Financial Market and Monitory Policy
Added on 2021-06-18
16 Pages3531 Words128 Views
Running head: FINANCIAL MARKET AND MONITORY POLICYFinancial market and monitory policyName of the studentName of the universityAuthor Note
1FINANCIAL MARKET AND MONITORY POLICYTable of ContentsAnswer 1:...................................................................................................................................2Answer 2:...................................................................................................................................8Answer 3:.................................................................................................................................10References:...............................................................................................................................14
2FINANCIAL MARKET AND MONITORY POLICYAnswer 1:It has remained an important but controversial concept among economists todetermine rate of interest. For this, two main concepts are liquidity preference theory ofKeynes and bond market theory. According to Keynes, interest rate is a monetaryphenomenon (Palley 2017). Figure 1: Liquidity preference theoryOn the other side, loanable funds theory is an extension of classical theory, where thisinterest rate is determined with the help of savings and investment. The loanable funds theoryis based on the market interest rate (Taylor 2017). According to this theory, demand andsupply of loanable funds determine the market interest rate. The concept, loanable fundincludes all types of credit like loans, savings deposits and bonds. In business cycle, an economy experiences natural fluctuation between two periods,which are, expansion and contraction. Expansion implies economic growth and contractionimplies recession (Garin, Pries and Sims 2018). This business cycle can be influenced byvarious factors, which are gross domestic product (GDP), levels of employment, consumerspending and interest rates. During expansionary period, economy faces rapid growth andconsequently interest rate becomes low. Moreover, within this phase, production increases
3FINANCIAL MARKET AND MONITORY POLICYand inflationary pressure occurs within the concerned economy. On the contrary, duringcontractionary period, economic growth decreases further.The given scenario has stated that in U.S.A, economic growth has remained high forthe last two years though in next year this rate may become stagnant. As a result, borrowingof the country may decrease further and this in turn can lead the demand for loanable funds todecrease (Blanchard, Furceri and Pescatori 2014). On the other side, stagnant economicgrowth implies a contractionary period in business cycle. During this phase, investment of thecountry can decrease. Moreover, lack of supply in bond market can increase the price of it infuture and interest rate falls again. Thus, in this situation supply curve may shift to left. Thiseconomic phenomenon is represented below. Due to economic growth, demand for bond can increase the price of it in bond market.This in turn can decrease the interest rate further. Lower interest rates help to increase thequantity of investment demanded. However, in the U.S.A, due to stagnant economic growth,the country can decrease its profitability, which in turn can decrease the investment of thecountry. As a result, aggregate supply of bonds decreases further from S0 to S1 and this leadsthe price of bonds to increase, that is, from P0 to P1 and interest rate to fall from i0 to i1. Thisphenomenon can be explained with the following figure.
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