MONEY MARKET

a set of institutions, conventions, and practices, the aim of which is to facilitate the lending and borrowing of money on a short-term basis. The money market is, therefore, different from the capital market, which is concerned with medium- and long-term credit. The definition of money for money market purposes is not confined to bank notes but includes a range of assets that can be turned into cash at short notice, such as short-term government securities, bills of exchange, and bankers' acceptances. The details and the mechanism of the money market are complex and vary greatly from country to country, but in all cases the basic function, performed by middlemen providing a service for a profit, is to enable those with surplus short-term funds to lend and those with the need for short-term credit to borrow. In most countries the government plays a major role in the money market, acting both as a lender and borrower and often using its position to influence the money supply and interest rates according to its overall economic priorities (see monetary policy). Apart from domestic money markets, there is an international money market, which, although it utilizes many different mechanisms, provides fundamentally the same service by facilitating the borrowing, lending, and exchange of currencies between countries. Two of the oldest and most developed money markets are those of the United States and Great Britain. In Great Britain the money market is sometimes referred to as the discount market, because one of the key institutions in short-term money transactions are the 12 banks known as discount houses. The main function of discount houses is to buy short-term credit notes and to resell them. The two most important forms of these notes are the commercial bill of exchange, which is a short-term obligation by one party to pay another, and the treasury bill, which is a similar obligation issued by the government. Discount houses borrow call money (that is, money repayable on demand) from commercial banks in order to purchase bills of exchange or treasury bills, which they may resell at a profit to commercial or clearing banks. By lending call money to the discount houses, commercial banks earn interest on reserve assets not required for immediate operations, and by buying bills, which fall due on specific dates usually up to three months, they obtain a regular supply of funds. The government borrows from the banking system by selling treasury bills to discount houses, which sell them in the same way as bills of exchange. The discount and price attached to bills depend on their maturity (the date on which they must be redeemed) and the level of interest rates. The acceptability and price of commercial bills of exchange also depend on the reputation and standing of the issuer, although they may be guaranteed by one of the acceptance houses for a small fee based on the value of the bill. The government also acts as a lender of last resort. Thus, when commercial banks are short of cash and recall their call money from discount houses, the government, through the Bank of England, will lend to the discount houses at the official minimum lending rate, which includes a penalty component to discourage overuse. In the United States the money market operates on similar principles, but the institutions and the mechanisms are different. One of the unique features of the U.S. money market is the large number and great variety of participants. This is due partly to a much smaller degree of concentration in the banking system, because of severe restrictions on branch banking, and to the large number of financial and non-financial concerns handling short-term funds. Much of the business in bills of exchange and other liquid financial instruments is transacted by dealers who buy and sell in basically the same way as the discount houses in Britain, using a variety of sources for finance. There is a market for a wide assortment of financial instruments including bills of exchange, government securities, securities issued by official federal agencies, clearinghouse funds (deposits at one bank loaned to another), as well as time certificates of deposit issued by commercial banks. In addition to the availability of these and other financial instruments, the Federal Reserve System provides considerable short-term credit directly to the banking system. For many smaller banking operations, the money market is not always capable of meeting their needs for short-term funds quickly enough to cope with the inevitable peaks and troughs of their business. In situations like this, banks (as long as they are members of the Federal Reserve System) can obtain funding through their own Federal Reserve Bank at the non-penalty discount rate of interest. In addition, banks can acquire immediate funding through the Federal Reserve System at variable rates of interest known as the federal funds rate. The Federal Reserve System also participates on its own accord in the daily market, acting to smooth fluctuations in money supply and distribution and in interest rates. a set of institutions, conventions, and practices, the aim of which is to facilitate the lending and borrowing of money on a short-term basis. The money market is, therefore, different from the capital market, which is concerned with medium- and long-term credit. The definition of money for money market purposes is not confined to bank notes but includes a range of assets that can be turned into cash at short notice, such as short-term