Finance 301 1st Edition Lecture 8 Outline of Last Lecture I Mechanics of Monetary Policy II Limitations of Monetary Policy III Tradeoff in Monetary Policy IV Monetary Policy Shifts Overtime due to Trade Offs Outline of Current Lecture V VI Monitoring the Impact of Monetary Policy Global Monetary Policy VII Impact of the Crisis in Greece on European Monetary Policy Current Lecture I Monitoring the Impact of Monetary Policy a Impact on Financial Markets i Monetary policy affects the valuation of securities ii How are bonds related to interest rate movements iii How are stocks affected by interest rate movements 1 A bond is an investment for an investor and we invest in the debt of someone else We are expected to get paid those debt payments It depreciates it and goes down in value if interest rates increase Interest rates go down value goes up b Fed s communication to the markets i After the FOMC meeting the conclusion is announced through an FOMC statement c Impact of the Fed s response to oil shocks i Why is the Fed concerned about oil shocks ii Does the Fed have any control over oil prices d Impact on Financial Institutions i When interest rates rise why are banks affected very quickly in the short terms ii Why are financial institutions such as commercial banks bond mutual funds insurance companies and pension funds that maintain large portfolios of bonds hurt when the Fed raises interest rates iii Why are financial institutions such as mutual funds insurance companies and pension funds that maintain large portfolios of stocks affected by changes in interest rates 1 Want to do it slowly because of banks Banks get affected by changes in interest rates 2 Less people will apply for loans if interest rates rise too fast 3 Banks pay their debt in short term and make their money in the long term 4 Banks can fail if interest rates go up 5 Raise interest rates bonds go down in value everyone wants new bonds with higher interest rates 6 3 If they change interest rates you expect companies to make more or less money 7 Fed is very conservative they do not want to get jumpy with lowering or raising interest rates II Global Monetary Policy a Impact of the dollar i If the U S economic conditions are weak a weak dollar can stimulate the economy by stimulating U S exports and discouraging U S imports How ii If U S economic conditions are weak a strong dollar will not provide the stimulus needed to improve conditions The Fed may need to implement a stimulative monetary policy iii Weak dollar less purchasing power weak compared to other countries b Impact of global economic conditions i Because economic conditions are integrated across countries the Fed considers prevailing global economic conditions when conducting monetary policy ii The Fed s decision to lower U S interest rates during the 2008 credit crisis and stimulate the U S economy was partially driven by weak global economic conditions iii We don t always have control over the value of our currency iv FED can affect trade currency weak vs strong dollars c Transmission of interest rates i Given the international integration in money and capital markets a government s budget deficit can affect interest rates of various countries This is referred to as global crowding out III Impact of the Crisis in Greece on European Monetary Policy a Greece debt crisis defaulted on their bonds it lead to greek and european monetary policy b Greeks let their defecits get bigger and bigger raised peoples salaries 50 decided their military needed to be bigger then they couldn t raise enough tax money 1 3 of the country was self emplyeed bonds became junk bonds no one would buy the debt too much europe as a whole had to develop monetary policy to help greece c When coming out of a recession you should raise interest rates and quit spending d In the spring of 2010 Greece experienced a weak economy and a large budget deficit