The Impact of financial Market development on economic performance of the United States Essay:
Well developed financial markets have the ability to generate diverse economic benefits such as high levels of productivity, widespread employment opportunities as well as macroeconomic stability within the economy. The United States is a developed economy that has been reached the level of highly developed financial markets. The United States has a well functioning financial system which has greatly contributed towards improved macroeconomic environment within the country. From chapter two of the book, Economics of Money, Banking and Financial Markets, the financial markets play crucial roles in the macroeconomic development. Many authors and researchers have acknowledged the importance of well functioning financial markets for the economic development of a country. The United States is an example of an economy with very highly developed financial markets that have led to the current level of economic development. With well functioning macroeconomic fundamentals, the financial markets are able to successfully perform the intended functions. The economic success of the United States amid well functioning financial markets is an indication that there is a strong relationship between economic development and effective financial markets.
Researchers have established that the financial markets are the driving force towards the development of a developed economy for all nations (Hubbard, 1998). Financial markets and stock markets in particular have experienced unprecedented growth in developed countries with sound macroeconomic fundamentals. Multiple factors have been associated with the growth of financial markets in the United States and many other developed economies such as Germany, UK, Japan and many others (Tadesse, 2005). Macroeconomic variables such as interest rates, exchange rates, fiscal policy, and monetary policy play a crucial role in determining the nature of financial markets of any nation. Compared to many other world economies, the United States’ economy has undergone unprecedented development to the extent that the financial markets have almost reached a level of efficiency. Financial markets are important for any economy as they play multivariate functions. The functions and purpose of the financial markets can only be attained in economic environments where macroeconomic variables have been organized and attained an advanced level (Allen & Santomero, 2001). Research indicates that has shown that reforms in the capital markets and general economy have major impacts towards the development of the capital market.
The past few decades have been characterized with extensive liberalization of the financial markets. Consequently, there have been massive capital flows across the borders of different countries. This has particularly been facilitated by the increase in financial links among various financial markets of the world. The financial markets in the United States have developed to the extent that numerous financial instruments have been developed leading to the intensification of economic development and growth. Presently, the financial market in the United States is awash with highly and functioning financial markets. Several financial instruments have been developed in the United States’ context to facilitate economic development. Several financial instruments have characterized the financial markets of the United States such as private equity (PE); sovereign wealth funds (SWFs), hedge funds and many other private capital pools are part of the intensifying shadow banking products in the United States (Butt, Shivdasani, Stendevad & Wyman, 2007). The numerous financial intermediaries in the form of shadow banking in the United States have been a major source of investment alternatives besides the traditional banking systems.
The United States has been involved in the development of several of the shadow banking investment avenues such as HFs and PE. However, SWF was created by the government of Kuwaiti in the year 1953. Primarily, these alternative investment vehicles have differing business models and roots. However, the investment vehicles have been highly involved in the process of overarching management of funds involving the three investment alternatives. The impact on the use of PSs, HFs and SWFs has seen an increase in power of both the non-financial and financial sectors of the economy. The non-financial and financial sectors of the United States have therefore been impacted positively by these alternatives investment sources through several ways including through alternative investments as well as strategies. Particularly, there has been an unprecedented increase in the level of use of debt to finance various investments (Appelbaum, Batt and Eun Lee, 2012).
Many investment arms of the banks have therefore embraced the use of these alternative investment channels that integrate debts. Furthermore, several corporations whose shares trade in public exchanges have embraced these investment alternatives to a great extent. The use of such alternative investments alternatives are particularly facilitated by the existence of favorable investment environment in the United States (Fitzgerald, Stickler & Watts, 1979). Indeed, such alternative investment channels can only function effectively in an economy with appropriate regulatory environment like the United States. These alternative investment channels have several positive implications on individual investors, firms as well as the economy as a whole. The growth of use of PES and HFs in the United States has been driven by existence of favorable regulatory environment and particularly the nature of existing laws on labor institutions and markets.
Financial regulation is an important factor for all forms of investment alternatives within the financial system. All financial products are based on certain regulations that determine the manner in which such financial products are operated and handled by financial stakeholders. In the United States, there are four main laws that are concerned with the provision of a framework under which public corporations and providers of financial services should operate: the Securities Act on the year 1933, Securities Exchange Act of the year 1934, Investment Company Act of the year 1940, also known as the Company Act and finally, the Investment Advisors Act of the year 1940, also known as Advisors Act (Greenwood & Jovanovic, 1990). Each of the four financial and investment regulation Acts have specific requirements that are to be adhered to by all stakeholders at all times. All the stakeholders are required to act within the provisions of these laws to avoid being on the wrong side of the law hence being exposed to massive losses on the investments undertaken.
The Securities Act specifically prohibits any form of fraudulent behavior while undertaking either the registration of the reporting in the publicly traded corporations. The Act also mandates the Federal Securities and Exchange Commission (SEC) to exercise power in the regulation of the securities market. The Company Act also has specific requirements that need to be observed at all times. This Act requires that investment funds undertake a full disclosure of the financial policies, undertakes to restrict short selling and use of leverage, and also advocates for a board structure that has a large number of members who are non-partisan. On the other hand, the Advisors Act requires all fund managers to be fully registered. The Act also requires that investment advisors fully comply with fiduciary responsibilities. It also limits the fees charged by the investment advisors (Goldberg et al., 2010). The operation of HFs and PEs has been undertaken in a manner that practically avoids the regulations by not reaching the size upon which the provisions of these laws apply. The HFs and PEs therefore operate under the exempt level of these laws. The fact that these alternative investments enjoy substantial exemptions from the underlying legislation requirements has been associated with numerous advantages. For instance, these alternative investments often use high level of leverage, undertake short-selling, and also apply fees based on performance.
