Money & Capital Markets 1

Introduction:

Monetary policy influences the economy wide demand for goods and services, inflation and thus

the demand for the worker who formulate those goods and services primarily through its

authority on the financial conditions facing Organizations and households. Right through normal

times, the Federal Reserve has influenced primarily on overall financial conditions by regulating

the rate of federal funds, the rate that banks arraign among them for short-term advances.

Movements in the rate of federal funds are passed on to other short-term interest rates that

manipulate borrowing costs for households & other organizations. Changes in short-term rate of

interest also affect long-term interest rates as a whole, such as residential mortgage rates and

corporate bond rates because those rates imitate, among other factors, future values of the current

and expected short-term rates. In addition, alteration in long-term interest rates affects prices of

other asset, most notably in foreign exchange and equity prices. All else being identical, decrease

in interest rates may tend to raise equity prices as investors discount the rate of future cash flows

associated with equity.

As return, these financial conditions changes impinge on economic activity. As an example,

when long-term & short term rate of interest decreases, it becomes inexpensive to borrow, so

households are highly willing to purchase goods and services and organizations are in a healthier

position for the expansion of their businesses, such as assets and paraphernalia. Organizations

counter to these augments in total (business and households) squandering by employing more

members of staff and speeding up their production. As an outcome of these factors, increase in

the wealth of households observed, this causes more frittering than usual. From monetary policy

to production and their linkages and employment don't be evidence for on immediate basis and
 Money & Capital Markets 2

are affected by a range of aspects, which precisely makes things difficult to measure the effect on

the economy by monetary policy.

Monetary policy furthermore has a significant impact on inflation. The reduction in the rates of

the federal funds do outcomes stronger goods and services demand that in contingent directly to

a higher cost of other things and wages, imitating the enhanced requirement for materials and

workers that are essential for manufacturing. Furthermore, policy plan can affect the economy

expectation that how it should be performing in the future, which includes expected wages and

prices, and such anticipation, can unswervingly influence contemporary inflation.

Since past couple of years, the rate of short term interest incapable to fall much further as it’s

already at zero and thus, the Federal Reserve has commenced measures which are nontraditional

for a monetary policy just to provide greater support to the economy. Different government

subsidized ventures’ long-term mortgage backed securities and notes issued have also been

acquired by the Federal Reserve in addition, it has also acquired Treasury bonds and notes.

These purchases have been made primarily to decrease the level of interest rates for longer term,

thereby recovering financial state. This monetary policy which may seem nontraditional but

functions through the same extensive ways as traditional policy, ignoring the differences which

may have occurred in the policy implementation. (Federal reserve, 2011)

There are four main channels credit, interest rates, exchange rates, and wealth through which

central banks use monetary policy to influence the supply and demand for goods, services, and

labor. By altering monetary policy or changing public expectations about prospect monetary

policy, a central bank influences the volume of bank lending, the exchange rate, asset prices, and

the supply of money in the economy. (Bhattacharyya, 2012)

The monetary policy performs a steady role in enhancing economic development and growth

through various methods. Since, the extent of such a task may be limited by the synchronized

pursuit of other essential objectives of monetary policy, its nature and its conduction mechanism,

and through certain other aspects, including the vagueness facing policy architects and the

deportment of economic strategies. (Ruben, July, 2010)

Central banks in the region of the world have set a standardized monetary policy as they become

conscious that a decreasing rate of inflation is entirely critical for achieving other significant

objectives, like healthy employment markets, sustainable economic development, and financial

steadiness. (Pianalto, 2011)

Conflict in the current monetary policies of State banks can be seen and may vary at certain

stages. As one Central Bank may choose a lower interest rate while the other agreed for higher

interest rate. Unemployment rate, growth and development may be affected with certain

measures taken by the Central Banks and depending upon the current conditions of their country.

The Federal Open Market Committee (FOMC) is responsible for open market operations. Open

market operations, and dealt in trading of Treasury bills and federal agency. The primary tool of

implementing strategies of monetary policy is securities that are the Federal Reserve's principal

tool. Depository institutions provide balances at the Federal Reserve to other depository

institutions overnight at different interest rate at which depository institutions lend balances at.

