Introduction
Financial markets are subject to market factors including those that affect demand and supply for money. In that respect, this discussion refers to an article on US debt crisis to demonstrate the effect of such factors by analyzing the effect of US debt ceiling crisis that include foreign financial institutions hoarding funds and their refusal to accept US treasuries as collateral.
Body
- Financial market’s debt ceiling impact on interest rate and private investments without an agreement that US was no longer able to borrow.
With a debt ceiling but lack of an agreement that the US government could not be able to borrow, there could be no effect on the interest rate and the private investments. This is given that, only the inability to borrow could affect money supply hence interest rate that could in turn affect the private investments. Thus, the graph shows that money supply and demand should maintain the initial equilibrium at interest re and money quantity Me.
- Effect of US debt ceiling on government spending in short run and its comparison with size of the effect on private investment.
Without an agreement that the US government was no longer able to borrow, the effect would be on government spending rather than on money supply. In that respect, there would be reduced government spending to cut on dependence on dept but no reduction in private investments since interest rate would remain the same.
- Effects on US interest and private investment if foreign financial institutions refuse to accept US treasuries as collateral
If foreign financial institutions could refuse to take US treasuries as collateral, there could be a reduction in money supply in the US financial market hence a shift in supply curve from S1 to S2. This could have an impact of increasing interest rate from r1 to r2 and reducing money quantity from M1 to M2 as shown on the first graph. In that respect, the increase in interest rate could attract US investors to invest in bonds as their prices falls as shown on the second graph rather than other investments which could result to a reduction on private investments.
- Foreign financial markets if foreign financial institutions hoard funds resulting to market seize up
With foreign financial institutions hoarding funds, the effect on their financial market would be reduced demand for funds hence a fall in interest rate as shown by a change from initial interest r1 to a lower interest r2 on the first graph. That would be accompanied by a rise in bonds prices from p1 to p2 as shown on the second graph.
Conclusion
The discussion has shown that a debt ceiling without an inability to borrow would not significantly affect the US financial market’s interest rate and private investments although government spending would be reduced in the short run. However, if the foreign financial institutions could refuse to accept US treasuries as collateral, there could be a decrease in money supply for US financial market hence a rise in interest rate that could then reduce private investments and increase bond prices. On the other hand, if foreign financial institutions decided to hoard funds, their financial markets could be affected by a fall in money demand hence a fall in interest rate and a rise in bond prices that could result to increased private investments.
