Finance 301 1st Edition Lecture 8Outline of Last Lecture I. Mechanics of Monetary PolicyII. Limitations of Monetary PolicyIII. Tradeoff in Monetary PolicyIV. Monetary Policy Shifts Overtime due to Trade OffsOutline of Current LectureV. Monitoring the Impact of Monetary PolicyVI. Global Monetary PolicyVII. Impact of the Crisis in Greece on European Monetary PolicyCurrent LectureI. Monitoring the Impact of Monetary Policya. Impact on Financial Marketsi. 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 marketsi. After the FOMC meeting, the conclusion is announced through an FOMC statement.c. Impact of the Fed’s response to oil shocksi. Why is the Fed concerned about oil shocks?ii. Does the Fed have any control over oil prices?d. Impact on Financial Institutionsi. 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 rates2. Less people will apply for loans if interest rates rise too fast3. Banks pay their debt in short term and make their money in the long term4. Banks can fail if interest rates go up5. Raise interest rates, bonds go down in value everyone wants new bonds with higher interest rates6. 3. If they change interest rates you expect companies to make more or less money7. Fed is very conservative they do not want to get jumpy with lowering or raising interest ratesII. Global Monetary Policya. Impact of the dollari. 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 conditionsi. 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 currencyiv. FED can affect trade/currency, weak vs strong dollarsc. Transmission of interest ratesi. 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 Policya. Greece debt crisis- defaulted on their bonds, it lead to greek and european monetary policyb. Greeks let their defecits get bigger and bigger raised peoples salaries 50%, decided their military needed to be bigger, then they couldn’t raiseenough 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 hadto develop monetary policy to help greece c. When coming out of a recession you should raise interest rates and quit spendingd. In the spring of 2010, Greece experienced a weak economy and a large budget