Fama (1981) reckoned that the elementary relationship between monetary policies and stock market is built by the changes of money supply through policies made by the government and this relationship is a negative one.
Loosening Monetary Policy:
The loosening monetary policy lessens the interest rate of the whole economy, the discount rate of stock and thus increases the expectation and income of buyers. An enlarged money supply will make an increase not only in goods consuming but also in financial assets buying, which includes stocks. When money supply increases, liquidity of stocks also rapidly goes with the same trend. However, Cooper (1974) and Nozar & Taylor (1988) asserted that there is no relation between the money supply and the stock index despite the loosening monetary policy.
Tightening Monetary Policy:
An increase in interest rate due to this policy usually negatively affects the stock market. First, it raises the operating costs of companies. Second, it reduces the needs of borrowing of investors to stocks. Third, investors are likely to invest in bonds more than stocks, making the liquidity of stocks decrease. Yet, this negative relationship does not always exist. Maysami & Koh (2000) proved that there is a positive relationship between Singapore government’s tightening the monetary policy and returns on stocks when the investors believe that the current policy can help their economy.
On the other hand, the price of stock is determined by the present value of future cash flows. The present value of the future cash flows is calculated by discounting the future cash flows at a discount rate. Money supply is significantly related to the discount rate; hence, it will affect the present value of future cash flows.
PV=FV...
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... money supply) symbolizes a weak economic situation, thus investors will demand to hold more risk premium, which makes the businesses less attractive and lower stock price.
The research of Friedman & Schwartz (1963) gives an explanation between money supply and stock returns: an increase in money supply will raise the liquidity of securities for buyers, and thus leads to a higher price of stocks. Hamburger & Kochin (1972) and Kraft (1977) also supported the claim on the relationship between these two variables in their researches; whereas, Cooper (1974), Nozar & Taylor (1988) could not find any connection between them. According to Mukherjee & Naka (1995), after studying on Indian stock market, claimed that the impact of money supply on a stock market varies in different market in different countries. Such impacts might be either positive, negative, or even a zero.
The demonstration in this research is simple and the resources are not rich enough. The query to the relevance between the monetary policy and the house bubble still has not been answered. The level of effect the monetary policy made to the financial crisis is still has not been assessed.
To fully grasp the similarities and differences of these financial crises one must first understand the circumstances that surrounded the panics. The financial panic of 1907 can be traced back to 1901, the beginning of the Roosevelt presidency, and his crusade against monopolies and big business by enacting strict anti-trust laws. Business began searching for ways around these new anti-trust laws which led them to chasing riskier profit. This activity went nearly completely unregulated, as there was no central bank at the time. Stocks suffered a period of increasing volatility stemming from multiple factors including: the April 1906 San Francisco Earthquake and the Hepburn Act, a form of regulation which depreciated the value of railroad securities and international market interest rate changes. Decreases in money supply lead financial institutions to begin deleveraging. The panic would truly begin with an attempt to corner the market orchestrated by Augustus Heinze, a copper tycoon, his brother Otto, and Charles Morse a Wall Street banker. They devised a scheme to manipulate the price of United Copper stock and gain market share. The Heinze brothers created a short squeeze where they planned to purchase the remaining shares and force short sellers to pay for their borrowed stock. They believed that this would drive up the share price of copper and force the short sellers to pay whatever price the Heinze brothers and Morse wanted. To properly pull the scheme off a large amount of financing was needed, which they looked to the Knickerbocker Trust Company for. President Charles Barney had financed Morse’s previous schemes but decided that this particular scheme was too risky. However, Barney’s denial was not enough to discourage the...
Over the past few years we have realized the impact that the Federal Government has on our economy, yet we never knew enough about the subject to understand why. While taking this Economics course it has brought so many things to our attention, especially since we see inflation, gas prices, unemployment and interest rates on the rise. It has given us a better understanding of the effect of the Government on the economy, the stock market, the interest rates, etc. Since the Federal Government has such a control over our Economy, we decided to tackle the subject of the Federal Reserve System and try to get a better understanding of the history, the structure, and the monetary policy of the power that it holds.
In normal times, the monetary authority (usually a central bank or finance ministry) can stimulate the economy by lowering interest rate targets or increasing the monetary base. Either action should increase borrowing and lending, consumption, and fixed investment. When the relevant interest rate is already at or near zero, the monetary authority cannot lower it to stimulate the economy. The monetary authority can increase the overall quantity of money available to the economy, but traditional monetary policy tools do not inject new money directly into the economy. Rather, the new liquidity created must be injected into the real economy by way of financial intermediaries such as banks. In a liquidity trap environment, banks are unwilling to lend, so the central bank's newly-created liquidity is trapped behind unwilling lenders.
