Complexity of the US Financial System

Michelle Bates

Professor: Ahmad Zia Rawish

Strayer University

May 6, 2015

Principle of Finance 100

Complexity of the US Financial System
How does the US financial market impact the economy? The financial market has different financial products including derivatives, bonds, and stocks among others. Derivatives are very complicated financial products that gain value from stocks and bonds (Altig, Christiano, Eichenbaum & Linde, 2011). These financial products are futuristic in the sense that they are based on future investments. Their effect on the economy is that they reduce its volatility.
How does the US financial market impact business? One of the most significant impacts of financial markets on businesses is access to credit (Garbade, 2014). When the financial markets are not doing well, the general access to credit for businesses is also affected. Banks and financial institutions reduce their lending rates as a precautionary measure to avoid defaulters. As a result, businesses cannot get access to loans hence impeding their ability to continue running and expanding.
How does the US financial market impact individual? When the financial markets are failing, the borrowing rates increases while the number of investors reduces (Garbade, 2014). Due to the raised borrowing rates, the prices of commodities go up reducing individuals’ purchasing power. As the prices go up, people are left with less money to use on other expenses. This prompts them reduce their expenses especially on luxury products hence compromising on their standards of living.
Roles of the US Federal Reserve The US Federal Reserve is the central bank of the United States and it was created by the congress (Garbade, 2014). The main purpose of the Federal Reserve is to give the nation a safer and more flexible financial system (Garbade, 2014). The Federal Reserve is tasked with the mandate of creating a stable financial system that promotes sustainable economic growth in the country (Garbade, 2014). Over the last decade, the Federal Reserve has been effective in its roles. It provided the nation with trillions of dollars in an attempt to support and boost the economy to recover from the financial crisis in 2008/2009 (Garbade, 2014).
Roles of the US Federal Reserve’s chairman The Federal Reserve chairman is responsible for guiding the Federal Reserve’s open market committee (Duygan‐Bump, Parkinson, Rosengren, Suarez & Willen, 2013). This is the committee that sets and creates the Federal Reserve’s policies that govern the short and long term interest rates (Duygan‐Bump et al., 2013). Even though his or her vote is one among the 12 possible votes, he or she sets and moderates the schedules of the committee’s meeting (Duygan‐Bump et al., 2013). The chairman is the ultimate authority in any matters arising within the Federal Reserve. Recently, the effectiveness of the Federal Reserve has been under scrutiny especially after the 2008/2009 economic crisis.
Roles of the US Federal Reserve’s board The board of the Federal Reserve makes major decisions regarding the US’s monetary policies (Ilbas, 2012). They supervise the functions of the Federal Reserve and they also get involved in the creation of critical banking and consumer-credit regulations (Ilbas, 2012).
How do interest rates influence the US’s financial environment? When the interest rates set by the Federal Reserve are high, the banks increase their lending rates. The rise in the rates of borrowing reduces investments and therefore economic activities in the US are reduced. High interest rates reduce investments and vice versa.

How does the interest rates influence the Global financial environment? Globally, interest rates have the same impact as discussed above. When the banks lending rate increases, investments stall and vice versa. In fact, high interest rates may lead to inflation as the prices of goods and services escalate.

References

Altig, D., Christiano, L. J., Eichenbaum, M., & Linde, J. (2011). Firm-specific capital, nominal rigidities and the business cycle. Review of Economic Dynamics, 14(2), 225-247.
Duygan‐Bump, B., Parkinson, P., Rosengren, E., Suarez, G. A., & Willen, P. (2013). How Effective Were the Federal Reserve Emergency Liquidity Facilities? Evidence from the Asset‐Backed Commercial Paper Money Market Mutual Fund Liquidity Facility. The Journal of Finance, 68(2), 715-737.
Garbade, K. (2014). Direct purchases of US Treasury securities by Federal Reserve banks. FRB of New York Staff Report, (684).
Ilbas, P. (2012). Revealing the preferences of the US Federal Reserve. Journal of Applied Econometrics, 27(3), 440-473.