Monthly Archives: March 2013

Foreign Investment – Why Invest In Foreign Stock?

It feels very different and influencing when you have foreign stocks. These foreign stocks are being purchased for the sake of having money and the actual purpose behind having this investment is to earn profit. An investor with the foreign stocks finds an opportunity to have more money by capitalizing the different market fluctuations across the world. These stocks facilitate the investors to shun the national markets at the time when these markets are not behaving well.

What is Diversity?

If an investor has diversity in his investment then he can surely avoid the risk of losing money. If an investor possesses the stocks of numerous companies and one of these companies decline then he may have to suffer less loss. But it is a fact that many companies are dependent on each other with in a nation. So it is recommended to have stocks of both foreign and local companies to reduce the risk of investments because diversity in investments lowers down the risk. Investors can have positive rate of return by having their foreign investments in case when the national investments or stocks are facing downward trend.

What are called emerging markets?

When the economy of some certain countries faces a rapid growth, the local businesses get the benefits and profits from this growth. Local businesses can easily understand the demands and the desires of the people and they can supply the goods and the services according to the demand of the people. It is a fact that the most widely used products in a country may be the imported ones but the local transportation and facilities are required to deliver these products to the people. It has been observed that the foreign stocks of the domestic companies generally provide the higher returns. But the investors should take proper care while investing in the stocks of the rapidly growing economies because it has been observed that the countries with such economies have unstable governments.

What is regarded as Potential Growth?

It is a matter of fact that the countries with the minor economies have great potential to grow and progress as compared to the larger ones like U.S. The investors who do not prefer to invest in such smaller economies, they restrict their profit potential no doubt. It can be risky to invest in different foreign stocks no doubt but it is also a fact that there are many economies that have stable governments and they offer the appropriate profits.

What is called Regional Economic Cycle?

Foreign investments are also preferred to get the benefit of the regional economic cycles. It is a time when the economies of the planet are largely dependent on each other but still the regional differences take place. We can understand it with one example. If a natural calamity happens in one part of the world, it would definitely increase the demand of the building products. The local economy will be affected the most in such case. Such type of events can produce the opportunities of selling and buying of different stocks.

Foreign Investment In The United States

Now days it is a matter of concern that whether the issue of global imbalances will solve or not. Some researchers have a view that this system of global imbalance will not continue because US will definitely stabilize its external debt ratios and the adjustments will be made too. Amongst one of these adjustments, there will be downfall of dollar whereas some people claim that this system will continue for some specific period of time. This is due to some factors that create value for U.S. assets and make them more attractive.

A question often arises why do foreigners invest in the United States? Kristin Forbes says that if we look a few years back, we come to know that the people have received low returns on their particular US investment in past few years as compared to other foreign investment. This return difference exists even in the individual assets. But in spite of all this, the people may continue to invest in U.S. for a number of reasons. They can prefer to buy different United States portfolio investments so that they could get benefits from the highly developed and effective markets and from the sound governance of the US. However these two strengths have shown some weaknesses in the recent financial crunch. Should the risk be expanded, they prefer it especially when the returns in United States markets have any connection with the returns of their own country’s local financial markets. They can also prefer investment in US due to some other factors like strong connections with United States, sharing a general language, inexpensive communication etc.

Forbes asks that what you think is the key factor for deciding the foreign investment in US. She has a view that the country’s financial development is a key factor that has a profound effect on the investment in U.S. equity and the debt markets and she has a strong belief that the return differences are quite evident in forecasting the investment in U.S. equity and the foreigners prefer to invest in US equity when the returns on equity are offered in their own local markets, are less than the US returns.

Forbes noticed these results carefully and cleared that the role of financial development is primary in deciding the U.S. investment and it has 3 significant implications. First of all, the actual results strongly defend the theoretical literature on the issue of global imbalances. Secondly, it is a time when the different countries are trying to make their financial markets very strong so this phenomenon will slowly reduce the significant driver of the capital flows into US. Thirdly; it is evident that the strong financial markets and institutions are the thrust behind the tremendous U.S capital flows. So anything that will affect the U.S. equity and different bond markets, it will definitely create the atmosphere of risk for the United States capital inflows. If it happens that the less progressed financial markets get start to question the comparative benefit of US markets, this situation will lead towards more rapid settlement of asset prices, capital inflows and the global imbalances.

Dow Jones – Human error’ behind huge Dow Jones share market plunge!

