Macroeconomics and Microeconomics - Interest Rate - Assignment Example

A developed money market is essential to the development of an economy as it provides the sources of finance to carry out the necessary business transactions. Firstly, it provides the cash required on a short term basis to finance the working capital requirements of businesses and entire industries. Lenders can borrow the money from financial institutions to finance their necessary transactions and thus the money market allows the economy to keep running. It also helps to keep the financial institutions self sufficient as the institutions can recall their loans at any point if they need it.

Money market instruments are significant for the central bank because it regulates and controls its monetary policy by increasing or decreasing the money market rates. It also provides the finances to the government who may issue treasury bills in order to finance its spending. (Importance of Money Markets) The money market rate is called the federal funds rate in the USA which is the lending of available funds from one institution to another on a short term basis. Q2) The above figure shows the graph of the U.S. Federal Funds rate and the Treasury Bill rate over a period from 1991 to 2009.

The interest rates of money market funds usually tend to move in the same way as the future interest rates are based on the expectations. The year 1991 began with the federal fund rate and treasury bill rate set at 5.69% and 5.41% and was on a constant decrease until the year 1993, after which it began to rise and more or less maintained the same level until the year 2000. In the year 2001, the terrorist attacks in U.S. badly damaged the confidence in the economy and the people, both local and foreign, were not willing to invest in the U.S., therefore the federal bank and the government reduced the interest rates in order to encourage the spending.

The interest rate encouraged the potential investors to increase the borrowing and the investments along with decrease the savings. The government, in 2004, increased the interest rates gradually and increased it constantly on a quarterly basis. After the interest rates reached a point of 4.5% to 5% in the year 2006, the world was hit by the recession and the central banks had to lower the interest rates to once again encourage the spending and investments in the U.S. economy to limit the recessionary impact on the economy.

The government and the central bank still had to decrease the interest rates due to the recession and reached a low point of 0.16% in 2009. Q3) The above graph shows the money market rate and the treasury bill rate in Bahrain over the time period from 1991 to 2009. Again both the curves move in the same direction as they are based on the same expectations. The interest rates of Bahrain move in a direction similar to that of the U.S. because the currency of Bahrain Dinar is pegged to the U.S. Dollar.

The Bahrain Monetary Agency (BMA) regulates the interest rates on a quarterly basis keeping the national and international indicators into consideration. The year 1991 began with a declining interest rate which was restored in 1993, similar to the case in the U.S. and the interest rates were more or less stable with only a few changes in it. This was the time when there was stability in the world throughout. However, in 2001 after the terrorist attacks, the economies throughout the world took a big hit especially the U.S. economy that had to lower the interest rates drastically until 2004.

The same was followed by the Bahrain government