10 - CREDIT MARKETS AND MONETARY POLICY

Abstract

This chapter discusses credit markets and the monetary policy. Financial markets are an important part of the economy. Corporations raise funds by borrowing in the credit market or selling ownership shares on the stock market. The commodities market trades futures contracts in goods, stabilizing mineral and agricultural markets. Bonds are an important part of the credit market. Borrowers sell bonds to the lenders who supply funds. The demand for credit depends on the interest rate, expectations about inflation and income, and government policies. Interest rates are set by the forces of supply and demand. Borrowers and lenders compete and this competition brings interest to equilibrium. Inflation is built into the interest rate through market forces. Higher expected inflation rates increase credit demand but reduce the supply of loans. Interest rates must rise in this situation, unless government regulations intervene. Federal Reserve policies that alter the credit supply affect investments and aggregate demand through the interest rate link. Monetary policy is an alternative to fiscal actions. The variable lag between interest rates and investment spending adds to the uncertainty of monetary policies.