Chapter 2 The Financial Market and Interest Rates Chapter Objectives

Federal Reserve System Board of Governors

Commissioner	Entered Office	Term Expires
Ben S. Bernanke, Chairman	02/01/06	01/31/20
Janet L. Yellen, Vice Chair	10/04/10	01/31/24
Jerome H. Powell	05/01/12	01/31/14
Elizabeth A. Duke	08/05/08	01/31/12
Daniel K. Tarullo	01/28/09	01/31/22
Sarah Bloom Raskin	10/04/10	01/31/16
Jeremy C. Stein	10/30/12	01/31/18

www.federalreserve.gov

Recent Interest Rate Cycles

Early 1994 & 1997	Inflation	Raise interest Rates
Fall 1998	International Pressures	Lower interest Rates
Summer 1999	Tight labor markets, aggregate real growth, inflation	Raise interest Rates
Early 2001	Contracting manufacturing output, slower business capital spending, equity market sell-off, recession	Lower interest Rates
Summer 2004	Firming Labor market, stronger retail sales, improving industrial production, hot housing market, increases in energy prices, all suggesting unacceptable future rates of inflation.	Raise interest Rates

Nonfinancial Corporate Business Sources of Funds, 1981-2000

• Changes in market conditions influence the way corporate funds are raised
• Example: High interest costs discourage the use of debt.

Corporate Securities Offered for Cash

• Nonfinancial Corporations- 3yr. Cash Weighted Average, 2001-2003
• Total Volume($M)
• $1,288,515

Source:Statistical Supplement to the Federal Reserve Bulletin, Table 1.46, October 2004, A29.

Debt/Equity Mix

• U.S. tax system favors debt as means of raising capital
• Interest expense is deductible
• Dividends paid are not deductible

Financial Markets

• Financial markets are institutions and procedures that facilitate transactions in all types of financial claims
• Financial markets exist in order to allocate the supply of savings in the economy to the demanders of those savings.