The of monetarypolicy procedures would have developed. Moreover,

The existence of broad-based, active financial markets in theUnited States is very important to Federal Reserve policy implementation.The markets provide a place where the Federal Reserve can buy and sellTreasury debt instruments in carrying out open market operations. TheFederal Reserve uses such transactions to make large-sized reserve adjustmentsquickly. If active markets in financial instruments did not exist, theFederal Reserve would not be able to make open market operations itsprimary policy instrument, and a very different, less efficient set of monetarypolicy procedures would have developed. Moreover, without large-scalefinancial markets, the economic conditions addressed by Federal Reservepolicy would barely resemble the complex system that has evolved in theUnited States, since the variety and efficiency of means of borrowing andlending have affected the course of economic development.1The financial markets encompass a vast array of techniques and instrumentsfor borrowing and lending that facilitate investment, consumption,saving, and the convenient timing of purchases and sales of goods andservices. The borrowers are mostly businesses, individuals, and governmentalunits with a variety of needs for funding. Lenders are businesses andindividuals with savings or excess cash to invest. Many entities fall intoboth categories. Financial institutions, including commercial banks, investmentbanks, and insurance companies, intermediate between borrowersand lenders. In addition, a wide variety of financial instruments have beendeveloped that permit borrowers to sell their own securities, usually withThe Financial MarketsChapter 4Chapter 480the assistance of investment banks, without relying on the intermediaryservices of commercial banks.Active financial markets help potential borrowers and lenders find themost advantageous terms and interest rates. The market-making processesallocate savings to the uses offering the highest return and search out theinterest rates that bring supplies and demands into balance. The determinationof the overall level and the structure of interest rates according tothe maturity of the instrument is a complex process (see the discussion inChapter 8). For any maturity, rates will differ among instruments if they areperceived to have different credit risk, tax, or marketability characteristics, orif they are available to different classes of purchasers (lenders). The spreadbetween interest rates on two financial instruments of the same maturity maychange if perceptions about such characteristics change.The highly developed nature of financial markets in the United Statesand the wide range of choices for borrowing and lending have facilitated amassive expansion of outstanding debt. The large volume of debt can beseen as a sign of economic and financial vigor, but at times it can also beworrisome. Servicing the debt could be a problem in a period of economicretrenchment, when corporate profits and personal income tend to weaken. Inaddition, with market development has come increased integration amongthe various financial instruments, an outcome that may speed the transfer ofcredit problems from one part of the financial markets to another.Market participants often distinguish financial instruments withmaturities of a year or less from those with longer initial maturities. Themarket in which instruments with shorter maturities are issued and traded isreferred to as the money market. The money market is really a market forshort-term credit, or the option to use someone else’s money for a periodof time in return for the payment of interest. The money market helps theparticipants in the economic process cope with routine financial uncertainties.It assists in bridging the differences in the timing of payments andreceipts that arise in a market economy. Borrowers rely on it for seasonal orshort-term cash requirements; lenders use it to offset uneven flows of funds.By providing a means for funds to be placed temporarily, the moneymarket also permits borrowers to time their issuance and lenders to timetheir purchases of bonds and equities in accordance with their forecasts ofstock prices and long-term interest rates. (Table 1 lists characteristics of anumber of money market instruments.)Markets dealing in instruments with maturities that exceed one year areoften referred to as capital markets, since credit to finance investments in newcapital would generally be needed for more than one year. The time divisionis arbitrary. A long-term project can be started with short-term credit, with