The monetary and financial condition in turn, affects the interest rate which ultimately has direct

effect on output, employment and the level of prices as a whole. (Edwards)

Other key Central Banks perform such operations by lending to Government and by borrowing

from other commercial banks. Central Banks also rotate Treasury Bills, commercial paper, other
 Money & Capital Markets 4

securities for the circulation of money and balancing the money market operations by such

methods. Recent Open Market Operations by Reserve Bank is named as System Open Market

Account (SOMA), managed by the Federal Reserve Bank of New York, contains currency

denominated assets which are acquired via operations by open market. These securities provide

three purposes:

Firstly, collateral for reserves and U.S. currency that are in circulation that shows up as liability

in Federal Reserve’s accounting books, for the Fed’s management of reserve balances it can be

considered s a tool and lastly in the event an emergency need, a store of liquidity when needed.

(NewYork, 2012)

Federal Reserve System consists of current structure that has three major components instituted

by the original act. A Board of Governors which supervises the entire system and has

accountability for monetary policy. A total of 12 regional Federal Reserve Banks has been made

accountable, which are responsible for the administering and examining of commercial banks

that are Fed members. Lastly, the member banks, all state-chartered and national banks that opt

to be member of the system make up the last component. (Smale, November, 2010) While

Central Bank of England comprises of different teams who look after their different Banking and

other operations like,

The Monetary Analysis (MA) divisions are liable to provide their analytical feedback at

economy to the Banks and tend to release its monetary policy responsibilities.

Markets have main function in the area of sterling money. Conducting operations in the market

to implement the decision provided by the Committee for Monetary Policy. It also provides the

banking system liquidity insurance.

Financial Stability area is dependent upon the numerous Banks’ financial stability functions. It

works with critical authorities like HM Treasury and the FSA under the MOU, and working with

other senior officials, it offers support to the provisional committee for Financial Policy.

Central Services Divisions includes a variety of sustaining functions that shows the Bank's

activities and helps in ensuring the Bank’s reputation. These include various departments of the

Banks, i.e. the Governors' private offices, IT, business continuity, legal services and other depts.

Like Finance, Internal Audit, Communications etc. (England)

The reason for U.S. money supply needs to be discussed, when recently the Federal Reserve did

trading of Treasury bonds and the ways it affected U.S. banks’ abilities to loan and the U.S.

economy. The economy is injected with money directly through open market operations that

attracts borrowers to pay back their previous liabilities and apply for new credit. This made

practically possible by acquiring government securities by the Federal Reserve, like bonds from

external sources. Hence, a speculation mechanism is made and only on paying an interest of only

50 dollars per year, a $1000 government bond could deprived the economy, in theory, it can be

converted back into a thousand dollars again. Since the Federal Reserve have the authority to

balance the incurred liabilty of buying as many government securities as it likes against their

value, or, tobe precise, with what it has bought, it pays for what it has bought.

The buying of government securities by theFederal Reserve with money it never had with him.

Such transactions are known by Bankers as magical and alchemy; they are legal for Federal

Reserve but certainly if practiced by a private enterprise they be considered illegal.

The biggest fact is that the Federal Reserve is a massive buyer of government securities.

Therefor the demand is undoubtedly outpaced by supply which expectedly creates additional
 Money & Capital Markets 6

money than subsist. The Federal Reserve pay off its bills by printing money and disburses for

bonds without withdrawing its own reserves. Thus the original cause of inflation is expediently

concealed. The speculative trading of government securities has heavily incomed the Federal

Reserve that the the largest financial market in the world is particularly 'government securities

market'. (Porter)

The essential function of the global economic structure is to allot scarce resources like, capital to

their most highly valued use, labor, land, management skill, and fabrication of the goods and

services as and when needed by the public. What most of us enjoy today as high standards of

living is dependent The high standard of living most of us enjoy today depends on the knack of

the global economy which must turn out everyday with a massive volume of basic needs that are

essential for normal and for modern living. Due to scarce resources, this task is very much

complexed because procurement of scarce resources should be in accurate amounts so that such

can be provided with the materials of manufacturing and coalesced at just the perfect time with

capital to generate the products and services, labor, management as and when required by end

user. In short, each system must merge inputs like natural resources, management skills, land,

labor and capital equipment to produce output, goods and services. A flow of production is

generated in return for a flow of payments by global economy. (perspective)