There is a great possibility that the trading blunder by one person can wreck the share market of the United States in one night. If the trading error happens in the investment market or bank, this problem is called fat finger. The horrible crash in the American history in share market happened at 2.25 pm, the local time. The shares of the prices plunged to points 998.5 that were about nine percent of the whole. About 30 top companies saw this wipe out of billions with in just 20 seconds. When the markets opened next after 9/11, the marketers were shocked to see the wrecked Lehman Brothers. After the incident, the rumors started to disseminate that a trader mistakenly in a transaction of Procter and Gamble, entered the word ‘M’ for million instead of a ‘B’ for billion. This little blunder reportedly wrecked the whole market condition. This small mistake led to the greatest plunge in the historical background of the average Dow Jones Industrials.

The shares’ price went down from $61.56 US to $39.37 US per share that were invested in the Procter and Gamble but it again bounced back in no time. The Procter and Gamble affirmed later that drop in the prices of the shares was due to an error. The company said that they cannot comment or explain the individual transaction but the trade was undoubtedly a grave error. Another powerhouse named Accenture working as management consultant was also affected by the hitch. The trading on the opening was with the price of $41.78 US which in no time it drastically dropped to 1 US cent, as reported by the Zdnet. At last, the shares again recovered to $41.09 US in next few minutes. It was reported then to CNBC the responsible firm for all this glitch was Citigroup that tackled the trade of Procter and Gamble wrongly. The bank responded that there was no clue that the trade was badly treated but the investigation was still going on. Stock exchange of New York reported that there was no error in the system. In one day, about every major firm in US stock exchange faced 3 percent index loss which reminded the financial crisis of 2008.

When the market closed that day, the NASDAQ firm was at 2319.64 with 82.65 points down. While the Dow Jones was 347.80 points down and recovered back at 10,520.32. The 500 index of the Standard and Poor’s was at 1,128.15 with 37.72 points down. There were severe reservations that the greatest plunge has led to the debt issues of Greece which would restrict the revival of international economy. There are fears in the market that the Greece would be unable to put into practice the stern measures that would facilitate the govt. to hold back the debt issues which in turn would be able to hurt not only the US but some big financial hubs of the Europe too. This depression of the Greek would be able to hurt the great US and European economies if not dealt properly.

Transmission mechanism of monetary policy

Following is the transmission mechanism by which monetary policy influence the economy. The central bank is responsible for providing the funds to different banking systems of the country and in return they charge interest. Central bank is solely in charge for determining the interest rates because it has monopolistic power on the issuance of money.

Influences on the rate of interest of money market and banks:

When the changes occur in the official rate of interest, it directly affects the interest rate of the money market. It also indirectly affects the deposit and lending rates that a bank sets for its respective customers.

Expectations are affected:

When changes happen in the future of different official rate of interest, it ultimately affects the medium term and long term rate of interest. This is because long term rates of interest greatly depend on the expectations of the market which is about short term rates of future courses. Monetary policy no doubt can guide the expectations of the financial agents about future inflation rates which in turn affects the prices. Central bank has sound credibility so it caters the expectations related to price consistency. When this is the case, the economic agents are not forced to boost up the prices cause of the fear of price hike or they neither have to decrease the prices with fright of deflation.

Prices of the assets are affected:

The actions resultant from the monetary policies may guide a way to the settlement of prices of the assets for example rate of exchange and prices of stock market. The modifications in the rate of exchange can directly affect the inflation because all the imported products are used by the consumption. But this is a fact that they also function through some other channels too to influence the inflation rate.

Investment and saving verdicts have influences:

The decisions of different firms and households regarding saving and other investment policies are affected by the changes in the rate of interest. When the rate of interest is higher then the attraction to take loans for investment purpose or financial consumption decreases vehemently. The prices of the assets can also influence the demand through the collateral value which permits the borrowers to take out more and more loans.

Credit supply is affected:

When the interest rate is high increases the possibility that the borrowers won’t be able to pay the loans back. When the risk factor increases, the banks start cutting back the loans to the firms and small households which in turn reduces the level of investment and consumption ratio by the firms and household.

Modification in collective prices and demand level:

The demand levels related to the domestic services and goods are affected by the modification in the investments and consumption levels. The upward pressure on the price is very much expected to happen when demands gets higher than the supply. When the changes happen in the aggregate demand levels, then it may lead to some lenient or tighter conditions of market products and labor. This ultimately affects the wages and prices in the concerned market.

Macroeconomics And Monetary Policy

Macroeconomics and monetary policy have proved the two important strategies or tools that are utilized by the government policy makers to optimize the employment in an economy. These tools are also exercised for the sake of minimizing inflation and improving the overall standard of living of the people every year. However these techniques are not considered as an exact science to flourish the economy but these tools have become the central point of the government economic policies since the year of 1930.