In this research, I undertook a literature review of the secondary published data on the topic of financial markets in the United States. Particular attention was taken into consideration while using academic articles in economics and finance to obtain the relevant secondary data. I ensured that specific keywords were integrated into the search engine to ensure that reliable data was obtained. In particular, I was guided by the discussion in Chapter two of the course book. The chapter is devoted to discussing the role of financial system. The researcher sought to find out the impact of macroeconomic variables in the United States’ economy that have led to the creation of highly effective financial instruments and unprecedented economic growth. The United States has a highly developed financial system ranging from the banking sector, the capital markets and financial markets as well as the non-financial sector. I therefore, sought to identify the specific factors that have contributed to the development of the United States as a highly developed financial market. The findings from the study were discussed using the various available models of financial intermediation and explanations offered on the basis of the argument found from the literature review.
In this research study, I was interested in the dimensions of domestic financial market activity in the United States on the basis of effective macroeconomic fundamentals. In particular, my interest was to establish whether there is efficiency of capital allocation in the United States’ financial markets. Consequently, I applied a methodology that can facilitate the realization of relevant data related to the objective of the study. I was also faced with an immense challenge of finding data for the determination of efficiency in the U.S financial markets. Therefore, a simple methodology based on assumptions was used. For instance, I assumed that optimal investment meant an increase in investment in the growing industries and at the same time decreasing the extent of investment in the declining industries. From the economic point of view, the sum values added in all firms in a given economy make up GDP. Similarly, economic growth is assessed in terms of GDP.
The growth in the value added to the industry is often termed as the most important and natural factor through which GDP can be assessed. Therefore, I used gross growth in industry capital formation to measure investment growth as there was no depreciation value. The estimate for the growth in investment was undertaken using the equation below:
ln (Iict/Iict-1) = ᾳc + ncln (Vict/Vict-1) + ɛict
I is the fixed capital formation,
V, the value added, i the index of manufacturing industry, c, the index of country and t, the index of the year.
The estimate of the slope in the equation shows elasticity, and measures the extent to which the country has increased investment in growing industries and decreased investment in the declining industries. A consideration is undertaken about the nature of the slope coefficient. According to Hubbard (1998), a model of firm investment widely used utilizes capital adjustment costs as quadratic functions. The model above therefore is based on the premise that when adjustments costs are set at low levels, there is a responsive trend of investment towards existing opportunities for investment. When slope coefficients are associated with a specific country, the outcome reflects a general perspective of adjustment costs of capital. It has also been determined that the slope coefficients are strongly correlated to the level of financial development existing in a given country (Beck et al., 2000). Such a remark is an indication that capital markets do not exhibit pure technological adjustment costs but rather depict market frictions.
There is also an assumption that value added portrays the investment opportunities and that value added has a strong correlation with the traditional measures of ascertaining opportunities for investment. There is numerous data about the United States’ firms available in the WorldScope database. The analysis of the U.S firms therefore used SIC Codes in grouping the firms in terms industry. The correlations between value added growth to the industry and level of investment were analyzed. The outcome indicated that price earnings ratio, output of investment and growth of sales were highly significant (Carlin & Mayer, 1998). The interpretation was that value added is a reasonable measure on opportunities for investment.
It has been documented in literatures that reverse causality may have impact on the outcome of the model above. It has been argued (Mayer, 1960; Hall, 1977) that investment has a contemporaneous change especially on the value added. Fixed capital remains without productivity for up to two years after the investment decision has been made. Researchers have provided evidence of the prevailing gestation gap in the United States context (Hall, 1977 and Mayer, 1960). Therefore, it has been established that an investment can only influence value added in a contemporaneous manner if fixed capital expenditures become productive as soon as the investment decision is made.
The differences in the quality of data among different nations are also associated with variations in the contemporaneous of value added (Fitzgerald et al., 1979). It is therefore important to use industry aggregated levels of value added and investment aggregates to eliminate cross-firm differences that exist in financial reporting. The model also integrates the use of growth rates to account for differences among countries in policies such as accounting. There is minimal knowledge among financial economists on how a firm can accurate measure its expected marginal return to capital employed. They are also limited in the availability of data for stocks within the industry under analysis. The existence of adequate data has sometimes prompted financial economists to infer that capital allocation in cases where dispersion of returns reduces. However, Henry (2000) has argued that there is a likelihood of shocks in factor markets, or industrial organization shifts as well as many types of economic liberations to take near financial liberalizations.
This research sought to determine whether the advanced nature of the United States’ financial markets is as a result of the existence of appropriate macroeconomic environment. The research particularly sought to determine how effective the United States’ financial markets have allocated capital based on the existence of sound macroeconomic variables and efficiency of the financial markets. The research has established that financial markets are crucial in the allocation of capital as seen through value added. The United States boasts of highly developed financial system. This is associated with efficiency in the allocation of capital across numerous industries. Consequently, a developed financial system such as the United States is characterized with increasing capital allocation on growing sectors of the economy and decreasing capital allocation on the declining sectors of the economy. Furthermore, capital allocation in financial markets has been strongly correlated to regulatory environment. It has also been established that the variables in financial markets explain the existence of significant variation in the quality of capital allocation in different countries. There is also significant correlation between development of the financial market and capital allocation for one year period or more. The regulatory environment of the United States has shaped the manner in which financial intermediaries behave. PEs, SWFs and HFs have been used by banks as they attempt to take advantage of the exemptions allowed in the use of these alternative investment commodities. The U.S financial market has passively regulated financial market that has led to the creation of private capital in large pools.
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The Impact of financial Market development on economic performance of the United States Essay: