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Collection of tutorials and a guide for using TGJU & Financial Markets
The impact that inflation has on the time value of money is it decreases the value of a dollar over time. The time value of money is a concept that describes how the money available to you today is worth more than the same amount of money at a future date. This also assumes you do not invest the money available to you today in an equity security, a debt instrument or an interest-bearing bank account. Essentially, if you have a dollar in your pocket today, that dollar will be worth less one year from today if you keep it in your pocket.
Inflation increases the prices of goods and services over time, effectively decreasing the amount of goods and services you can buy with a dollar in the future as opposed to a dollar today. If wages remain the same but inflation causes the prices of goods and services to increase over time, it will take a larger percentage of your income to purchase the same good or service in the future.
So, for example, if an apple costs $1 today, it’s possible that it could cost $2 for the same apple one year from today. This effectively decreases the time value of money, since it will cost twice as much to purchase the same product in the future. To mitigate this decrease in the time value of money, you can invest the money available to you today at a rate equal or higher than the rate of inflation. (For related reading, see: How to Profit From Inflation.)
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After the bell” is financial slang for activity occurring after the close of the stock market, including after-hours trading, illegal late trading of open-ended funds (during the mutual fund scandal of 2003), earnings announcements, acquisition plans and merger agreements. The term originates from the ringing of the bell on the NYSE, which denotes the open and close of trading sessions.
Generally, important, company-specific news is released after the bell to give investors time to dig through the information and make informed buy and sell decisions. In addition, announcements after the close of trading provide order and stability to the markets. News released during the trading day or before the bell (prior to the start of the trading session) could generate negative consequences, like panic-selling, unbridled speculation and buy/sell imbalances. Pertinent news announced after the bell leads traders to trade stock based on the fresh information, although in very thin markets. However, it should be noted that traders may trade stock after the bell for a variety of reasons, which may not be related to company news releases. (For more on this topic, read What is after-hours trading?)
This question was answered by Justin Bynum.
In theory, the impact that disposable income has on the stock market is that a widespread increase in disposable income leads to increases in stock valuations and, therefore, increases the overall value of the stock market.
Disposable income is defined as the total amount of household income that’s available for spending and saving after paying income taxes.
If disposable income increases, households have more money to either save or spend, which naturally leads to a growth in consumption. This increase in consumption could increase corporate sales and corporate earnings, increasing the value of individual stocks. This increase in individual share price valuations could then lead to a market-wide increase in value. This potentially leads to an economic boom.
The opposite also holds true. If disposable income decreases, households have less money to spend and save, which then forces consumers to consume less and become more frugal. This decrease in consumption could then decrease corporate sales and corporate earnings, decreasing the value of individual stocks. This decrease in individual share price valuations could then lead to a market-wide decrease in value. This potentially leads to a depression or recession.
Increases in disposable income don’t always result in an increase in value of the stock market, and vice versa.
Sometimes, especially in the wake of a recession and during a recovery period, although disposable income increases, many consumers remain frugal and do not use the increases in disposable income to increase consumption. When this occurs, even an increase in disposable income can lead to a recession since, as of 2015, over 70% of U.S. GDP is accounted for by consumption.
In microeconomics, utility represents a way to relate the amount of goods consumed to the amount of happiness or satisfaction a consumer gets. Marginal utility tells how much marginal value or satisfaction a consumer gets from consuming an additional unit of good. Microeconomic theory states that consumer choice is made on margins, meaning consumers constantly compare marginal utility from consuming additional goods to the cost they have to incur to acquire such goods. A consumer buys goods as long as the marginal utility for each additional unit exceeds its price. A consumer stops consuming additional goods as soon as the price exceeds the marginal utility.
In microeconomics, marginal utility and the law of diminishing marginal utility are the fundamental blocks that provide insight into the consumer choice of quantity and type of goods to be consumed. The law of diminishing marginal utility states the marginal utility from an additional unit of consumption declines as the quantity of consumed goods increases. Consumers choose their baskets of goods by equating marginal utility of a good to its price, which is a marginal cost of consumption.
The price a consumer is willing to pay for a good depends on his marginal utility, which declines with each additional unit of consumption, according to the law of diminishing marginal utility. Therefore, the price decreases for a normal good when consumption increases. The price and quantity demanded are inversely related, which represents the fundamental law of demand in consumer choice theory.
