The United States (US) financial market is a complex system of macroeconomic policies and varying industry dynamics. Several federal policies, federal regulations, and economic factors influence this system. This paper explores the complexity of the US financial system by demonstrating how exchange rates and interest rates affect the financial market. By extension, this document also elaborates the role of the Federal Reserve in the financial market and its effect on the economy.
How US Financial Market Affects the Economy
The relationship between the US financial market and the economy is very profound. A properly functioning financial market plays a significant role in maintaining the health of the economy. Researchers who have studied the impact of financial market growth on economic performance say that financial markets have a positive impact on the economy (Alvarez & Atkeson, 2008).
The impact of financial markets on economic performance stems from the creation of efficient models of investments that vary the price of credit and investments. This way, financial markets provide businesses and individuals with an array of products and services that meet their needs (thereby saving them the hassles of incurring search and transaction costs) (Alvarez & Atkeson, 2008).
Role of US Federal Reserve
The US Federal Reserve plays an instrumental role in maintaining the country’s financial system. At the helm of the Federal Reserve is the chairperson of the Federal Reserve. The chairperson appoints the board members of the Federal Reserve (Melicher & Norton, 2011). The main role of this board is to analyze the domestic and international economic environment, to understand how the prevailing macroeconomic dynamics affect the country’s economy.
The president, subject to the approval of Congress, appoints the chairperson of the Federal Reserve. The chairperson later reports to Congress regarding the activities of the Federal Reserve and advises Congress on serious macroeconomic matters (Melicher & Norton, 2011).
Based on the functions of the chairperson of the Federal Reserve and its board, the Federal Reserve is the banker of the US government and a regulator of the country’s financial system. This role requires that the Federal Reserve controls the country’s financial institutions by ensuring that they comply with existing banking, consumer, and other relevant laws (Melicher & Norton, 2011). This way, the Federal Reserve protects the economy by maintaining steady prices and lowering unemployment levels (Alvarez & Atkeson, 2008).
The 2008/2009 financial crisis exemplified the role of the Federal Reserve as the banker of the US government. During the crisis, the Federal Reserve maintained a low interest rate to jumpstart the economy after the crisis slowed it down. Slowly, the economy has been recovering because of increased money supply through Federal intervention. The Federal Reserve therefore has an immense power to influence the country’s financial system, either positively or negatively
Interest rates normally have an impact on the supply of money in an economy. High interest rates are synonymous with a low supply of money, while low interest rates are synonymous with a high supply of money. Low interest rates may lead to increased investments because people will have more money to spend.
However, a high interest rate means that it will be more expensive for people to get credit, thereby reducing their power to invest. Low interest rates therefore have a positive impact on the economy because they increase investments. The same outcome is true for the global financial market because low interest rates increase the amount of money for investors to undertake more investment projects. Similarly, a high interest rate would mean that the investors do not have cheap access to credit and therefore, they would be less willing to undertake investment projects (Alvarez & Atkeson, 2008).
Nonetheless, there needs to be a careful balance between the supply of money in the economy and the supply of goods and services because an overwhelming increase of money supply (brought by low interest rates) may overwhelm the supply of goods and services, thereby leading to inflation (Alvarez & Atkeson, 2008).
Exchange rates have a very profound impact on global business. Therefore, businesses that intend to participate in the global financial market need to be aware of the prevailing exchange rates since they affect bottom-line operations (Alvarez & Atkeson, 2008). Countries that have weak currencies are often desirable markets for investments because it is cheaper to invest in such countries, as opposed to countries that have a strong currency because strong currencies make it more expensive to buy goods, services, and labor.
Many multinational companies have exploited the opportunities that exist in exchange rate variations by outsourcing some of their production processes to countries that have a weaker currency. For example, Apple Inc. has exported some jobs to China because China has cheaper labor than America (Rawson, 2013). From this understanding, multinational companies cannot ignore the impact of exchange rates on global business.
After weighing the findings of this paper, exchange rates and interest rates surface as key macroeconomic tools for economic stabilization. These tools also affect global trade and financial markets. The Federal Reserve stands at the pinnacle of this system as it plays the role of the regulator. The chairperson of the Federal Reserve and its board mainly coordinate its roles. Comprehensively, the financial market system intertwines with the economy as one giant system. This system is pivotal to the economic health of the country.
Alvarez, F. & Atkeson, A. (2008). If Exchange Rates are Random Walks, Then Almost Everything We Say about Monetary Policy Is Wrong. Quarterly Review, 32(1), 2-9.
Melicher, R., & Norton, E. (2011). Introduction to Finance: Markets, Investments, and Financial Management. London: John Wiley and Sons.
Rawson, C. (2013). Why Apple’s products are ‘Designed in California’ but ‘Assembled in China.’ Web.