EFFECT OF MONETARY POLICY ON
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Monetary policy also affects the values of stocks.
Let's say that the Federal Reserve increases the money supply. This
means that companies are able to borrow more easily, thus allowing
them to make new investments. These new investments often lead to
increased earnings, as well as increased demand for raw materials,
equipment, labor, etc. In general, the economy starts to expand.
During this expansion, stock prices often increase due to higher
earnings and growth opportunities.
Let's take this example one step further. After a
long period of this kind of growth, inflation rears its ugly head.
To keep inflation under control, the Federal Reserve decides to
raise interest rates. Now companies find it more expensive to
borrow, and they decide to make fewer new investments. This slows
the economy. Companies' earnings growths slow as well, thus
lowering the values of their stocks.
Monetary policy has a big impact on the overall
stock market. It sets off a chain of events of the kind we just
described. While individual stocks may react differently, the
general tone of the market is often determined to some extent by
the Federal Reserve's monetary policy.
Let's summarize what we have learned so