Governments may make policy changes in response to economic conditions. Government regulation of the economy is frequently used to engineer economic growth or prevent negative economic consequences. During periods of weak growth, Keynesian economists recommend lowering interest rates to encourage borrowing and restore economic growth. In response to inflation concerns, governments may decide to increase interest rates. Government policies may use tax incentives to direct economic conditions also. The active use of these strategies demonstrates government interest in preserving particular economic circumstances to further the economic well-being of important stakeholders and the public.
In the United States, the Federal Reserve has the authority to direct economic policy for the country as a whole. Established in 1913, the Federal Reserve controls the money supply and actively uses policy to respond to and influence economic conditions. Increasing or decreasing available funds influences bank behavior. Banks are offered a discount rate by the Federal Reserve on funds borrowed to re-lend to consumers and industry clients. Changing the costs of borrowing by changing rates is another means of directing bank activity. Major banks have tremendous influence on the consumer economy because they are gatekeepers. Funds flow from the Federal Reserve to the major banks and the government actively uses this means to direct the economic rate of growth.
Outside events may influence economic activity and governments may use economic means to enact changes. Tax policy is frequently used to direct economic action, as is legislation. Government responses to economic conditions typically include using multiple strategies simultaneously.
The Dow Jones Industrial Average (DJIA) is the second-oldest and best-known stock market index. Owned by Dow Jones & Company, it measures the daily price movements of 30 large American companies on the Nasdaq and the New York Stock Exchange. It is widely viewed as a proxy for general market conditions and even the U.S. economy itself.
Started in 1896, the DJIA is comprised of blue-chip stocks, approximately two-thirds of which are represented by companies producing industrial and consumer goods. The rest are chosen from all the major sectors of the economy including information technology, entertainment and financial services.
The Dow Jones Industrial Average (DJIA), popularly referred to as “The Dow,” is regarded as the “pulse of the stock market,” as it is one of the most quoted and followed stock market indexes by investors, financial professionals and the media. The Dow was unveiled on May 26, 1896 by Charles H. Dow and Edward Jones as a composition of 12 industrial-company stocks. Dow, a financial journalist, believed that investors should have an impersonal, numbers-based benchmark to see how the stock market was trending. The published average of the first index was a roaring 40.94.
Today, the DJIA’s components are chosen from all the major sectors of the economy, with the exception of the transportation and utilities industries. Stocks from these sectors are covered by the Dow Jones Transportation Average (DJTA) (which was Dow and Jones’ first index, the oldest in the U.S.) and Dow Jones Utility Average (DJUA). The current roster includes the likes of Apple, Goldman Sachs, Microsoft, Coca-Cola, Exxon Mobil and General Electric (the only corporation that has been included since 1896).
The component stocks of the DJIA are not permanent; new additions and deletions are made from time to time based on certain non-quantitative criteria. Only companies with a substantial growth record and wide investor interest are considered for inclusion.
The DJIA was calculated by hand hourly for a number of years. Back in 1896, Charles Dow simply added up the prices of the 12 stocks and divided them by 12. In 1923, Arthur “Pop” Harris was assigned the task of calculating these numbers. After his retirement in 1963, computers were used to calculate the figures. Originally, there was a delay of about seven minutes between the close of the NYSE until the final number came out over the wires. Eventually, electronic technology enabled a constant minute-by-minute calculation of the average while the market is trading.
The DJIA is a price-weighted index, which means stocks with higher share prices are given a greater weight in the index. Instead of dividing by the number of stocks in the average, as is done in an arithmetic average, the sum of the component stock prices is divided by a special divisor. The purpose of this Dow divisor, which is continually adjusted, is to smooth out the effects of stock splits, dividends paid or corporate spinoffs; this allows for a consistent index, keeping the Dow from getting distorted by one-time events. The result is the DJIA is affected only by changes in the stock prices, and stocks with a higher share price have a larger impact on the Dow’s movements.
The DJIA is simply a reflection of the weighted average of the stock prices and can be considered a price in itself. If the quote …
Government regulation affects the financial services industry in many ways, but the specific impact depends on the nature of the regulation. Increased regulation typically means a higher workload for people in financial services, because it takes time and effort to adapt business practices that follow the new regulations correctly.
