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Interest Rates Financial Markets and Monitory Policy

   

Added on  2021-05-30

12 Pages3139 Words472 Views
Running Head: Interest RatesFinancial Markets and Monitory PolicyBy (Name)(Tutor)(University)(Date)

Interest Rates2Table of ContentsIntroduction......................................................................................................................................3Part A...............................................................................................................................................4Demand for Loanable Funds........................................................................................................4On the Supply Side of Loanable Funds.......................................................................................4Government Budget Deficit.............................................................................................................6Justification......................................................................................................................................7Part B...............................................................................................................................................8Recommendation and Justification..............................................................................................8Part C...............................................................................................................................................8Relationship between UK and US...............................................................................................8A Raise in the Level of Interest Rates by the UK in UK.............................................................9Effect of Higher Interest Rates in the UK on the US.................................................................10Justification................................................................................................................................10Bibliography..................................................................................................................................12

Interest Rates3Financial Markets and Monitory PolicyIntroductionThere are various factors that affect the level of interest rates in an economy. They include the state of the economy, inflation levels, government spending and money supply in the economy to name just but a few. When the economy is experiencing growth it means there is a heightened economic activities in the economy. This economic boom attracts more and more investors in the economy investing. This leads to an increased demand for funds in the loanable funds market which leads to higher interest rates demanded by lenders to increase the money supply. However, the relationship between interest rates and economic growth is a two-way street as each can affect the other’s direction. Inflation eats into earnings as it lowers the real value of earnings. With rising inflation lenders are forced to raise interest rates to keep up with the rising inflation (Schneider, 2017). This is because every rise in the inflation level translates into a loss in value in the sense that with inflation the amount of goods one could have purchased with say $500 is reduced. In the money market higher inflation tends to lower the real interest rate they thus need to revise the rates to maintain their profitability. The government through the Federal Reserve can also influence the level of interest rates through manipulation of the money supply. The Federal Reserve manipulates the money market in an effort to regulate economic growth in the country, consequently regulating unemployment and inflation in the state. When inflation is growing rapidly and with negative effects on the economy, the Federal Reserve in order to reduce the money supply in the economy raises the rateat which they lend out money (Koziol, 2012). This in turn leads to higher rates charged by borrowers from the Federal Reserve to the households and businesses. This higher interest rate deters more borrowing thus reduced money supply.In this case however, economic growth being stagnant, inflation being expected to remainconstant, the level of saving not changing and the Federal Reserve not expected to change the existing supply of loanable funds they are thus non factors. Therefore we shall stress on reduced government spending and the effect of a foreign interest rate change in determining the level of interest rates in the US economy.

Interest Rates4Part ADemand for Loanable Funds Lower interest rates encourage consumers to borrow more to finance their purchase of durable commodities such as televisions. Lower interest rates also entice firms to acquire and hold more capital. This is because the capital is now acquired cheaply and the projected income from that acquisition remains unchanged thus a higher NPV as compared to if the acquisition is made at a higher interest rate. Therefore, the lower the interest rates, the greater the demand for loanable funds. The reverse is also true. As a result, the demand for loanable funds curve is downward sloping as illustrated below.Fig: Demand for loanable funds Interest Rate ii I0DLFqiq0 Quantity of Loanable fundsOn the Supply Side of Loanable Funds.The main tool used by the Federal Reserve to manipulate interest rate is through the setting of the target federal funds rate. Banks are required to keep a certain amount of capital anddeposit with the Federal Reserve Bank known as federal funds. The federal funds vary depending on the banks outstanding loans and deposit.it is acceptable for banks with excess reserves to loan those that run short. The rate at which these loans are made out depends on the current target federal funds rate. This funds rate forms the base upon which interest rates are

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