (Norton & Melicher, 2013). The impact of exchange rates on a business’s decision to operate in foreign markets. Foreign exchange rates are used to describe the domestic currency valuations taking into consideration factors such as political and economic standings of the country. Exchange rates will affect the international trade as they determine the level of trade to a country in a free market.

As such, a decision to operate in a foreign country must be made considering exchange rates. First, when the rates are low, it may signify that the country is likely to undergo a recession or high inflation rates. Consequently, when the exchange rate is higher, the balance of trade for the country will likely be lower and vice versa: hence, businesses must take this into consideration before setting base in a foreign country. Since exchange rates influence the investment funds or capital flow that circulates in the country, a foreign business should only set base when the value for their investments will be preserved (Brigham & Ehrhardt, 2013).

References Brigham, E. F., & Ehrhardt, M. C. (2013). Financial management: Theory and practice. Mason, Ohio: South-Western. Choudhry, M., & Beehler, B. (2011). The Money Markets Handbook: A Practitioner's Guide. Chichester: John Wiley & Sons. Norton, A. E & Melicher, R. W. (2013). Introduction to Finance: Markets, Investments, and Financial Management (14 ed.). New York: Wiley Publishers. Pozen, R. C. (2010). Too big to save: How to fix the U.S. financial system. Hoboken, NJ: Wiley.