money market versus capital market

Financial markets are the places — physical or, today, mostly electronic — where people buy and sell financial instruments such as loans, bonds, and shares. Just as a vegetable market matches sellers and buyers of carrots, financial markets match those who have money to lend with those who want to borrow, and set a price (the interest rate or the share price) in the process. The most useful way to carve them up is by time horizon: the money market versus the capital market.

The money market is where short-term money is borrowed and lent, for periods of up to about a year. The instruments traded — Treasury bills, commercial paper, short-term bank loans between banks — are low-risk, highly liquid, and close to cash; this is where governments and big firms manage their day-to-day cash and where you can park money safely for a short while. The capital market is where long-term funds are raised, for years or decades, through bonds and shares (stocks). This is where a company finances a new factory or a government funds a railway, and where savers commit money to long-lived, riskier, higher-returning assets. A second cut is the primary market (where new bonds and shares are first sold to raise fresh money) versus the secondary market (where those securities are then traded among investors, like a second-hand market).

These markets matter because they decide the price and availability of finance for the whole economy. A healthy capital market lets good long-term projects get funded; a smooth money market keeps cash flowing so that solvent firms do not fail simply because they cannot get short-term funds. When the money market seizes up — as it did in 2008, when banks suddenly stopped lending to each other overnight — even healthy companies can be starved of cash, which is one of the fastest ways a financial problem becomes an economic one.