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Macroeconomics of Financial Markets - Assignment Example

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Microeconomics of Financial Markets Name Instructor Task Date This paper discusses various topics in economics with the purpose of enabling a better understanding of the financial markets. It focuses on exchange rates, inflation, financial markets and monetary policies…
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Macroeconomics of Financial Markets
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Macroeconomics of Financial Markets

Download file to see previous pages... Foreign businesses that would like to purchase goods in the US have to convert the currencies they have into US dollars. However, a rising dollar makes the foreign businesses to use much of their currencies to obtain a unit of US dollar. Thus, the foreign businesses will use more US dollars to obtain a product in the US. This means that businesses in the US that export goods and services will prefer a rising dollar. As the dollar rises, they obtain higher amounts for the goods that they export. This would be the same for a European tourist who comes to the US to visit the Grand Canyon. The tourist will have to change the European pounds that he or she has for US dollars. However, in case the dollar is rising, it means that the value of the dollar is declining. Thus, one unit of European pound will fetch more units of US dollar (Thomas, 2006). Therefore, the European tourist will obtain more units of US dollars. He or she will be able to access more products and services when he or she reaches the United States. Question Two The Fed can use various methods to create money. Creation of money refers to the methods that the Fed uses to manage the quantity of money that is in circulation in the economy. One of the methods is through open market operations. This refers to purchase and sale of United States’ government bonds (Ritter, Silber, & Udell, 2004). The Fed can buy government bonds from the public. This increases the amount of money in circulation in the United States. As the government buys bonds, it releases money into the economy. Alternatively, in case the Fed wants to reduce the amount of money in the economy, it can sell government bonds to the public (Mishkin, 2010). The sale of government bonds makes the Fed take money from the public and offers the public bonds. Therefore, the amount of money in circulation decreases. The Fed can use commercial banks’ reserve requirements to influence the amount of money in circulation (Burton, Brown, & Burton, 2009). Commercial banks must retain a given proportion of the deposits they receive. Thus, commercial banks cannot lend all the money deposited in their accounts. An increase in reserve ratio means that commercial banks will reduce the amount of money that they lend to the public. This reduces the amount of money in circulation. On the other hand, a decrease in reserve ratio requirement means that commercial banks can lend more money to the customers. Thus, the amount of money in circulation increases. The Fed can also influence the amount of money in circulation through the discount window (Thomas, 2006). Commercial banks usually borrow money from the Fed since it is the lender of the last resort. The Fed usually charges an interest whenever commercial banks borrow money. The Fed can increase the interest rate it charges to the commercial banks to reduce the amount of money in circulation. Alternatively, it can reduce the interest rate to increase the amount of money in circulation. Finally, the Fed can make recommendations to the treasury so that money supply can be increased through printing (Ritter, Silber, & Udell, 2004). The Fed does not directly control money through printing or minting. The treasury prints notes and mints coins. This method can be used to direct the quantity of money in the economy. The most powerful method is the open market operation. However, the most commonly used method is the discount window or rate. It enables gradual reduction or increase in money in ...Download file to see next pagesRead More
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