 Hello, and welcome to this session. This is Professor Farhad in which we will discuss how federal government policy Effect investments and analysis this topic is covered in essential of investments as always I would like to remind you to connect with me on LinkedIn if you haven't done so YouTube is where you would need to subscribe. I have 1900 plus accounting, auditing, tax, finance as well as Excel tutorials If you like my lectures, please like them and share them if they benefit you it means they might benefit other people on my website farhadlectures.com you will find additional resources to supplement this course as well as your accounting courses So from a government perspective, they have two broad classes of macroeconomic tools that can affect the demand for goods and services and those that affect their supply and those two tools are Physical policy as well as monetary policy and both of these policies are Demand oriented. It means they are designed to increase the demand to to to grow the economy They can stimulate the total demand for goods and services Starting with the physical policy. What is the physical policy? Well, it's simply put It's when the government used their taxing power their spending and taxing power for the specific purpose of Stabilizing the economy. Usually they want to create demand side. They want to grow the economy So physical policies is the most direct way either to stimulate if you want to grow the economy or slow down the economy Simply put any decrease in government spending directly reduce the demands for goods and services Or what they can do they can increase the taxes and when they increase the taxes They take away all your spendable income so the economy will contract the thing with physical policy is its subject to politics The formulation of that of the physical policy and the implementation is usually Painfully slow and involved sometime. It's not Like back in March of 2020 when we had the corona virus Congress and the president they work together real quick to To to to to to get to get some help to the people through physical through spending Now we are on October 2020 Congress and the and and the president are working on the heroes act, but it's back and forth and really Painfully slow. Okay. Obviously, this is because you have Republican you have Democrat You have different political agendas physical policy require enormous amount of compromise between executives and legislative branches And sometimes they are from different political Parties and that what happened politics guts gets into the way So tax and spending policy must be initiated and vote owned by Congress you start there which require Considerable political negotiation and this is what's happening right now with the heroes act of 2020 and any legislation passed must be signed by the president So again if the president doesn't agree, he will throw it back So it requires more negotiation, especially this year. We have the election. So many things are going on all at the same time The impact of any physical policy is relatively immediate and this shows in the stock market The stock market react positively for any physical policy reliefs like stimulus checks Giving credit to businesses or loans the stock market reacts immediately Okay, although it's formulation could take time formulation could keep could take time The best way to look at how well the physical policy is how well it's being run Not how well like the effect of it is to look at the budget either deficit or surplus What's the surplus or deficit? Simply put the difference between revenues which is tax revenues and expenditure if you have more revenues than expenditure You have a surplus you're not spending as much and you are collecting You are collecting more money that you are spending if you have a deficit you are spending and simply put We are going through a deficit. So this is the physical policy basically an overview It has an immediate effect, but it's Cubbersome to formulate monetary policy when you think of monetary think of the world money Monetary policy is administered by the Federal Reserve System, which is the Fed refer to the manipulation of the money supply to affect macro economy and Is the other main leg of the demand side policy that the government had under their control? So it's not it's not Congress and the president here We are talking about the Federal Reserve although although it's the government It's supposed to be in a sense independent. So how do they affect the money through interest? Monetary works largely through the impact on interest rate. What happened is this? They increase the money they increase the money supply which in turn if you have a lot of supply for money Yeah, we have lower short interest rate lower short interest rate encourage people to buy homes stocks make investment Consume goods which in turn stimulate the economy So the monetary policy does not directly like the physical policy goes into the pocket of the of the consumer Like when they send you the stimulus check if you receive a stimulus check Well, you receive that money in your bank account. You can spend it monetary policy the influence interest rate which in turn Kind of trigger other Reactions such as people will buy homes because interest rate is low people will invest in stocks because they have no other Alternative to invest companies will invest in capital project because now the cost of money is lower however Some theory would say over the long longer longer periods most economists believe in higher money supply Only leads to higher prices and does not permanently affect the economy. That's that's what they say That's monetary policy phase a difficult balancing act. Well, I'm gonna tell you for