Financial Markets Assignment

FINANCIAL MARKETS &038 INSTITUTIONS fitting 1. formulate how profitr pass judgment winnow out fol diminisheding major feed purchases of mortgage- cloged securities. The provide implements quantitative travel by buying financial assets of yearner maturity, e. g. , mortgage-backed securities, from commercial banks and opposite private institutions in order to inject a pre-determined quantity of money into the frugality. This is a center of stimulating the miserliness and move foresightfuler-term s invades rates further out on the yield make out quantitative temperance increases the excess reserves of the banks, and raises the prices of the financial assets bought, which turn d witnesss their yield.Graphically, this discount be explained with the aid of Figure be scummy. The supply of money is shifted from point 1 to the right wing (MS1 to MS2) and, all else equal, the new equilibrium point (with aggregate money accept curve) is at point 2, where the interest rate is overturn. i i1 i2 AD1 MS1 MS2 Quantity of gold 2. What could be the implications of lower interest rates for households and linees? By implanting the indemnity of buying mortgage-backed securities, the FED has set its sight on increase consumption and investment, which ordain ultimately increase employment.As described in question one Bernankes polity decreased interest rates to new record lows, load-bearing(a) take uping for both businesses and households. The ability to borrow money at to a greater extent attr sprightly rates stimulates investment in durable consumer goods, such(prenominal) as automobiles, and in operational necessities such as buildings and capital equipment for businesses. Indeed, after the slaying of the policy mortgage applications increased significantly.Because of low interest rates households and businesses as investors could shift their preference amodal value from bonds and into descents. According to frbsf. org, the increase in declension tr ading volume has the belief of raising the value of existing stock portfolios, which in turn stimulates consumer and spending across the country delinquent to the mental effects of rapid capital appreciation. Lower interest rates can have negative effects on the value of the local nones comp atomic number 18d to other currencies.As foreign investors dump their local-denominated investments in favor of more utile currencies, exchange rates can shift to the detriment of the local currency. The alter of the local currency serves to increase the attractiveness of local goods to foreign purchasers, which has the effect of salary increaseing exports and international sales. All of the factors mentioned above have the combined effect of increasing productive output, or GDP, and increasing employment across a unspecific range of industries.As individuals, businesses and foreign investors are encouraged to spend more due to increased access to capital, uplifteder portfolio valuati ons and weaker currency values, businesses in weedyly each sector experience an increase in sales, often requiring them to grow their trading operations and employ additional labor. However, at that place are some negative implications from this policy. Without a strong commitment to control pompousness oer the long ply, the assay of higher inflation is one potential implication of experiencing real interest rates below the prudences natural interest rate.Low interest rates provide a powerful incentive to spend quite than save. In the short term, this may non matter much, but over a longer period, low interest rates penalize savers and those who depose heavily on interest income. If short-run interest rates are low relatively to long-term rates, households and firms may overinvest in long-term assets, such as Treasury securities. If interest rates rise unexpectedly, the value of those assets leave behind fall (bond prices and yields move in opposite directions), exposing investors to substantial losses.Finally, low short-term interest rates reduce the profitability of money market funds, which are key providers of short-term credit for many (large) firms, e. g. the commercial paper market. 3. Explain the Feds policy dilemma and try to rationalize wherefore unemployment in the US is stubbornly high while inflation is low. found on the theory of the Philips curve diagram we notice that there is an inverse relationship between inflation and unemployment. Stated simply the lower the unemployment in an rescue the higher the rate of inflation.Philips Curve splashiness Unemployment The explanation of the inverse relationship between inflation and unemployment is based on two assumptions. The first has to do with the fact that as unemployment rises there is no room for workers and labor unions to demand an increase so a wage inflation that would increase the prices of the final products cannot occur. Secondly high unemployment is a reproval of the dec line in economic output and indicates an economys slowdown. consequently competition among firms in fadeout go out lead the prices at lower levels.But this is not the case currently in the US since we observe high unemployment and low inflation. The FED is concerned about the unemployment rate and in an attempt to stimulate the economy and improve the labor market conditions it started implementing the quantitative easing policy. So the FED purchased MBS, helped banks to rebuilt their balance sheets, contributed into maintaining price stability, preserved interest rates near zero for more than three years, and prevented the economy from slipping into greater recession. Despite all these efforts the situation in the labor market did not improve.Apparently the fact that unemployment is still very(prenominal) high depicts the go downations of the financial policy. The low business confidence, policy uncertainty, and the disposals reluctance to act are beyond the FEDs capacity. W hat is more the infinite use of the quantitative easing may produce undesirable effects in the long run such as stagflation. The only optimal solution under these slew is the co ordination of the FEDs monetary policy with the governments fiscal policy plan that could boost the societys confidence. . Do you think that another round of quantitative easing (QE) by the Fed would help stimulate the US economy? Please explain. The FED declared that the use of QE will be aggressively continued until the economy is improved. The cash injections into the economy helped interest rates to remain at low levels. Consequently everyone wins from this decision in the short run homeowners can borrow at historical low levels of interest rate, corporations can also take advantage of this act and invest, consumption increased and also the banks increased their remuneration and the stocks record a growth. So as long as the QE is active in the short run everyone is a winner. But in the long run things become vague. First of all historical evidence shows that scorn the fact that interest rates may be at levels near zero it remains uncertain whether this will be the incentive to boost the actual economy. Secondly the fact that consumers will have more money to spend but fewer goods to buy might lead to a hyper inflation.Furthermore by repeating the use of QE is very thinkable to lead to a liquidity trap, unless the economy finds ways to stimulate production. Last but not least the FEDs decision to inject cash into the economy by purchasing MBS is questionable Mortgage backed securities entail the hazard of defaulting once again as they did in the real estate crisis and that would comprise the Americans a lot more money repeating the history that started back in the September of 2001. To sum up the use of QE is indeed very effective but only in the short run.Short periods of economic recession can be avoided by stimulating the economy temporarily by cash injections but to maint ain growth on the real economy we need to improve labor market conditions, productivity, innovation and bolster the economys confidence. So a combination of fiscal and monetary policy is the only way to prevent an economy from collapsing, and also is this is the only way to avoid a possible systemic risk that will negatively affect all the institutions and individuals. . How is a loose Fed monetary policy in the US affecting fundamentals (such as inflation, asset and good prices) in other countries? What does that imply about ball-shaped monetary policy? Since the dollar is the vehicle currency in the global economy around every country is tied to its value and everyone is affected by the monetary decisions of the FED. By the QE, the supply of dollars is increased and consequently the dollar depreciates against foreign currencies.This means that Americas exports will increase and on the contrary the imports will decrease. So countries trading with the US fear about the capital inf lows and the possible inflation on commodities. On the other hand the FED take for that there can be no further inflation since the global economy is in recession. Moreover countries experiencing huge capital inflows resulting in inflation can implement fiscal policy, such as imposing taxes, in order to contain the effects of foreign capital inflows which push up local stock prices and the currency itself.Every country should focus on its own monetary policy adjusting it to the problems that may experience. For example the US chose to inject more money in the economy. The results of such a decision are low interest rates, more exports but always with the risk of inflation. On the other hand a country experiencing high inflation might limit the money supply, increasing the interest rates with the risk of experiencing a decline in exports.