UK MONEY MARKETS

UK Money Markets

UK Money Markets

Money Supply

The Fed changes the money supply according to the following principle: The lower the aggregate demand, the lower the supply, and the higher the unemployment rate. A decrease in the money supply, which can be accomplished by raising rates, will shift the aggregate demand curve to the left and move the economy to a point with low inflation and higher unemployment. This will not only keep the economy away from possible inflation, but it will also provide companies with a larger and more qualified applicant pool. Raising the Federal Funds Rate (interest rate that banks charge each other) and the Discount Rate (interest on the loans that the Fed makes to banks) will decrease the demand by banks to borrow from the Fed. This leads to the reduction in the money supply.

If the money supply within banks is reduced, then banks will raise their interest rates, which will discourage the non-bank public from borrowing, and encourage them to save. This in turn will reduce consumer spending. Inflation is at a very low point, and many economists, such as Alan Greenspan, are doubtful that it will get any lower. However, additional rate hikes might prevent the excessive overheating that many economists fear. The Federal Reserve Board made the decision to tighten monetary policy on November 16, 1999. The federal funds rate was raised 25 base points to 5.5%. The discount rate was raised 25 base points from 4.75% to 5%.

Impact Of domestic Monetary Policy

The United States, when the Federal Open Market Committee wishes to increase the money supply, it can do a combination of three things: Purchase securities on the open market, known as Open Market Operations Lower the Federal Discount Rate Lower Reserve Requirements.

These all directly impact the interest rate. When the Fed buys securities on the open market, it causes the price of those securities to rise. Bond prices and interest rates are inversely related. The Federal Discount Rate is an interest rate, so lowering it is essentially lowering interest rates. If the Fed instead decides to lower reserve requirements, this will cause banks to have an increase in the amount of money they can invest. This causes the price of investments such as bonds to rise, so interest rates must fall. No matter what tool the Fed uses to expand the money supply interest rates will decline and bond prices will rise.

Increases in American bond prices will have an effect on the exchange market. Rising American bond prices will cause investors to sell those bonds in exchange for other bonds, such as Canadian ones. So an investor will sell his American bond, exchange his American dollars for Canadian dollars, and buy a Canadian bond. This causes the supply of American dollars on foreign exchange markets to increase and the supply of Canadian dollars on foreign exchange markets to decrease. The lower exchange rate makes American produced goods cheaper in Canada and Canadian produced goods more expensive in America, so exports will ...