The demographic transition of most emerging and many developing economies that

accompanied slower population growth supported greater capital intensity and fasterper capita

growth. At the same time, many of these countries enjoyed a golden age as the ratio of the

economically active to the total population peaked. Meanwhile, the share of the aged increased

significantly in the advanced economies, particularly in Europe and Japan. (Dervi, 2012)
 Money & Capital Markets 7

The most recent surge in financial services growth began with the cyclical rate cuts that started at

the beginning of 2001. During this cycle, the effective federal funds rate fell to 1% by mid-2003,

where it remained until mid-2004. Despite a series of ensuing rate increases by the US Federal

Reserve, forward rates remained relatively low for a sustained period, reflecting investor

expectations for a continued low rate environment. As a result, indicators of financial risk, such

as the spread between rates on 3-month Treasury bills and 3-month LIBOR, declined sharply.

The major strategies of the

international banks were

supported by a firm belief in

capitalist markets, self-

regulation and small

government. The financial

services sector of U.S. saw

major deregulation, most

notably the rescind of US

Glass-Steagall Act, which

until 1999 had prohibited

bank holding companies from owning broker-dealers. Another significant event was the 2004

amendment of the net capital rule for investment banks with assets over US$ 5 billion. This

change allowed the banks to use their own risk management systems to compute capital

requirements, effectively shifting certain oversight responsibilities from the Securities and

Exchange Commission (SEC) and European Union regulators directly onto the banks

themselves.
 Money & Capital Markets 8

Conclusion:

Federal Reserves and the other central Banks Monetary policy has emerged in the controlling of

their money supply, economic growth, sustainability and employment related matters. The fact

that the Money Markets take part in and perform a vital task in the economic progress of the

countries and these monetary policies are issued with broader focus over the future and its

related consequences with reference to population, demographical changes and other material

impacts that may differ country to country but certainly has a vital role in economical growth.
 Money & Capital Markets 9

References:

Bhattacharyya, N. (2012). ILO Asia-Pacific Working Paper Series. Thailand: International

Dervi, K. (2012). Finance & Development. THE INTERNATIONAL MONETARY FUND.

Edwards, C. L. (n.d.). Open Market Operations. Retrieved October 19, 2012, from Board of
Governance of the Federal Reserve System:
http://www.federalreserve.gov/pubs/bulletin/1997/199711lead.pdf

England, B. o. (n.d.). Structure. Retrieved October 19, 2012, from Welcome to the Central Bank
of the United Kingdom:
http://www.bankofengland.co.uk/about/Pages/structure/default.aspx

Federal reserve. (2011, November 2). Board of Governors for the Federal Reserve System.
Retrieved October 19, 2012, from http://www.federalreserve.gov/faqs/money_12856.htm

NewYork, F. R. (2012, October 10). System Open Market Account Holdings. Retrieved October
19, 2012, from Federal Reserve Bank of NewYork:
http://www.newyorkfed.org/markets/soma/sysopen_accholdings.html

perspective, T. G. (n.d.). Functions and Roles of Financial Institutions and the Market. Retrieved
October 19, 2012, from The Global Financial System in perspective:
http://highered.mcgraw-hill.com/sites/dl/free/0078116856/846499/Sample_Chapter.pdf

Pianalto, S. (2011, April 7). Current Issues in U.S. Monetary Policy . Retrieved October 19,
2012, from Federal Reserve Bank of Cleveland:
http://clevelandfed.org/For_the_Public/News_and_Media/Speeches/2011/Pianalto_20110
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Porter, G. (n.d.). THE US FEDERAL RESERVE SYSTEM. Retrieved October 19, 2012, from
http://www.converge.org.nz/pirm/fr_paul.htm

Ruben, M. (July, 2010). Monetary Policy and Motivations. Restraining the Fed: Monetary
Policy, Political Control and the Economic Crisis in the US , 1-2.

Smale, P. (November, 2010). Structure and Functions of the Federal Reserve System.
Congressional Research Service , 1.

WYMAN, O. (2009). The Future of the Global Financial System. World Economic Forum.
Geneva: @ 2009 World Economic Forum.