International Financial Markets and Institutions - Assignment Example

Financial stability Name: Institution: Date: Word Count: 2022 Question 1: Analysis Yield curves for 5-year government bonds in the UK, the USA, and Japan Neither the use of micro-prudential oversight, through the Financial Services Authority (FSA), nor the achievement of price stability, via the MPC, caused the financial stability. A portion remains that can only be filled by the Financial Policy Committee (FPC) and the macro-prudential authority in the United Kingdom; the macro-prudential authority has the authority to change the positions of the assets of the central bank by addition or subtraction from its claims holdings in the private sector. The body also has the mandate to alter the margins such as loan-to-value ratios, liquidity ratios, and Capital adequacy ratios, among others to have affected the behavior of the financial intermediations. Some argue that the application of such authority makes the FPC be in a difficult conflict with the Monetary Policy Committee. The argument is, however, not justified and does not receive support from many financial experts (Frait et al., 2011; Foster & McChesney, 2012). The emergence of the financial crisis that commenced in the summer of 2007 made the concerned experts realize that there was in existence a link that was missing in the general structure of the regulation of finance. The monetary policies had put their focus on general macroeconomic stability and the price stability. The focus had been a success story till the beginning of the financial crisis. Nevertheless, this was not enough method to make sure there was economic stability (Goodhart, 2011; White, 2012). Goodhart had enumerated that Micro-prudential regulation laid undue focus on the prospects and factors of the individual financial intermediaries, particularly the individual banks. This was globally spread through the Basel Committee on Banking Supervision and acted upon nationally by different known firms in most cases without the national central banks although some acted within the central banks. The bodies mandated with the power to regulate did allow the financial systems to enter into a countercyclical zone that is dangerous because of the connection with the increasing utility of mark-to-market accounting. The following diagram shows that there was a reduction in the CDS rates of the major banks for the United States, the United Kingdom, Japan and other Euro areas. It is important to note that there is a gain in traction of the growth momentum of the economy of Japan. The evidence of the statement is found in the economic growth rates that are notable in the last few years and the significant drop in the unemployment rate. With the attention from the global media on the QQE, it can be said that the japan financial market has become familiar with many market participants and financial experts. Examining the QQE from the perspective of forward guidance is thus called upon. Forward guidance is defined as the strategy of communication that is taken by a central bank to give information to the public (firms and households) and market on the bank’s monetary stance in the future (Campbell et al., 2012; Ahdieh,2016). The financial institutions increasingly become more accustomed to investment strategies that are deflation oriented. Many of them change their investment from risk assets like foreign securities, real estate, loans, mutual funds, corporate bonds, and stocks to safer assets like cash, deposits and the Japanese government bonds (Downes & Goodman, 2014; Shiller, 2015). The institutions do an adjustment to their expectations according to the underlying conditions, even when the monetary policy of the stance of the central bank is withheld constant. Instances occur where their better comprehension to reducing the level of uncertainty, and is capable of resulting into reduction of the term premiums and the volatility of the bond market. There are other occasions when the public and the market feel that the central bank is holding with it superior information useful in assessment of future economic activities and prices (Blinder, 2001; Moravcsik, 2013; Keynes, 2016; Christensen & Tågmark, 2016). The Financial Policy Committee (FPC) view on economic prospects Over the time, financial experts have to settle on one benchmark yield curve only; concentrating the price discovery on just one homogeneous instrument. Currently, there is a competition for bench mark status over multiple instruments, and there is no curve that has been singled out to be the focus for hedging and positioning the risks of interest rates. The government securities show several importance; tremendous liquidity among others. The interest payments made as bond coupons are usually fixed and can be redeemed after a specified period of time. The Financial Policy Committee (FPC) is mandated to determine, monitor and even act to remove or reduce the systematic risk, with the aim of protecting and promoting resilience of the UK financial systems. The Financial Policy Committee identifies some means through which the financial stability could be lowered by the referendum. Financing the large current account deficit of the UK, this is dependent upon foreign direct investment and continuing material inflows (Amorello, 2016). The FPC reports that some risks are beginning to crystallize and concludes that the UK financial stability outlook is very challenging. They expect some economic and market volatility during the stability process and creation of relationships with other European markets and the rest of the world. The report shows that the nature of adjustments and the degree of uncertainty can be seen in the financial market prices. The FPC is focuses on the promotion of financial systems capable of dampening, instead of amplifying, the effect of uncertainty and adjustment on the real economy (Adrian & Liang, 2016; Lombardi & Moschella, 2017). These circumstances are extraordinary. Monetary authorities have not engaged in the utility of many of the unconventional policies for a long time. The risk management and forward planning is very complex; increased by divergent of economic prospects around the world. Question 2: Analysis of the link between the money supply and inflation in the UK, the USA, and Germany Money supply and inflation correlate with each other in