While the increased time and workload resulting from government regulation can be detrimental to individual financial or credit services companies in the short term, government regulations can also benefit the financial services industry as a whole in the long term. The Sarbanes-Oxley Act was passed by Congress in 2002 in response to multiple financial scandals involving large conglomerates such as Enron and WorldCom. The act held senior management of companies accountable for the accuracy of their financial statements, while also requiring that internal controls be established at these companies to prevent future fraud and abuse. Implementing these regulations was expensive, but the act gave more protection to people investing in financial services, which can increase investor confidence and improve overall corporate investment.
The Securities and Exchange Commission (SEC) regulates the securities markets and is supposed to protect investors against mismanagement and fraud. Ideally, these types of regulations also encourage more investment, and help protect the stability of financial services companies. This does not always work, as the financial crisis of 2007 demonstrated. The SEC had relaxed the net capital requirement for major investment banks, allowing them to carry significantly more debt than what they had in equity. When the housing bubble imploded, the excess debt became toxic and banks started to fail.
Other types of regulation do not benefit financial services or asset management at all, but are intended to protect other interests outside of the corporate world. Environmental regulations are a common example of this. The Environmental Protection Agency (EPA) often requires a company or industry to upgrade equipment and to use more expensive processes to reduce environmental impact. These types of regulations often have a ripple effect, causing tumult in the stock market and overall instability in the financial sector as the regulations take effect. Companies often try to shift their increased costs to their consumers or customers, which is another reason why environmental regulations are often controversial.
Government regulation has also been used in the past to save businesses that would otherwise not survive. The Troubled Asset Relief Program was run by the United States Treasury and gave it the authority to inject billions of dollars into the U.S. financial system to stabilize it in the wake of the 2007 and 2008 financial crisis. This type of government intervention is typically frowned upon in the U.S., but the extreme nature of the crisis required quick and strong action to prevent a complete financial collapse.
The government plays the role of moderator between brokerage firms and consumers. Too much regulation can stifle innovation and drive up costs, while too little can lead to mismanagement, corruption and collapse. This makes it difficult to determine the exact impact government regulation will have in the financial services sector, but that impact is typically far-reaching and long-lasting. (For related reading, see: Government Regulations: Do They Help Businesses?)
The Fisher effect is a theory first proposed by Irving Fisher. It states that real interest rates are independent of changes in the monetary base. Fisher basically argued that the real interest rate is equal to the nominal interest rate minus the inflation rate.
Most economists would agree that the inflation rate helps to explain some differences between real and nominal interest rates, though not to the extent that the Fisher effect suggests. Research by the National Bureau of Economic Research indicates that very little correlation exists between interest rates and inflation in the way Fisher described.
On the surface, Fisher’s contention is undeniable. After all, inflation is the difference between any nominal versus real prices. However, the Fisher effect actually claims that the real interest rate equals the nominal interest rate minus the expected inflation rate; it is forward-looking.
For any fixed interest-paying instrument, the quoted interest rate is the nominal rate. If a bank offers a two-year certificate of deposit (CD) at 5%, the nominal rate is 5%. However, if realized inflation during the lifetime of the two-year CD is 3%, then the real rate of return on the investment will only be 2%. This would be the real interest rate.
The Fisher effect argues that the real interest rate was 2% all along; the bank was only able to offer a 5% rate because of changes in the money supply equal to 3%. There are several underlying assumptions here.
First, the Fisher effect assumes that the quantity theory of money is real and predictable. It also assumes that monetary changes are neutral, especially in the long run – essentially that changes in the money stock (inflation and deflation) only have nominal economic effects, but leave real unemployment, gross domestic product (GDP) and consumption unaffected.
In practice, nominal interest rates are not correlated with inflation in the way that Fisher anticipated. There are three possible explanations for this: that actors do not take expected inflation into consideration, that expected inflation is incorrectly taken into consideration or that rapid monetary policy changes distort future planning.
Fisher later held that the imperfect adjustment of interest rates to inflation was due to the money illusion. He wrote a book about the topic in 1928. Economists have debated the money illusion ever since. In essence, he was admitting that money was not neutral.
The money illusion actually traces back to classical economists such as David Ricardo, though it did not go by that name. It essentially states that an introduction of new money clouds the judgment of market participants, who falsely believe that times are more prosperous than they actually are. This illusion is only discovered as such once prices rise.
