Lecture 4: The Financial Market
MIT OpenCourseWare・2 minutes read
Interest rates are influenced by central banks through the money supply, with central bankers like Jerome Powell playing a crucial role in setting policy rates. Monetary policy, conducted through open market operations, aims to affect people's portfolio holdings towards more money and fewer bonds, ultimately impacting interest rates.
Insights
- Central banks, like the Federal Reserve, play a pivotal role in determining interest rates through monetary policy adjustments, such as expanding the money supply to lower interest rates or contracting it to raise them. This process involves open market operations, where bonds are bought or sold to impact the equilibrium between money and bond markets, ultimately influencing interest rates.
- The interaction between central banks, financial markets, and interest rates is a complex yet transparent process aimed at balancing money supply and demand. Interest rates have a profound impact on individuals' portfolio decisions, with high rates favoring bond investments over holding money for transactions. As interest rates rise from historically low levels, the strategic allocation between equities, cash, and bonds becomes increasingly significant for investors seeking stable returns.
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Recent questions
How do central banks influence interest rates?
Central banks adjust money supply to change interest rates. They conduct open market operations, buying or selling bonds to impact the money and bond market equilibrium.
What is the role of the Federal Reserve System?
The Federal Reserve System in the US consists of the Board of Governors and 12 regional banks. The FOMC within the system sets policy interest rates, crucial for managing short-term output.
Why do individuals choose between money and bonds?
Individuals decide between money and bonds based on transaction needs and interest rates. In a high-interest rate environment, investing in bonds is more beneficial than holding money for transactions.
How do expansionary monetary policies affect interest rates?
Expansionary monetary policies involve increasing the money supply, leading to a decrease in interest rates. Central banks conduct open market operations to buy bonds and provide cash, influencing interest rates.
What is the relationship between bond prices and interest rates?
The relationship between bond prices and interest rates is inverse. When bond prices rise, interest rates decrease, and vice versa. Expansionary open market operations increase demand for bonds, driving up prices and lowering interest rates.
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