the best decade I keep saying this it's working perfectly. Okay Expansionary monetary policy probably with lower interest rate and thereby stimulate investment This is what it's doing and some consumption when that's what it's doing in the short run But it's not in the short run that these but these circumstances ultimately will lead only to higher prices That's according to some economist. That's not happening these days. We are looking for inflation and we cannot find it So it's working perfectly So the stimulation slash inflation trade-off is implicit in all debate over proper monetary policy. It seems the more we print money Everybody better off the stock market is better off the consumer is better off It seems so monetary policy in contrast to physical policy is easily formulated because you have the Federal Reserve They're not as Paul they're not into politics and Implemented but has less immediate impact. So again the the impact is not immediate because it has to go through the Interest rate interest rate tool, but they do have other tools Let me let let's take a look at what the Fed stole. What do they use? Well, they use something called open market Open market operation in which the Fed buys and sells treasury bond from its own account What does it mean buys and sells when it buys securities when it buys securities simply write a check Thereby increasing this the money supply Simply put the Federal Reserve. It's not like us. They can pay for securities without drawing down funds at the bank So they can write checks as much as they want to it's basically simply put It's unlimited on the other hand if they want to take the money out the Fed The Fed sells a security the money paid for it leaves the money supply. So basically if they want to suck the money out That's what they would do. They will sell securities. So that's the open market operation occur daily allowing the Fed to fine-tune It's monetary policy and simply put what's happening now is mostly this part right here, which is basically Printing money's writing checks and printing and printing money That's one tool the other tool under the federal and under the Federal Reserve is the discount rate Which is the interest rate it charges bank on short-term loans because bank they need to borrow money some time How much they will charge them if they charge them lower rate banks will will borrow more and they also have another tool Let's call the reserve requirement banks will have to keep money at the Federal Reserve Which is the fraction of deposit that bank must hold as cash on hand or as the posits with the Fed So here what's gonna happen if they reduce the discount rate if they redo this discount rate. They signal a more expen Expansory Expanded monetary policy simply put if the bank is borrowing money at a low rate. They can afford to Lend it at low rate to which in turn stimulate stimulate the economy Also, when the Federal Reserve require you to keep less money at The Federal Reserve Bank as a reserve. It's allowing you simply put they're giving you if they if they ask you for less money Rather than 20% reserve they want from you from your bank accounts They want only 10 while you can keep the other 10 So it allows bank to make more loans with each dollar of deposit and stimulate the economy by increasing the effective money supply So that's what they do it they either lend the money at a low rate or they tell the bank to Keep less lower reserve amount at the Federal Reserve So the discount rate is under the direct control of the Fed and it's changed relatively and frequently Generally speaking then we have something called the federal fund rate The reason you want to you want to clarify that the federal fund rate is not said by the by the Federal Reserve Okay, is a guide is a far better guide to the Federal Reserve policy It's signal to the Federal Reserve policy. What's going on and sometimes it gives them really bad or good signals The federal fund rate is the interest rate at which banks make short-term overnight loans to each other to other banks So the federal fund rate is market oriented. It's not said by the government But what happened is the Federal Reserve monitor this federal fund rate and they will intervene when one bank is charging too much for another bank It means there is some shortage of money in the market So the so so the Federal Reserve will intervene and know what to do print more money These loan occur because some banks need to borrow fund to meet reserve requirement while others they have access funds So if you have access fund you lend to the banks that need the fund So unlike unlike the discount rate as I told you the Fed fund rate is a market rate Although it's a market rate. I'm gonna put market rate in quote the Federal Reserve can influence it Market rate means it's determined by supply and demand rather than be rather about being set nevertheless The Federal Reserve board target the Fed fund rate Expanding or contracting the money supply through the open market operation so they can easily influence this rate simply put It's another tool for the For the Fed so the so they look at the Fed fund rate as a signal What's really going on in the market and they would react appropriately they would react appropriately now if you talk to some people these days You know, they would say, you know, the Federal Reserve isn't intervening too much printing a lot of money Which is it's inflationary down the road But remain to be seen If you you know if you'd like additional resources about this course Please visit my website for head lectures comm and if you're studying for your CPA or other accounting courses Please visit my website Study hard. 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