government securities, bills of exchange, and bankers' acceptances. Every country with a monetary system of its own has to have some kind of market in which dealers in short-term credit can buy and sell. The need for such facilities arises in much the same way that a similar need does in connection with the distribution of any of the products of a diversified economy to their final users at the retail level. If the retailer is to provide reasonably adequate service to his customers, he must have active contacts with others who specialize in making or handling bulk quantities of whatever is his stock-in-trade. The money market is made up of specialized facilities of exactly this kind. It exists for the purpose of improving the ability of the retailers of financial servicescommercial banks, savings institutions, investment houses, lending agencies, and even governmentsto do their job. It has little if any contact with the individuals or firms who maintain accounts with these various retailers or purchase their securities or borrow from them. The elemental functions of a money market must be performed in any kind of modern economy, even one that is largely planned or socialist, but the arrangements in socialist countries do not ordinarily take the form of a market. Money markets exist in countries that use market processes rather than planned allocations to distribute most of their primary resources among alternative uses. The general distinguishing feature of a money market is that it relies upon open competition among those who are bulk suppliers of funds at any particular time and among those seeking bulk funds, to work out the best practicable distribution of the existing total volume of such funds. In their market transactions, those with bulk supplies of funds or demands for them, rely on groups of intermediaries who act as brokers or dealers. The characteristics of these middlemen, the services they perform, and their relationship to other parts of the financial mechanism vary widely from country to country. In many countries there is no single meeting place where the middlemen get together, yet in most countries the contacts among all participants are sufficiently open and free to assure each supplier or user of funds that he will get or pay a price that fairly reflects all of the influences (including his own) that are currently affecting the whole supply and the whole demand. In nearly all cases, moreover, the unifying force of competition is reflected at any given moment in a common price (that is, rate of interest) for similar transactions. Continuous fluctuations in the money market rates of interest result from changes in the pressure of available supplies of funds upon the market and in the pull of current demands upon the market. Additional reading Glenn G. Munn, F.L. Garcia, and Charles J. Woelfel, Encyclopedia of Banking and Finance, 9th ed., rev. and expanded (also published as The St. James Encyclopedia of Banking & Finance, 1991), provides comprehensive definitions, many with bibliographies. Edward I. Altman and Mary Jane McKinney (eds.), Handbook of Financial Markets and Institutions, 6th ed. (1987), is a thorough compilation. Detailed information on a variety of markets is provided in Francis A. Lees and Maximo Eng, International Financial Markets: Development of the Present System and Future Prospects (1975), a descriptive treatment; Charles R. Geisst, A Guide to the Financial Markets, 2nd ed. (1989), for the general reader; Frank J. Fabozzi and Frank G. Zarb, Handbook of Financial Markets: Securities, Options, and Futures, 2nd ed. (1986); and Perry J. Kaufman, Handbook of Futures Markets: Commodity, Financial, Stock Index, and Options (1984), including the history, regulation, and mechanics of futures trading. Further discussion of financial futures is found in Mark J. Powers and Mark G. Castelino, Inside the Financial Futures Markets, 3rd ed. (1991), an explanation of the exchanges and their functions; and Nancy H. Rothstein and James M. Little (eds.), The Handbook of Financial Futures: A Guide for Investors and Professional Financial Managers (1984), a discussion of the market's development, organization, and regulation. The development and operation of the international capital market is addressed by M.S. Mendelsohn, Money on the Move: The Modern International Capital Market (1980). Reference works include Marcia Stigum, The Money Market, 3rd ed. (1990), comprehensive and readable; and Gunter Dufey and Ian H. Giddy, The International Money Market (1978). Timothy Q. Cook and Timothy D. Rowe (eds.), Instruments of the Money Market, 6th ed. (1986), explains such key instruments as Eurodollars, treasury securities, and federal funds. David M. Darst, The Handbook of the Bond and Money Markets (1981), is a practical guide. Money markets in countries in Asia and the Pacific are studied by Aron Viner, Inside Japanese Financial Markets (1988); Yoshio Suzuki, Money and Banking in Contemporary Japan, trans. from the Japanese (1980), analyzing Japan's participation in international capital markets; The Japanese Financial System (1978), published by the Bank of Japan, a brief description of financial institutions, financial markets, and characteristics of the financial structure; and Michael T. Skully (ed.), Financial Institutions and Markets in the Far East (1982), Financial Institutions and Markets in Southeast Asia (1984), Financial Institutions and Markets in the Southwest Pacific (1985), and Financial Institutions and Markets in the South Pacific (1987).