The Money as the Appropriate Measure of the Policy - Literature review Example

INTRODUCTION Many economists are of the opinion that money is not to be considered neutral on short term basis. Friedman and Schwartz have argued that Great Depression was extended due to the implementation of the policy of tight money by the Federal Reserve. Economists have derived 'negative relation between wage inflation and unemployment', it was later confirmed that 'money growth raises output in the short run'. The latter argument has proven wrong since 1970 onwards, and the real interest rates are not influenced by money. A conclusion that can be reached that 'exogenous part' of the money influence the interest rates on the basis of the assumption that the money responds to real variable, therefore the money supply has further overshadowed the liquidity effect on the interest rates. However it is incorrect to regard the money as the appropriate measure of the policy towards the increase in the interest rates, the interest rates are based on the supply of bonds, and rate of interest is regarded as the return on bonds, through bonds the evaluation of the liquidity effect can be exercised. The measurement of the money can be exercised through the non-borrowed reserves; the purpose of injecting the money can not be achieved through the withdrawal of say, Treasury bills. The injection of money can also be exercised through the purchase of long-term bonds, and this is expected to develop an impact on the short-term rates. DISCUSSION The bond market risk are associated with the occurrences when the agents allocate the funds towards the bond market without any evaluation and analysis of the purchasing and selling price of the bond afterwards. Such concerns are imminent because asset markets are considered to be incomplete and segmented. The risk within the bond market based on the supply of the bonds is experienced when the agents and dealers are willing to invest their resources in the trade market. The buyers are the expected beneficiaries when the bond-supply shock is positive, the positive effect is based on the lower prices of the bond as compare to the expected prices, and when the expected rate of return has been crossed. Therefore within the bond market business, the dealers are expected to make good fortune, and 'any real consequences are distributional because the shock has favored some agents at the expense of others'. The expansion and growth of the bond market is expected to determine the time period associated with the downgrade within the bond market the time is considered to be major dimension, and the expansion of the bond market is based on the 'relationship between the indicators and the downgrade'. In the case of banks, the relation between the market indicators which include rating changes, abnormal stock returns, and the proportion of equity owned by institutional investors and bank insiders and supervisory information have failed to explain the supervisory assessments and bond ratings, and for this purpose the equity indicators have been ignored. It was reported that the 'bond spreads with particularly poor supervisory assessments reducing spreads and vice versa', therefore market is based on the market discipline i.e. supervisory assessments. It was investigated that market prices incorporate additional information as compare with the accounting variables, and therefore influence the ratings of the respective bonds, however there is no variance in the future prospects and worth of the bond, it is the debt market indicators which have predictive power to influence the performance and operations of the bond market. In normal practices are dealer who offer successful bid 'in the course of their direct interactions with the New York Fed', as per the terms and conditions of the Treasury department is entitled to be announced as successful bidder, and the bonds are issued within the period of three days. It is expected that in bond market, some depository institutions, brokers and agents are expected to pay towards their successful bid on the date of issuance of the bonds, however there is an allowance, and some of the dealers and agents can pay at the time of 'submission and are either refunded excess balances or called upon to remit additional funds based upon the final auction price and security allocations'. The supply risk associated with the bond market is associated with residual supply risk. In cases where there is heavy demand of the Treasury Bills in the bond market, the demand in many of the cases is expected to surge due to the interests of the 'foreign financial institutions and international monetary authorities regarding whether to roll over their substantial and various holdings of bonds, such decisions are expected to influence the residual supply which is provided to the 'remaining traders because they count against the issue quantity stated in the auction announcement'. The dealings by the foreign financial institutions are based on their status of noncompetitive bidders. It has been observed that within the bond market the dealers and agents have the allowance for offering noncompetitive bid, however the 'the quantities of such bids are restricted and thus more predictable'. Therefore within the bond market it can be expected that the supply risk might originate at the auction stage, and such situation can arise in contradiction with the announcement of the face values of the Treasury Bills by Treasury, which are expected to be issued shortly. It is speculated that the within the bond market the final auction price of the bond is less predictable and difficult to determine because public is unfamiliar about the rollover plans, and 'the randomness in these plans, from the perspective of the dealer' makes it difficult for the public to make serious efforts. Consequently, the change in the policy was expected to develop more accommodative stance which reduced the risks associated with the residual supply, the risk was deterred by imposing limitation on the ' unexpected noncompetitive rollover decisions could affect the final auction price'. According to the report by Cammack, the Fed and FIMA combined were involved in the purchase of the T-bills that were auctioned between 1973 and 1984, and intended to purchase more than 40 percent of the all the auctioned T-bills. It is later examined that the portion increased to 45 percent during 1998. Therefore within the bond market, the risk associated with the rollover decisions have superceded the variation based on time, and the spread in the distribution of bids. The bond supplies are dependent upon the standard deviation of the monthly per capita real growth of the monetary base, T-bills and T-notes, and all marketable T-secondary, including bills, notes, bonds, and certificates of indebtedness. It has been observed that number of secondary dealers have secured new issues from the primary agents, and 'presumably pay for them upon delivery, though the bonds trade actively prior to their issue in a when-issued market'. The tenders which are signified as noncompetitive are offered for the purchase of the bonds at the final auction price; the prices are paid on the suction days irrespective of its valuation. The predictive power of the bond market is expected to improve by introduction of market variables into the standard models which are based on evaluation and inspection of the financial reports of the respective companies. According to the report, 'the accounting information has no predictive influence over the supervisory rating downgrades; there was unexpectedly the subordinated debt spreads perform only insignificantly better'. CONCLUSION It has been reported that the Fed has already planned to roll over the shares of private portfolio of maturing bonds at reasonable prices, it is believed that 'the securities that the Fed rolls over do not count against the total offered to the public in that auction and, thus, have at best a minimal impact on the final auction price, but they will affect the size of subsequent auctions'. Although it has been observed that Treasury has tried to avoid further rollovers, and have therefore changed its policies to diminish the supply risk associated with the bonds. In one of the cases, the Treasury was entitled to issue additional securities towards foreign accounts, in such cases where the sum of the new bids from such sources bypassed the present holdings of maturing bills such sources. In the start of the auction the Treasury placed a barrier of '$3 billion on the amount of foreign rollovers that would be counted against the public's total, agreeing to make additional issues automatically if the rollover bids were expected to exceed this amount'. Reference 1. Reint Gropp, Jukka Vesala, Giuseppe Vulpes. Equity and Bond Market Signals as Leading Indicators of Bank Fragility. Journal of Money, Credit & Banking, Vol. 38. 2006 Read More