Typically, when the supply of money increases, interest rates fall. And when the supply of money tightens, interest rates increase. So, the Fed actions discussed earlier have an impact on the following:
- Consumer spending
- Interest rates on newly issued bonds
- Market prices of existing bonds: when interest rates rise, the prices of bonds with lower coupon rates decrease and vice versa
Fed actions can also indirectly impact stocks:
- When monetary policy expands credit, lower interest rates make bonds less appealing as investments, and stocks more appealing.
- From the corporate perspective, company earnings may rise because of lower interest expense, which may cause the market price of the stock to rise.
- Of course, when the opposite occurs and monetary policy tightens credit, interest rates will rise, earnings will decrease, and the market price of the stock is likely to decrease as well. As interest rates rise, bonds become more attractive to investors.
Consider these sample exam questions:
- Which of the following short-term effects could result from increases in the money supply?
- Interest rate increases
- Bond price decreases
- Stock price increases
- Inflation
- I & II
- I & IV
- III & IV
- I, III, & IV
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