U.S. financial markets have a strong impact on the economy, businesses, and individuals. For example, the economy is generally positive or negative according to the state of the financial markets. This occurs because financial markets control the flow of cash into and out of the economy, specifically in the areas of capitalization, savings, and provision of material goods and services. A healthy market allows money to flow freely without excess inflation, permitting the growth of the economy, while an unhealthy market is associated with inflation or deflation, unemployment, and excessively high or low interest rates (Anonymous, 2014).
Financial markets affect businesses as well. For instance, greater costs of capital (higher interest rates) make it more difficult for small businesses to get start-up money, and larger companies may not be able to take on some capital projects since the cost of debt is too high. In both cases, growth is stymied. Another effect is that a downward turn in the market, if it is reflected in decreased share prices, may make a company an attractive acquisition. If the company is agreeable, a merger may take place, but if not, there may be a hostile takeover (Edmans et al., 2012).
The effects of financial markets on individuals may be direct or indirect. A person who owns stock, bonds, mutual funds, or other financial instruments will be affected directly by changes in the markets, especially excess volatility and sudden extreme changes in price. But individuals who do not actively participate in the markets will also be affected. An example is the effect of interest rates on a couple with an adjustable rate mortgage on their home. Their payments are subject to sudden increases at any time, which could potentially cause them to lose their home. This is especially true when medium to high interest rates encourage people with less money to choose ARMs instead of fixed-rate mortgages, because the people with less money are the most likely to be devastated if interest rates rise drastically (Buttonwood, 2014).
The U.S. Federal Reserve is the nation’s central bank. The responsibilities of “The Fed” include (1) monitoring and regulating banks, as well as related financial institutions; (2) keeping the financial system as stable as possible; (3) participating in the country’s payment systems, and (4) controlling monetary policy by changing parameters of money and credit (Federal Reserve, 2014). The Chairman supervises the Board’s staff and speaks to the public, presenting the Board’s policies, and is the presiding officer at Board meetings. The 7 members (including the Chairman) of the Federal Reserve Board are selected by the President of the United States for staggered 14-year terms. Since the beginning of the 2007-2008 financial crisis, the Federal Reserve has sought to stimulate the economy by decreasing interest rates for member banks almost to zero, buying bonds from member banks to furnish them with more capital to loan out, and quantitative easing (buying other securities, such as mortgage-backed securities, from member banks; Economist writers, 2014). These actions have apparently stimulated the economy but it continues to grow slowly. For this reason, the Fed continues to maintain low interest rates and to buy back bonds and securities, although tapering of the latter has begun (Applebaum, 2014).
The 7 members of the Federal Reserve Board, plus 5 of the 12 Reserve Bank presidents, serve on the Federal Open Market Committee. This is the body that makes monetary policies, such as interest rates, quantitative easing, and reserve requirements (Federal Reserve, 2014). The president of the FOMC is the president of the FRB, and the vice-president of the FOMC is the president of the Federal Reserve Bank of New York, who is a permanent member of the committee (Federal Reserve, 2014). The twelve regional Federal Reserve banks are located in large cities around the country. They supervise banks in their regions, provide information to the public, and hold reserve accounts for member banks (Federal Reserve, 2014).
The Secretary of the Treasury, the Treasury Department, and the Securities and Exchange Commission are also responsible for making decisions related to monetary policy. The Treasury encourages growth of the economy by influencing policies for investment increase, job creation, and economic stability (Department of the Treasury, 2014). The primary goal of the SEC is to protect investors, but it is also charged with stabilizing financial markets and encouraging growth of capital. (SEC, 2014)
The money supply consists of all cash, coins, and other liquid financial instruments in a country. Different types are designated as ‘M’ plus a number. For example, M0 and M1 include coins and bills. A monetary system is a hierarchy of bills and coins representing different amounts that are negotiable within a given country as well as in other countries with appropriate exchange rates. The U.S. monetary system includes dimes, quarters, $1, $5, $20, and $100 bills (Bloomberg, 2014).
The international monetary system relates the currencies of different countries to one another and establishes rates of exchange between one and another. Exchange rates can have significant impacts on worldwide trade, since a country with higher currency value is likely to have a trade deficit, and vice versa. For example, if the dollar is higher in value that the Japanese yen, then U.S. products will be more costly and fewer exports will occur. If the dollar is lower, U.S. exports are cheaper and there will be a trade excess (IMF, 2014). The International Monetary Fund receives money from member nations like the U.S. and uses it to help nations having financial difficulties. In addition, it seeks to create a stable financial system around the globe in order to encourage trade (IMF, 2014).
- Anonymous. (2014). Financial markets affect economic performance. Federal Reserve Bank of San Francisco. Retrieved from http://www.frbsf.org/education/publications/doctor-econ/2005/january/financial-markets-economic-performance
- Bloomberg. (2014). Money supply. Retrieved from http://topics.bloomberg.com/money-supply/
Edmans, A., Goldstein, I., Jiang, W. (2012). The Real effects of financial markets: The Impact of prices on takeovers. The Journal of Finance, 67.
- Federal Reserve Board. (2014). What is the Purpose of the Federal Reserve System? Retrieved from http://www.federalreserve.gov/faqs/about_12594.htm.
- Buttonwood. (2014). Markets, inequality and monetary policy. The Economist. Retrieved from http://www.economist.com/blogs/buttonwood/2014/03/markets-inequality-and-monetary-policy
- Economist writers. (2014). What is quantitative easing? Retrieved from http://www.economist.com/blogs/economist-explains/2014/01/economist-explains-7
- Applebaum, B. (2014). Fed cuts bond buying by another $10 billion. The New York Times. Retrieved from http://www.nytimes.com/2014/03/20/business/fed-cuts-bond-purchases-by-another-10-billion-as-expected.html?_r=0
- Department of the Treasury. (2014). The Purpose of the Treasury Department. Retrieved from http://www.treasury.gov/Pages/default.aspx.
- SEC. (2014). About the SEC. Retrieved from http://www.sec.gov/about/whatwedo.shtml#.U2F-bvldUSo
- IMF. (2014). About the International Monetary Fund. Retrieved from http://www.imf.org/external/about.htm