Question

1. How should the actions of the FED (such as raising interest rates) affect the economy and the stock market? Has this been the case over the last several years? Why not?

Answer 1

The federal reserve is the reserve bank of the country and is responsible for managing good health of the economy through proper and effective management of money supply and interest rates in the economy. If FED makes changes in interest rates, the same will affect the way banks lend to its customers including businesses, therefore, it will lead to either higher cost of borrowing or lower cost of borrowing. A lower borrowing cost would mean, money is available cheap for business projects and investments, hence higher earnings and good capital markets in general. However, higher interest rate would mean expensive capital, investments in business projects would go down, higher interest payment will take away earnings of businesses resulting in lack of earning growth and eventually declining stock market in long run. Therefore, there is a direct relationship between interest rates and the way other money market and capital markets will function.

After the crisis of 2008, the fed has been consistently adopting the low interest rate regime in US. The money supply was increased in order to increase capital investment and boost economy growth. Since then, the stock market is on a surge and showing good growth, thus low interest is beneficial for the market because funds availability is cheap and businesses can boost their earning growth in an effective manner overtime. Even the hike in interest rate by FED was very negligible and economy is still in the low interest regime, therefore higher capital market growth can be seen from previous few years as well.