What is called Macroeconomics?

It relates to the study of an economy and it is a theory that checks that how the national income moves in an economy. It is used to forecast the true national economic signs like inflation, gross national product and the rate of unemployment. Economists utilize the diverse and different calculating models and the computer replications to estimate these different indicators. These estimates are being provided to the government policy planners so that they could get help from these estimations in their decision making. It would help them how to push an economy.

What is called Monetary Policy?

This policy is based on the rules and the methods that are utilized by the government or money related authorities to have a check on the supply of money. When we talk about US, we come to know that their monetary authority is the Federal Reserve Board and the basic variable that is used to keep check on the supply of money is the interest rate. In a situation, when this board decreases the interest rate, the supply of money increases ultimately. Interest rate is actually known as the cost of the capital and with the low interest rate, the cost of capital also remains low. So when it happens, this situation gives birth to the rise in the supply of money. On the other hand, when rate gets rise then the situation gets opposite to it.

What are the applications?

The two policies macroeconomics policy and the monetary policy work side by side to assist the government officials. The policy making authorities take decisions on the basis of these policies and plan that how to expand the economy. Economists are the persons who use econometric policies to predict that how an economy will react to different interest rates.

What are the Economic benefits?

Capital is regarded as the life blood of the entrepreneurs of a society and the entrepreneurs are considered the life blood of the economic expansion. So monetary policies help in guiding the cost of capital of an economy and the macroeconomics help the monetary policies planners to take the appropriate and the best possible decision.

What are the Considerations?

Principles of monetary policies and the macroeconomics theory are not the true sciences. It is actually a guessing game where predictions are made. A lot of variables are needed to consider, if you want to apply it as an exact science. The prominent variable is the economic shocks. It can be a natural phenomenon or it can be a terrorist attack. These events have power to destabilize an economy fully.

Expansionary Monetary Policy And Contractionary Monetary Policy – Difference

Federal Reserve System that we are having today, it was brought into existence after the introduction of Federal Reserve Act in the era of 1913. This act of Federal Reserve established a complete central banking system so that United States could be protected against the monetary disasters by managing and controlling the monetary policy.  This policy is actually the sum of all necessary actions that are exercised by the central banks to maintain and control the supply of money and credit. Federal Reserve System actually controls the monetary policy with the help of the open market operations, reserve requirements and the discount rate.

History of Federal Reserve System:

According to the Federal Reserve Act, 12 Federal Reserve banks were being established in which each bank was responsible for its particular section of country. These private banks were administered by the 7 member of Federal Reserve Board. In 1930, the Board of Governors was changed by the Federal Reserve Board. And the people were selected to form a Federal Open Market Committee. This Committee has a significant impact on the monetary policies in Federal Reserve System.

Open Market operations (OMO):

This type of operations are monitored by Federal Open market Committee and the operations are related to the sales and purchases of treasury securities of U.S. the basic purpose of these open market operations is to try to raise the circulation of Federal Reserves or to maintain the prices of the treasury securities of U.S. Open market operations are actually considered as the most authentic way to control the monetary policies.

Discount rate:

Each and every commercial bank borrows money from its relevant regional Federal Reserve Bank and this money is borrowed at an interest rate that is called Discount rate. The regional Federal Reserve Bank from which each commercial bank takes money is regarded as the discount window. This bank offers three discount window plans at three different discount rates. These are primary credits then secondary credits and then seasonal credits. In starting these rates are established by the directors of regional reserve banks. And these rates are evaluated by the board of governors of Federal Reserve System.

The Reserve Requirements:

These are the requirements that decide the amount of reserves that each and every banking institution is demanded to keep on hand every time. The Board of Governors is entitled to control the reserve requirements and these requirements are being presented in the form of ratio. These ratios are being utilized on the amount of assets of an institution that are known as reservable liabilities.

Monetory Policy:

This policy can be expansionary monetary policy or contractionary monetary policy. When there is the time of recession, the Federal Reserve exercises an expansionary monetary policy so that the interest could be lower down. It will help in gaining the economy back. When there is period of high inflation, the Federal Reserve institution apply the contractionary monetary policy because it will raise the rate of interest and keep the inflation down. And the economy will progress.

