Financial Markets Assignment
FINANCIAL MARKETS & INSTITUTIONS ASSIGNMENT
1. Explain how interest rates decline following major Fed purchases of mortgage-backed securities.
The FED implements quantitative easing by buying financial assets of longer maturity, e.g., mortgage-backed securities, from commercial banks and other private institutions in order to inject a pre-determined quantity of money into the economy. This is a means of stimulating the economy and lowering longer-term interest rates further out on the yield curve; quantitative easing increases the excess reserves of the banks, and raises the prices of the financial assets bought, which lowers their yield. Graphically, this can be explained with the aid of Figure below. The supply of money is shifted from point 1 to the right (MS1 to MS2) and, all else equal, the new equilibrium point (with aggregate money demand curve) is at point 2, where the interest rate is lower.
i i1
i2 AD1
MS1
MS2
Quantity of Money
2. What could be the implications of lower interest rates for households and businesses?
By implanting the policy of purchasing mortgage-backed securities, the FED has set its sight on increasing consumption and investment, which will ultimately increase employment. As described in question one Bernanke’s policy decreased interest rates to new record lows, encouraging borrowing for both businesses and households. The ability to borrow money at more attractive rates stimulates investment in durable consumer goods, such as automobiles, and in operational necessities such as buildings and capital equipment for businesses. Indeed, after the implementation of the policy mortgage applications increased significantly.
Because of low interest rates households and businesses as investors could shift their preference away from bonds and into stocks. According to frbsf.org, the increase in stock trading volume has the effect of raising the value of existing stock portfolios, which in turn stimulates consumer and
1. Explain how interest rates decline following major Fed purchases of mortgage-backed securities.
The FED implements quantitative easing by buying financial assets of longer maturity, e.g., mortgage-backed securities, from commercial banks and other private institutions in order to inject a pre-determined quantity of money into the economy. This is a means of stimulating the economy and lowering longer-term interest rates further out on the yield curve; quantitative easing increases the excess reserves of the banks, and raises the prices of the financial assets bought, which lowers their yield. Graphically, this can be explained with the aid of Figure below. The supply of money is shifted from point 1 to the right (MS1 to MS2) and, all else equal, the new equilibrium point (with aggregate money demand curve) is at point 2, where the interest rate is lower.
i i1
i2 AD1
MS1
MS2
Quantity of Money
2. What could be the implications of lower interest rates for households and businesses?
By implanting the policy of purchasing mortgage-backed securities, the FED has set its sight on increasing consumption and investment, which will ultimately increase employment. As described in question one Bernanke’s policy decreased interest rates to new record lows, encouraging borrowing for both businesses and households. The ability to borrow money at more attractive rates stimulates investment in durable consumer goods, such as automobiles, and in operational necessities such as buildings and capital equipment for businesses. Indeed, after the implementation of the policy mortgage applications increased significantly.
Because of low interest rates households and businesses as investors could shift their preference away from bonds and into stocks. According to frbsf.org, the increase in stock trading volume has the effect of raising the value of existing stock portfolios, which in turn stimulates consumer and