June 9, 2013
Abstract Financial markets play an important role in contributing to the health and efficiency of an economy. The combination of well-developed financial markets and institutions, as well as a diverse array of financial products and instruments, suits the needs of borrowers and lenders and therefore the overall economy.
Running head: FINANICAL MARKETS Financial markets are - any type of financial transaction that you can think of that helps businesses grow and investors make money. Financial markets such as those that trade stocks or bonds, and institutions provide opportunities for investors to specialize in particular markets or services, diversify risks, or both. Together financial markets and financial institutions contribute to economic growth. The U.S. Federal Reserve System known as the Fed was established to provide an independent means to help ensure the stability of the financial system and set monetary policy by determining the size of the money supply and various interest rates. Federal Reserve Chairman Bernanke is responsible for guiding monetary policy for the U.S. economy. The Board of Governors oversees the operation of the Federal Reserve System and exerts a great deal of control over the financial side of the macro economy. Today, the U.S. economy continues to recover at a moderate pace, but unemployment remains unacceptably high. Monetary policy is supporting economic growth, but monetary policy has limits. In current circumstances, it would be particularly helpful if fiscal and regulatory policies were among the forces supporting economic growth. Central banks worldwide are facing economic circumstances that are similar to those in the U.S., and are taking innovative monetary policy actions that may influence the theory and practice of monetary policy in years to come. I believe that our accommodative monetary policy stance is keeping the U.S. economy on the path of economic recovery, and is contributing to both U.S. and worldwide economic growth. Interest rates affect the economy slowly by influencing stock and bond interest rates, consumer and business spending, inflation, and recessions. As the United States Federal Reserve raises interest rates, the foreign exchange value of the dollar usually goes up as well because people outside of the country want a larger return for their investment and they are more likely to get it in a state of high interest rates. This causes more demand for the dollar, driving up its value in the international market. When the Federal Reserve changes the Fed funds rate, it can take 12-18 months for the effect of the change to percolate throughout the entire economy. As rates increase, banks slowly lend less, and businesses slowly put off expansion. This lowers the amount of credit available to fund purchases, slowing consumer demand. At the same time, it encourages more people to save (if they can) because they receive more on their savings rate. Higher interest rates also reduce the capital required to expand businesses, strangling supply. This reduction in liquidity usually slows the economy down. Foreign exchange rates directly impact international trade, capital flows and political sentiment. For businesses trading abroad, this has a significant