The money supply is considered an important component in the business industry. The circulation of money describes the financial standing of a company. The flow of money tells whether there is a need for money injection in the market or a need to reduce the money in circulation. Talking about the relation between stock prices and money supply, both carry a positive relation. The higher the money supply is in the market, the higher the prices of the stock move. With a lot of money being circulated in the market, the money becomes easy to access. There is extra money available to spend on stocks to make further investments in other instruments and projects, like bonds, which are less attractive.
Money circulation and interest rates are closely related to each other. As the interest rate decreases in any economy, the process of lending and borrowing increases. This process snatches the interest of investors towards borrowing money more. At the same time, the case is opposite when interest rate rises as borrowers decrease, so the investors are attracted towards investing in stocks. Such actions stunt the growth of individuals with an increase in the growth of the stock market.
How Does It Affect the Economy?
The sum of money present in the economy is referred to as the money supply. This money circulation is not something that can be ignored. Instead, it has more importance in the economy than the coins and bills. It is a fact that the physical money circulating in a developed economy is less than one-tenth of the money present in the whole economy.
The remaining percentage of the money in circulation is purely virtual. This money supply includes the unused line of credit in any credit card account or the amount existing in the commercial bank accounts of huge industries.
Economists keep a close eye on the money that is being circulated in any economy as it tells about the purchasing power of an economy. The purchasing power is the quality or value of goods and services that can be bought with a currency’s unit. This unit explains the possible demand for products and services.
How Federal Reserve Board Controls the Interest Rates?
The Federal Reserve Board of economy maintains the money supply in the economy by taking different measures. The most common way to control the money circulation is through buying and selling treasury bills.
How do treasury bills work?
Treasury bills work in a way that once a treasury bill is brought, business is actually lending money to the government. The term security is to invest in any medium like bonds, bills, or stocks. There is a certain face value of treasury bills when it comes to an economy, which tells its actual worth. However, they are sold below their real worth. This money helps the government in building the economy and working on the infrastructure of the country.
The outcome of this selling and buying results in the injection or withdrawal of money into the economy. The quickest way to control the money supply is by adjusting the interest rates. With a lot of money being circulated in the economy, borrowing becomes much cheaper. However, when the money supply is low, a lot of institutes and individuals will be short on cash to lend it out. In this case, borrowers must provide higher interest rates in order to borrow. The interest rates are usually mentioned as the cost of money in the market.
Relationship Between the Interest Rates and Stock Prices:
A rise in the money supply and a drop in the interest rates make stocks a lot more attractive to invest in. When investors can get a low level of return by lending money, even if to a bank, corporation, or by buying treasury bills, such investors change their direction and start to lean towards the stock. Such actions of an individual or investor are called chasing yield.
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