This will have a bad effect on homeowners with a mortgage and small business owners due to the increase in interest rates and decreased money supply in the market. The interest rate is determined by the interaction of the demand and supply of loanable funds market. “Increases in demand will increase both the interest rate and the total amount of borrowing and lending. Decreases in demand will decrease both the interest rate and the total amount of borrowing and lending. Increases in supply will decrease the interest rate and increase the total amount of borrowing and lending. Decreases in supply will increase the interest rate and decrease the total amount of borrowing and lending”(Macroeconomics Bus 302 Lab concept 4). Therefore, when the federal reserve tightens the monetary policy, the housing mortgage supply will decrease and as a result interest rates go
In an economy recently plagued with housing market crashes and financial crisis, we can easily see the vital functions that a monetary policy has on anticipating and preventing instability in our economy. Understanding how monetary policy works and how it’s affected by either rules or discretion is crucial, and all aspects must be taken into account to establish the most effective choice for our economy.
On the other hand monetary policy is the expansionary or contraction of the money supply in order to influence the cost and the availability of credit. The three major and two minor tools that the fed can use to conduct monetary policy are easy money policy, tight money policy, reserve requirement, open market operations, and the discount rate. With the easy money policy the Fed allows the money supply to grow and interest rates to fall. This stimulates the economy when the interest rates are low people buy on cred...
In the study of macroeconomics there are several sub factors that affect the economy either favorably or adversely. One dynamic of macroeconomics is monetary policy. Monetary policy consists of deliberate changes in the money supply to influence interest rates and thus the level of spending in the economy. “The goal of a monetary policy is to achieve and maintain price level stability, full employment and economic growth.” (McConnell & Brue, 2004).
The idea of the money growth rule is contingent upon the relationship between the money supply and inflation. Therefore, the question arises whether there even is a relationship between money supply and inflation. As stated earlier, one can see a relation between money and inflation. Presented above is series data that displays this relationship between money supply and the inflation rate over the previous decades. The problem is that there are fluctuations within the data and therefore a broader definition of the money supply must be utilized. Based on the research of Dr. Terry J. Fitzgerald, an economist at the Cleveland Federal Reserve Bank, if one defines money supply as M2, when examining the data over a multiple year progression, a pattern begins to present itself. Further, by graphing the difference between adjusted money growth and inflation, the link becomes evident. These graphs show the weight that changes to the money supply can have upon an economy’s inflation rate.
The term Monetary policy refers to the method through which a country’s monetary authority, such as the Federal Reserve or the Bank of England control money supply for the aim of promoting economic stability and growth and is primarily achieved by the targeting of various interest rates. Monetary policy may be either contractionary or expansionary whereby a contractionary policy reduces the money supply, reduces the rate at which money is supplied or sets about an increase in interest rates. Expansionary policies on the other hand increase the supply of money or lower the interest rates. Interest rates may also be referred to as tight if their aim is to reduce inflation; neutral, if their aim is neither inflation reduction nor growth stimulation; or, accommodative, if aimed at stimulating growth. Monetary policies have a great impact on the economic stability of a country and if not well formulated, may lead to economic calamities (Reinhart & Rogoff, 2013). The current monetary policy of the United States Federal Reserve while being accommodative and expansionary so as to stimulate growth after the 2008 recession, will lead to an economic pitfall if maintained in its current state. This paper will examine this current policy, its strengths and weaknesses as well as recommendations that will ensure economic stability.
In turn everything in the present and the future is judged through the stocks as they hold a high importance in industrialized economies showing the healthiness of said countries economy. As investing discourages consumer spending over all decreases, it lead...
Money supply is the availability of money in the hands of the public (economy) that can be used to purchase goods, services and securities. In macroeconomics, the price of money is equivalent to the rate of interest. There's an inverse relationship between money supply and interest rates. As money supply increases, interest will decrease. On the other hand, interest will increases as money supply decreases. It is very important to understand that the economy works at market equilibrium. There are several factors affecting money supply; and these contributing factors will be the main focus of this paper. Understanding the basic principle on money supply is imperative to have a good grasp on the macroeconomic impact of money supply on business operations.
the empirical relations based on the VAR test conducted for the period 1990 to 2009 show that, Money supply and inflation are weakly positively correlated, Money supply and interest rates are very weakly and negatively correlated, Money supply and real GDP are strongly positively correlated, Money supply and nominal GDP are very strongly negatively correlated. Furthermore, the response of inflation to shocks in money supply is very weakly positive or has no effect since it is constant through out. This indicates that the relationship between money supply and inflation is not too significant.
Primarily, financial managers look at the market price in maximizing the value of the firm. The market value is the present value of the net cash flow divided buy the risk. Investors consider the firm’s future and present earnings, disadvantages or risks and other factors that will influence a firm prior to deciding to create an investment decision and the market price of the stock that will reflect all the information considering these factors (Arain, 2011).
Following the trend of economy, it is important to investors to understand that strong economy creates strong stock market. To elaborate further, as stock prices are increased by current and future expectations of earnings, thus without a strong economy it would be difficult for the companies to increase and sustain their earnings (Kong 2013). The economy development is usually calculated using the gross domestic product of a countries. On the other hand, a change is the stock price can also cause a major impact to the consumers and investors directly. Hence, a loss in confidence by investors can cause a downturn in consumer spending in the long term, which will also affect the economy’s output (Aysen 2011). The graph below shows the relationship of stock market price (KLCI) and the GDP of Malaysia in 2009. Thus, it can be concluded that the economy and the stock market has a positive relationship.