Federal Reserve monetary policy

It was 1913, when the current system of Federal Reserve was created through Federal Reserve Act. This step was taken in order to create a banking system so that the financial catastrophes could be avoided in the US and so that the monetary policies could be regulated in the national interests. Monetary policy is in fact a calculation that is made in order to meet all economic objectives. Central bank of the country is responsible for controlling the amount of credit and the price of the money with respective supply. This is Federal Reserve that controls the policies related to monetary systems in the operations of the open market. It is also responsible for measuring the rate of discount and the likely requirements for reserves.

History of Federal Reserve:

About 12 regional banks were established for Federal Reserve under the 1913 act of Federal Reserve. In this system, every bank is solely responsible for its sections in the country. The banks on the regional level were supervised by the Reserve Board with seven members. In this board the president appointed the seven members which were later got approval from the senate. Later, in 1930, this board was named as “Board of Governors”. The five members of the federal bank served with the board of governors to establish the Federal Open Market Committee. This committee undoubtedly has great effect on the monetary policy in the reserve system working at federal level.

Operations in the open market:

Federal open market committee controls all the operations in the open market. It is also based on the treasury securities of US which regulates the selling and buying. The aim of the open market is to boost the Federal Reserve supplies. Its objective is also to regulate the prices of the treasury securities of US. Operations of the open market work as the most efficient tools for Federal Reserve in order to control the monetary policy.

The Discount Rate

Commercial banks in a country have to have a loan of money from the regional Federal Reserve Bank. The interest rate on which the commercial banks get the money is called the discount rate. Discount window is the money that every commercial bank gets from the regional bank. Every federal bank constitutes three different window programs at three completely separate discount rates. These programs are called, primary, secondary and seasonal credit. The rates of discounts are set according to the directions from the regional bank but the discount rates can be reviewed later and got approved from the governor’s board of the federal system.

Requirements for reserve:

The amount of all the reserves is determined by the requirements of the reserve that is controlled or handled by every bank. The reserve requirements are directly controlled by the BOG that appears in the shape of a ratio. The ratio is directly applied on the assets of an institution which are called the reservable liabilities but this ratio is kept aside to deal with the financial liabilities.

Expansionary or contractionary monetary policy:

Monetary policy can be either contractionary or expansionary. But this classification completely depends on the policy which can either increase or decrease the money supply. In the days of recession, Federal Reserve takes up an expansionary policy which lowers the interest rate and let the economy of the country going. But when the inflation is high in the country, the Federal Reserve adopts a contractionary policy which increases the rates of interest and inflation goes down.

Monetary Policy Inflation – Difference

Monetary policy is no doubt seems to be a simple idea but in fact it becomes complex and complicated when it comes to describe its impacts on the inflation and economy of the country as a whole.

Definition of Monetary Policy:

Monetary policy can be defined as mechanism which regulates the rates of interest and money supply in the country. These regulations are done by the central bank so that the currency could be stabilized and inflation can be controlled. In the United States of America, FRB (Federal Reserve Board) controls the monetary policy.

Meaning of Inflation:

Inflation is defined in many ways but usually inflation means a continuous increase in the prices of consumer goods. In other words, it can be said so, if the purchase power for the dollar continuously decreases, it is also called inflation. All this inflation either in form price increase or in the form of less purchasing power is caused due to monetary inflation levels. This happens when the government infuses a lot of extra currency in the supply of money. When the currency increases too much in the country but the production of goods is unable to meet the requirements, then it gives birth to price hike and monetary inflation takes place that is not healthy for the nation.

Influences of monetary policy on inflation:

It is very certain that monetary policy only work when the spending on services and goods by the customers are discouraged. This is done in order to level the influences of recessions and economic boosts. We can explain this better with an example. If the monetary policies are enforced in a way to increase the daily wages and prices of the goods much faster then it will ultimately increase the overall output of certain products and it will surely decrease the unemployment. The federal does tries hard to raise the demands with help of the monetary policies. This is done in order to increase the production levels of different goods and to boost up the money lending beyond real capacities. It is done in order to decrease the supply of currency in the country which will ultimately lower down the price hike.

Inflation with the help of monetary policy can be influenced by increasing the people’s hopes in monetary markets. When these markets get clear idea that the Federal Reserve is unable to focus on the inflation rate, they start adding their risk premiums in the rates of interests. This can be said in other words as, the financial markets increase the interest rates on their own and they do not wait for the actions from the federal. They do so in order to follow the mechanism of safety which can be compromised in future with the changes in the monetary policy and price hike (inflation).

Time required for changes to take place:

When some changes are made in the monetary policy, they do not have an immediate impression on economy and as well as on the inflation. The effects take utmost two years or at least 3 months to influence the manufacturing yield. While in case of inflation, the effects can take up to three years or more in order to influence the rate of inflation.

How does monetary policy affect unemployment?

Unemployment rate is given a great importance by the official representatives and the workers because it has a profound effect on the economy of a country. Politicians pledge that they will introduce such economic policies that will raise the job opportunities. At the time of recession in an economy, the government representatives have to face a huge pressure from the side of citizens to resolve the issue of unemployment. It happens sometimes that this pressure is being diverted to the central banks so that they could lower down the unemployment rate by adjusting the monetary policy. This policy is capable to influence the labor market however its effects are considered indirect. It means that it does not affect the labor market directly.

What is Monetary Policy?

This policy is capable to influence the supply of national income and it also affects the availability of cash and credit for the consumers and the business. Central banks are responsible to look after the monetary policies of their concerned countries. Central banks try to exercise those monetary policies that pave the way for the economic growth and establish a constant price system in which inflation remains under control. The policy makers of central banks prefer those strategies too that regulate the interest rates and money supply.

What are the Theories/ Speculation?

An economist of New Zealand had published a paper in 1958 in which he tried to consider the relationship between the inflation and unemployment. He observed that when the rate of unemployment in an economy was low, at that time inflation was very high or vice versa. This negative correlation was presented by A.W. Phillips so it is known as Phillips Curve. Harvard economist whose name is Gregory Mankiw says that the swap between the unemployment rate and inflation is impermanent but it can remain for many years. This is the burning point due to which we often find the policy makers and the economists to argue on the issue that to what extend a government must use the monetary policy to influence the rate of unemployment.

What are the key Effects?

It is said that the monetary policies made by the Federal Reserves have a direct influence on the credit and the supply of money but it has an indirect influence on labor market. The restrictive monetary policies influence the economic growth and these policies foster the firms to fire their works so as a result the unemployment rate gets higher. The Dallas Federal Reserve reports that if you can control the inflation, you can achieve the goal of stable economic growth. And this growth will ultimately result in the low rate of unemployment.

What is Prevention?

A previous Governor who belongs to Reserve Bank of New Zealand says that the greatest contribution of monetary policies toward unemployment rate is sustaining a constant price system. He says that when the monetary policies are being utilized as a tool for having the economic growth and high rate of employment then these policies result in high inflation in long rum ultimately.

Fiscal Policy Versus Monetary Policy

Two types of tools are being utilized by the economic policy makers to affect the economy and these two tools are actually two policies, i.e. the fiscal policy and the monetary policy.

Fiscal policy is related to government revenue collection and its spending like when the demand gets low in a certain economy then a government comes forward to increase the demand with its spending. It can decrease the taxes too for stimulating the demand. Monetary policy refers to the supply of money basically and it is controlled with the help of factors like interest rates and the reserve requirements. For example the interest rates can be increased to control the supply of money in case of inflation.

These two policies apply only in the market economy.

What are the policy tools?

Both these policies can be exercised as contractionary or expansionary. They will be expansionary when measures are governed to increase the growth and GDP and they are called contractionary when measures are taken to control the overheated economy.

Fiscal policy:

Regulating and the executive branches of a government manage the policy and in US President and the Congress are responsible for passing the law.

What is the Pro-cyclical and Counter-cyclical Fiscal Policy?

An economics professor who belongs to Harvard University claims that a good and understandable fiscal policy is always countercyclical. At the time of economy boom, the government must run a surplus and in recession it must exercise deficit. There is not found any good reason to follow the type of pro-cyclical fiscal policy. The main disadvantage of this policy is that it is very destabilizing policy and it makes the situation so bad and it raises inflation.

 What is a monetary policy?

This policy is exercised and managed by the Central bank and in case of US it is handled by the Federal Reserves. Government appoints the federal chairman and an oversight committee is also present in the congress for the Fed. A monetary policy utilizes many tools that are as follows:

First thing is the interest rate. It is known as the price of money or the cost of taking money. A central bank can raise or lower the interest rate to contract and expand the borrowing. When the rate is low, the people would like to borrow more or vice verse. Reserve requirement is a tool in which all banks and agencies are responsible to hold a certain amount of money as a reserve. In this way, the amount of giving loan can be controlled. Feeble economies can make a decision to peg their own currency against the strong currency. The Fed can invest money in the economy in the form of purchasing the government bonds.  This is quite handy tool.

Criticism on these policies:

Criticism is often done on fiscal policy versus monetary policy issue. The liberal economists argue that the actions of government always result in the form of unproductive outcomes and some say that monetary policy is not helpful.  So, it is a controversial issue that which one is the best.