an economy (Galí, 2015). Inflation is the sustained increase in the costs of consumer goods, usually, measurable using consumer price index primarily known as CPI, whereas the supply of money is referred to as the coins and the notes that are in circulation outside the central bank (Green, 2016). With the increase in the supply of money around the economy, there is an accompaniment of increment in the rate of inflation as well as an increase in the balance of payment, nevertheless, the effect of this is on employment is not significant. The increase in the supply of money is definable as the direct money conveyance method, which implies that increasing the supply of money causes the people to make use of the excess of their supplied money over the increase in demand. The aggregate demand usually increases whenever people have excess income disposed on them to spend on luxury goods. This calls for the increase in the aggregate supply by the business to satisfy the wants of the consumers. Whenever the state office wants to take control and make an attempt in reducing inflation, they must take the measurement of money supplied and use fiscal policy so that they can reduce the volume of the supplied money that is in circulation within the economy. Money supply and inflation have an effect on the consumer demand and lead to an increase in the cost of a business (Aruoba et al., 2016) Monetary policy is also applicable in targeting the level of inflation; however, it is primarily usable in targeting the level of growth. Its design is used in controlling the amount of money flowing around the economy. The main usage of monetary policy is the tackling of the problems of balance of payment and inflation. The state employs several mechanisms in the attempt to have an influence on the supply of money. Raising the rate of interest reduces the capacity of borrowing in the economy. The amount of money flowing in the economy reduces with the reduction in the amount of borrowing since the citizens are not able to afford the repayments. Rates of interest also have an influence on the pound value, thus a higher interest rate makes the overseas investors and the UK internationals to be attracted and put their money in the banks of UK (Zafar et al., 2016). They buy pounds to do this, escalating the value of sterling. The government can also regulate the volume of money that the credit financial institutions can give out by setting limits on the on the types and the amounts that the credit financial institutions are allowed to make. If the money supply rate is faster than the real output when the economic circumstances are normal, there will be inflation. The correlation experiences a breakdown in a depressed economy because of the reduced speed of circulation. For example, the central banks of US largely increased the money supply between 2008 and 2011 yet there was no inflation experienced. The increase in money supply, however, causes inflation in a recovering economy (Reifschneider et al., 2015; Calvo, 2016). Examining long-term rise in the rate of inflation in the UK, a strong correlation with money supply is notable. The following graph indicates indices of the prices in the UK since 1900 comparing it with the money supply in the UK. Deductions from the money supply have been done to satisfy the equation of exchange to account for the extra money needed because of the economy that is constantly expanding, that is, the index is the result of the difference between GDP* and money supply (Jonas et al., 2003; Aggarwal & Goodell, 2009). The graph is obtained from price index-ONS longitudinal series- the preferred measures of the bank of England-measuringworth.com. The graph indicates a fair relationship of inflation and money supply over the last century. There are times that one of the two was slightly higher. The consumer price inflation has been lower than the money supply the last couple of decades. The graph shows that in 20 years between 1992 and 2012, therewas a little correlation between retail inflation and increase in money supply in the UK. Economic experts have concluded that retail inflation in low-inflation environments is not predictd by by money supply (Rodríguez-Palenzuela et al., 2003). There is a link bbetween money supply and inflation in the United States; increasing supply of money has a slight effect on the inflation, although, it depends on many other factors such as the rate of circulation. The US economy has faced serious economic recession for a long time and the federal reserve bank are concerned about the potentiality of deflation than inflation. Creating too much money would be dangerous (Minsky, 2015; Bodea & Hicks, 2015; Green, 2016). The grapgh below shows that there has been an insubstancial link between National Output, inflation and money supply over the recent years. The inflation in Weimar Republic in Germany in the early 1920s is an infamous example of a case where the excessive money printing caused a dangerous increase in inflation. The figures for the case of Germany as shown by the following graph, shows that after a period of around 7months when the price level increased less than high powered money, the increase in inflation was constant increasing further than the rate of base money expansion (Eichengreen & Hausmann, 2010). The outcome was a 24 times shoot of the level of price in Germany between September 1922 and December 1920. The conclusion by many researchers as a result of this experience is that large injections of liquidity by the central banks have a serious danger on the price stability (Evans & Geary, 2015; Szymanski, 2015; Weinhauer et al., 2015). Again, from the monetary base and price levels indicated organisations are likely to pursue an investment heavy strategy to grow. Financial indicators, outline a challenging environment in terms of liquidity and internal funding options (Saunders & Cornett, 2012). In order to maintain leadership position and satisfy the interests of operations, companies may look for alternative ways to fund its operations and potentially move from a market penetration strategy to a product differentiation strategy (De Haan, Oosterloo & Schoenmaker, 2009). References Adrian, T., & Liang, N. (2016). Monetary policy, financial conditions, and financial stability. Aggarwal, R., & Goodell, J. W. (2009). 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