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Money & Banking - Essay Example

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The purpose of this study is to bring to light the mechanism of an economy and banking system. The study focuses on subprime crisis that has hit the US in the last two years. The study throws some light on the adverse effects of the crisis on the US as well as other economies of the world…
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Money & Banking
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Download file to see previous pages The Fed comes out with the monetary policy in order to ensure a certain key objectives like, delivering price stability with a low inflation level coupled with an objective to support the Government's economic objectives of growth and employment. To understand how the Fed monitors price related regulations to keep a check on inflation, we may consider a small example of the regulation of house and property prices. To take any decisions related to interest rates keeping in mind the ongoing inflation rate, the Fed must be thorough with the booming property prices and must take steps to ensure that the prices are not artificial.
Government intervenes through its central bank to regulate the prices of many commodities, similarly it also regulates the prices of houses like any other important commodity. Fed has the responsibility to keep a check on asset prices including the prices of houses. There can be a number of reasons why the prices of houses may shoot up, like the simple rule of demand and supply has a definite impact. (Demand and Supply for Housing).
Other reasons behind a change in property prices can be Mortgages. A mortgage is the money borrowed to buy a house, as for most people buying a house is not easy. Over the years mortgage market has picked up greatly and the current scenario is totally different from the one that existed in the beginning. Mortgages were supplied only by the building societies. Building societies were non-profit institutions and encouraged only the members for the grant of loans, so the people who were members and had contributed to an extent for a considerable period of time got loans easily and account with building societies became the only means to get mortgages. Soon these societies had to compete with the banks and other financial institutions specialized in granting housing loans. This price war resulted in a greater demand for owner occupied houses and consequently the demand for houses grew stronger, resulting in a substantial increase in price. (The UK Housing Market - Factors Influencing the Housing Market: Mortgages)
Besides the above-mentioned factor of mortgages there are other factors like stamp duty and planning that affect the market for housing. Mortgage interest relief at source (MIRAS) was a tax concession to owning a house. It reduced the house owner's liability to income tax as the money spent on the interest on mortgage was considered to be tax-free. This made borrowings cheaper and as a result there was a huge demand for housing and the prices shot up. With the introduction of MIRAS in 1990 many people were exempted from stamp duty. (The UK Housing Market - Factors Influencing the Housing Market: Stamp Duty and Planning)
The central bank sets a fixed interest rate at which it lends money to financial institutions and depending on this interest rate, individual banks and other financial institutions set up their own interest rates, which apply to the whole economy. This step is of indispensable importance to the economy, as this is very widely used to contain inflation. The only purpose behind such a step is just to contain undue inflationary levels prevailing in an economy. The point to be noted here is that, ...Download file to see next pagesRead More
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