In 1930, Fisher stated that “the money rate of interest (nominal rate) and still more the real rate are attacked more by the instability of money” than by demands for future income. In other words, the impact of protracted inflation affects the coordinating function of interest rates on economic decisions.
Even though Fisher came to this conclusion, the Fisher effect is still touted today, albeit as a backwards-looking explanation rather than a forwards-looking anticipation.
Industrialization is the transformation of a society from an agrarian economy to an industrial one. Industrialization has enormously positive impacts on wages, productivity, wealth generation, social mobility and standard of living. During industrialization, all wages tend to rise, though the wages of some rise much faster than others.
The impact of industrialization can be understood by looking at historical data or by reviewing its logical economic consequences. Standard of living, traditionally measured as real income per person, increases exponentially during and after industrialization.
According to researchers at the Minneapolis Fed, gross domestic product (GDP) per capita was essentially unchanged from the rise of agricultural societies until 1750; they estimate a per capita income of $600 for this period (using 1985 dollars).
In countries such as Japan, the United Kingdom and the United States – where economic policies allowed for the greatest industrialization – per capita income exceeded $25,000 (in 1985 dollars) by 2010.
The World Health Organization defines “absolute poverty” as living on less than $2 per day, although other definitions range between $1.25 and $2.50. By these standards, the average individual in every society in the world lived in absolute poverty until 1750.
Work in agrarian life often involved working as long as the sun was up, only stopping because there was no more light. Workers often lived at the behest of their lords (whatever their title). Children were expected to begin working at a very young age, and most people were not allowed to keep the fruits of their labor. Productivity was chronically low. This changed with the Industrial Revolution.
Large-scale industrialization began in Europe and the U.S. during the late 18th century following the adoption of capitalist economic principles. Under the influence of thinkers such as John Locke, David Hume, Adam Smith and Edmund Burke, England became the first country to emphasize individual property rights and decentralized economies.
Under this philosophy, known as classical liberalism, England experienced the earliest industrial development. Low levels of public spending and low levels of taxation, along with the end of the Mercantilist Era, sparked an explosion in productivity. Real wages in England grew slowly from 1781 to 1819 and then doubled between 1819 and 1851.
According to economist N.F.R. Crafts, income per person among the poorest increased 70% in England between 1760 and 1860. By this time, industrialization had reached most of Europe and the U.S.
The replacement of agricultural life was dramatic. In 1790, farmers made up 90% of the labor force in the U.S. By 1890, that number fell to 49% despite a much higher level of output. Farmers made up just 2.6% of the U.S. labor force by 1990.
Prior to the rise of classical liberalism, much of the wealth generated by a worker was taxed. Very little was invested in capital goods, so productivity remained very low.
Capital development became possible once private individuals could invest in competing corporations and entrepreneurs could approach banks for business loans. Without these, merchants could not afford to innovate or develop superior capital goods. Mass production led to cheaper goods and more profits.
Workers are more productive with industrialization’s capital goods, and companies have an incentive to bid up wages towards margin…
At a basic economic level, the interest rate set on savings account deposits is determined by the relationship between how much banks value receiving extra deposits and how much savers value the services of a savings account. Those valuations are manipulated by how governments and central banks target interest rates in the economy.
Most savings accounts are liquid accounts that protect the value of principal kept with the bank. Consumers value savings accounts for their safety and flexibility. Banks offer them as a means of enticing depositors to provide extra cash so bankers can make loans.
When banks want extra deposits, they can raise the interest rate offered on savings accounts to attract extra cash. If they want to decrease bank debits, they can lower interest rates. It is important that banks do not offer more interest for savings accounts than can be charged on loans or earned on other investments.
The interest rates on savings accounts are endogenously dependent on the rates offered on other savings destinations such as bonds and money market accounts. Each saver tries to find the best balance of security and return based on his preferences.
Suppose the Federal Reserve purchases a lot of new U.S. Treasuries. This bids up the price of Treasuries and lowers yields. Banks can subsequently lower the rate offered on savings accounts and probably must lower the interest rate charged on loans, too. There are many reasons for this, including the fact that banks tend to invest in Treasuries for safe returns.
Remember that savings account rates have to compete with the other returns available in the market. When interest rates decline, savings account rates also drop. When interest rates rise, savings account rates are bid up. Generally speaking, central banks and governments support low-interest rate environments. This artificially pushes down the rates earned everywhere else in the economy.