Complexities of the U.S. Financial Systems, Research Paper Example

Although the U.S. financial system has numerous roles in the economy, its central role is arguably the efficient allocation of capital between savers and borrowers. The financial system strives to efficiently channel capital (investment) from savers to borrowers who may invest the capital in business. “Savers” in the economy can take different forms such as individuals (wage earners), companies, and pension funds. “Users” of capital in the economy can also take different forms including entrepreneurs and firms. Thus, US financial markets consist of many different actors and markets that all work together to ensure efficient allocation of limited capital resources.

The U.S. Federal Reserve, typically referred to as “Fed”, plays an important role in the governance of the nation’s capital markets. The Fed performs many key functions including setting interest rates, regulating market participants, and being a steward of monetary policy. Most of us are aware of the Fed because of its role in setting interest rates. Fed conducts roughly 9 meetings during the year (including emergency meetings) during which it decides whether to raise, lower, or leave interest rates unchanged. This decision is based on a number of factors including the general health of the national economy and specifically, the nation’s unemployment rate. Although the Fed also has a broader mandate to ensure the health of the nation’s banks and other capital market firms, investors primarily pay attention to it due to its role in the interest rate policy (Investopedia, 2011).

The Federal Reserve Chairman, currently Ben Bernanke, is the executive in charge of the Fed (The Federal Reserve Board). The President of the United States nominates (or renominates) the Federal Reserve Chairman on a five-year basis. Once nominated by the President, the US Congress then either approves or disapproves of the candidate through the voting procedure. The Federal Reserve Board essentially serves as a “braintrust” with which the Federal Reserve Chairman consults regarding the promulgation of monetary policy. The Governors of the Federal Reserve Board are also in charge of running the Fed branches located throughout the country to monitor economic activity and vote on measures to change interest rates. Although there is a (somewhat eccentric) strand of economic thought that opposes central banks, most economists generally believe that the Fed is a good idea. Not only does the Fed monitor the economy and adjusts interest rates so as to promote economic activity and keep unemployment as low as possible, it also plays key roles in the regulation of banks and other capital market actors. Despite this, there is still ample room for criticism of the Fed’s performance: Many attribute the 2007-2008 financial crisis to overly accommodative interest rates (Taylor, 2009) that caused an asset bubble in the housing and equity markets; the Fed did not move quick enough to increase interest rates once economic activity had picked up.

Interest rates play a key role in helping investors and firms decide what to do with their money. Indeed, one can think of interest rates as a piece of information. If interest rates are high, investors may save their money in order to get a higher return and businesses may refrain from investment due to the punitive cost. If interest rates are low, investors may choose spending money over saving money while firms may choose aggressively investment in projects due to lower interest costs. Thus, interest rate policy plays a key role in either promoting economic activity or dampening economic activity from occurring.

Finally, exchange rates are pivotal consideration for businesses wanting to do business abroad. Even though a business may have operations in many different locations (countries), they ultimately must declare financial performance in their home currency. Thus, if there are volatile currency movements, this can have a deleterious impact on a firm’s bottom line. All firms are aware of this risk, and they attempt to “hedge” risk in order to deal with it.

References

Investopedia. (2011, September 6). How Interest Rates Affect The U.S. Markets. Retrieved May 03, 2013, from http://www.investopedia.com/articles/stocks/09/how-interest-rates-affect-markets.asp

Taylor, J. B. (2009, February 9). How Government Created the Financial Crisis. Retrieved May 3, 2013, from http://online.wsj.com/article/SB123414310280561945.html

The Federal Reserve Board. (n.d.). Board Members. Retrieved May 3, 2013, from http://www.federalreserve.gov/aboutthefed/bios/board/bernanke.htm