Federal Reserve System
The Federal Reserve makes the country’s monetary policy to improve aims of maximum job opportunities, stable prices, and favourable long-term interest rates.
What impact does the Federal Reserve play on the markets?
The initial connection in the chain amid the economy and monetary policy is the market for balances which is held at the Federal Reserve Bank. Depository organizations hold accounts at their Reserve Banks, and they trade actively balances which are held, in these accounts in the federal fund markets at a profit rate termed as the federal funds rate. It exercises considerable management over the federal funds rate by using its manipulation over the demand for and supply of balances situated at the Reserve Banks.
The economic indicators that the Federal Reserve influences and how they paint a picture about the economy
The FOMC comes up with the federal funds rate at a point it believes will improve monetary and financial situations consistent with gaining its monetary policy aims, and it puts up that target in line with changing economic developments. If a change is made on the federal funds rate, or a change is made in expectations concerning the future level of the federal funds rate, then it can set off a chain of happenings that will affect other long-term interest rates, short-term interest rates, the prices, and the foreign exchange quality of the dollar. In so doing, variations in these variables will have an effect on businesses and households spending decisions, therefore, affecting growth in the economy and aggregate.
Short-term interest rates, like those on commercial paper and treasury bills, are affected by the current level of the federal funds rate and by expectations about the overnight federal funds rate on or over the time of the short-term contract. Due to this, short-term interest rates could reduce if the Federal Reserve market participants are worried with a decline in the federal funds rate, or if unfolding incidences convinced participants that the Federal Reserve will hold the federal funds rate at a lower rate than it had been anticipated. Likewise, short-term interest rates will increase if the Federal Reserve surprised those involved in the market by announcing a rise in the federal funds rate, or when some event made market participants to think or believe that the FED will be holding the federal financial rate at increased or higher levels than had been expected.
It is for due to this that market participants do closely follow data statements and releases by Federal Reserve members of higher rank, watching for clues that the prices and economy are on a dissimilar trajectory than had been expected, which would have meaning or implications for the stance of monetary policy.
Alterations in short-term interests rates influences long-term interest rates, like those on corporate bonds, Treasury notes, fixed-rate mortgages, auto consumer loans, and others. Long-term rates are influenced or rather affected not only by alterations in current short-term rate but also by expectations of short-term rate over the whole of the life of the long-term agreement. Generally, economic statements or news by officials will have a higher impact or effect on short-term interest rates than on the longer rates since they significantly have a bearing on the course of the monetary policy and the economy over a shorter period; but, the effect on long rates can also be considerable due to the reason the news has clear or open implications for the course of short-term rates in a long duration.
On the other hand, alterations in long-term interest rates affects stock prices, consequently this affects the household wealth. Investors try to maintain their investment returns on stocks together with the return on bonds, after giving room for the higher riskiness of stocks. For instance, if long term interest rates reduce, then, all otherwise being equal, returns on stocks will increase returns on bonds and motivate investors to acquire stocks and bid up stock costs to the level at which anticipated risk on stocks are once again put together with returns on bonds. Furthermore, lower interest rates may make investors to think that the economy and profits will increase in the near future, which should further increase equity prices.
Moreover, alterations in monetary policies influence the exchange value of the dollar on currency markets. For instance, if interest rates increase in the United States, outcomes on dollar assets will look more favorable, this will ultimately lead to bidding up of the dollar on overseas exchange market (Grey, 2002). A rise in the dollar will reduce the cost of imports to the United States citizens and lower the price of U.S. exports to non U.S. Conversely, decreased interest rates in U.S will lead to a reduction in the exchange rate of the dollar, making an increase in demand for consumer goods, more so bigger-ticket items like motor vehicles. Decreased mortgage rate makes housing more affordable and leads to more home purchases. This will on the other hand, encourage mortgage refinancing, which will decrease ongoing housing costs and make households to buy other items. When refinancing, some possessors may withdraw a part of their home equity to pay for other items, like, a motor vehicle, other consumer items, or a long wanted vacation trip. Increased stock prices can on the other hand, add to household belongings and to the ability to make purchases that had before appeared to be beyond reach. The decrease in the value of the dollar linked with a decrease in interest values will tend to boost U.S. exports by decreasing the cost of U.S. services and items in foreign markets. It will also make the price of imported goods to rise, which will encourage marketers and households to buy domestically produced goods. All this will strengthen the rise in aggregate demand.
If the economy goes down and employment softens, those who make policies will be forced to ease monetary policy to stimulate aggregate demand. When the rise in aggregate demand is supported or boosted above growth in the economy’s capability to produce, slack in the economy will be reduced and employment will come back to a more sustainable path. In contrast, if there are signs of overheating and inflation pressures are building in the economy, the Federal Reserve will be forced to counter these pressures by tightening the monetary policy to bring arise in aggregate demand below that of the economy’s capability to produce.
Would the market be better off without the Federal Reserve?
In no doubt, it is better to be without the Federal Reserve System than have dejection and inflations and financial turmoil’s and the inconveniences that are faced. There could not have been this backdoor financing of big management fighting wars in foreign countries and getting individuals to rely on the welfare state. Not any of this can take place without a Federal Reserve.
There could probably have been a much healthier economy, it would not be so flimsy. Nobody would be disquieting about currency exchange rates and persons would not be in and out of currencies and spending all their force doing what they are doing. Besides, there could not have been a condition where the Fed creates currency and hands it out at no cost and lets the banks make billions of dollars. And the underprivileged people who have given up work and have CDs get nothing and due to the depression in the cycle, which the Fed creates, citizens lose their occupations and lose their houses. There could not have been any of that.
The Federal Reserve was an unfortunate alternative for deregulation. Because the Fed had domination privileges in issuing money, it authorized them to cause unchecked price increase. By 1919, the United States Inflation rate increased to nearly 20%. Given that the Federal Reserve had domination on currency, it also had to make certain that there was sufficient currency in the market to prevent a crisis.
In conclusion, all the guides to Federal Reserve policies discussed in this paper have something to do with the transmission of financial policy to the economy. All have some advantages; but, none has publicized so consistently close a relationship with the eventual goals of monetary policy that it can be relied on alone.