America’s financial system constitutes of several entities including the banking system, nonbank financial institutions, and financial markets, all of which function to coordinate the exchange of funds between borrowers and lenders. The role played by the financial system has both direct and indirect influences on the Gross Domestic Product, inflation rate, and the unemployment rate in America.
The GDP is a strong indicator of the strength of a country’s economy and according to UNEP, deepening of financial systems positively correlates with the GDP per capita (2015). Stronger financial systems ease lending rates with regards to interest rates and this results in increased consumption and production hence the positive correlation. However, the UNEP report also acknowledges that the relationship may turn negative if the financial institutions are too strong due to wastes and speculative investments. An example of the negative effect of strong financial systems is the Great Recession that was witnessed in 2007/2008.
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While inflation is common in the economy, researchers have identified a negative relationship between high inflation rates and the performance of financial systems. High inflation rates result in a decrease in the value of fixed assets, and this factor represents a decrease in returns. Due to this reduction, financial institutions are forced to increase their lending rates, and they make fewer loans which further impacts their financial power.
As is the case with regards to the relationship between America’s GDP and its financial institutions, the unemployment rate is also characterized by a positive correlation with financial performance. The emergence of new firms is dependent on the availability of finances, and these allow for the creation of employment opportunities. An illustration of the positive correlation is the Great Recession where financial institutions witnessed significant weakening. This resulted in significant layoffs by multiple economic sectors to allow for maximization of profits.
Reference
United Nations Environmental Programme (2015). Effects of Financial System Size and Structure on the Real Economy. Retrieved February 23, 2017, from http://unepinquiry.org/wp-content/uploads/2015/11/Effects_of_Financial_System_Size_and_Structure_on_the_Real_Economy.pdf
