3, Question#3 An Overview of Financial Management and the Financial tnvironment:

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3, Question#3 An Overview of Financial Management and the Financial tnvironment: Macroeconomic Factors that tofuence Interest Rate Levels have an important effect on both the general level of intrest ae and the shape of the weld corve. These primary factors are: Fodral Resere budget deficit or surplus, international factors like the foreign trade balance and interest rates abred, and the eet of buiress ashvoty money supely To stmulate the economy. the Kodca the money supply. The irnitial effect would be to cause short tem rates to dedine however, a Select money supply might lead to an increase in expected fut when the Fedlect the money supply. If the government spends more than it takes in as taxes, It runs alec, which must be covered by additional borrowing or by printing money. If the government borrows money, thi Select the demand for funds and Selt interest rates. If the government prints money, the result will be inflation, which aille-t-interest rates. So, the , r u s, businesses and individuals or more goods om abroad than they sea more mports than exports the us. is running a foreign rade s which must be financed. This generally means that the U.S. borrows from nations with export .The larger the trade salectthe higher the tendency to borrow, so u.S. interest rates become highly dependent on interest rate levels abroad. Consequently, this interdependency Sle the Fed's ability to use monetary policy to control U.S. economic activity. Business conditions influe the economy. As a result, there is a tendency for interest rates to dedline during t. During ence interest rates. During a the demand for money and the inflation rate tend to tall and the Fed tends to te , the money su ply to stimulate Select -Selectshort-term rates dedine more sharply than long term rates because inflation rate over the nest (1) the Fed operates mainly in the short- 20 to 30 years and this expectation doesn't change much due to the level of current inflation. So, short to term sector, so the Fed's intervention has the strongest effect there; (2) Long term rates reflect the average expected rates are Select volatile than long-term rates.

Explanation / Answer

To simulate the Economy, the Fed will increase the money supply

However a larger money supply might lead to an increase in expected future inflation

which would cause long-term rates to rise even as short-term rates fell. The reverse is true when the Fed tightens the money suppy.

If the government spends more than it takes in as taxes, it runs a deficit, which must be covered by additional borrowing or by printing money. If the government borrows money, this increases the demand for funds and increases interest rates. If the government prints money, the result will be increased inflation, which will increase interest rates. So, the larger the federal deficit other things held constant, the higher the level of interest rates

U.S. businesses and individuals buy more goods from abroad than they sell(more imports than exports), the U.S. is running a foreign trade deficit which must be financed. This generally means that the U.S. borrows from nations with export surpluses,The larger the trade deficit, the higher the tendency to borrow, so U.S. interest rates become highly dependent on interest rate levels abroad.Consequently, this interdependency constrains the Fed's ability to use monetary policy to control U.S. economic activity.

Business conditions influence interest rates. During a recession , the demand for money and the inflation rate tend to fall and the Fed tends to increase the money supply to stimulate the economy. As a result, there is a tendency for interest rates to decline during recessions. During recessions short-term rates decline more sharply than long-term rates because (1) the Fed operates mainly in the short-term sector, so the Fed's intervention has the strongest effect there; (2) Long-term rates reflect the average expected inflation rate over the next 20 to 30 years and this expectation doesn't change much due to the level of current inflation. So, short-term rates are more volatile than long-term rates.

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