Macroeconomic Impact On Business Oerations

Macroeconomic Impact on Business Operations

One of the greatest mysteries of macroeconomics is that banks create the money. This can be understood easier by viewing it as bank debt. A checking account is nothing more than money the bank owes you and paper money represents something that the Federal Reserve owes you (Schenk). Money creation is a side-effect of banking. To completely understand how banks create money it is best to go back to before there were banks and the Federal Reserve. This paper will explain how money was created from its beginning, the inception of the monetary policy and how the monetary policy affects inflation, GDP, unemployment, and achieving a balance between them all.

Before banks evolved in the 16th and 17th centuries, commodity money of gold and silver were used to purchase needed items. Theses metals are heavy and storing large amounts is risky and expensive, carrying them on long trips was dangerous. When used in coined form, it is difficult to determine quality and quantity or weight of the coins. This is because people were known for filing or shaving bits from the coins they obtain before they pass it on to others. Another problem is sweating, this is when people take the coins and shake them in a bag to create gold flakes which are saved for later use. In both cases not all gold coins are of equal value and some of the advantages of the coins are lost (Schenk). The first banks evolved in England due to these deficiencies. Goldsmiths became the fist bankers. This is because merchants needed places to temporarily store large amounts of gold. Goldsmiths were chosen because they had the best security systems of the day (Schenk).Merchants stored the gold with the goldsmiths and in turn the goldsmiths gave them a statement indicating how much money they had deposited (Schenk). Paper money evolved rapidly shortly thereafter. When a merchant wanted to buy a product they could return to the goldsmith to reclaim the gold or sign over the statement from the goldsmith to someone else to collect the gold (Schenk). Because this option was more popular the goldsmiths began issuing statements mad out to not one person but to the bearer. This is the point when money was created. The statement should change hands many times before the gold was retrieved. At this point in the story, no additional money has been created. The statements that are out equal what is being stored with the goldsmith (Schenk).

Once goldsmiths began to realize the gold in their vaults was rarely withdrawn, an opportunity for profit was realized. The goldsmiths learned that they could lend gold and collect a fee, or interest from the borrower (Schenk). If this is done the amount lent to someone is now circulating as new money. The promises to pay depositors were still there but now gold that has been in the vault "backing up" the paper was also circulating (Schenk). Another way of borrowing began to take place. Instead of taking the loan in the form, of gold, the borrower accepted the paper IOU's or statements from the goldsmiths. This transaction also increases he amount of money in circulation. When the goldsmiths began to create money, their careers as bankers began (Schenk).

In 1913 the Federal Reserve Act gave the Federal Reserve the responsibility of setting the monetary policy (Federal). The monetary policy is the actions taken by a central bank, e.g. the Federal Reserve, to influence the availability and cost of money and credit to assist in promoting national economic goals (Federal).

There are three tools of monetary policy. They are open market operations, the discount rate, and reserve requirements. The Federal Open Market Committee is responsible for the open market operations (Federal). The open market operations consist of purchases and sales of U.S. Treasury and federal agency securities. These are the Federal Reserve's principal tool for implementing the monetary policy (Federal Reserve). The specific short-term objective for open market operation changes over time and currently if poised towards the attainment of its long term goals of price stability and sustainable economic growth (Federal Reserve).

When the Federal Reserve Board wants to expand the economy it will use the method of buying securities. This increases the excess reserves of commercial banks while reducing commercial bank holdings of securities. This allows them more money to offer the public in loans to help the economy. When securities are pushed from the public, commercial bank excess reserves increase, but only by the amount the reserve ratio allows (Ramblings). This is because the public deposits the payment from the Federal Reserve Board into their bank accounts and only the portion required by the reserve ratio is put in reserve. However, when the Federal Reserve wants to shrink the economy it will sell securities, Commercial banks purchase the securities by using their reserves. , thus, decreasing the amount of money available for loans to the public. This decrease in reserves is also only by the amount allotted by the reserve ratio (Ramblings).

The discount rate and reserve requirements are governed by the Board of Governors of the Federal Reserve (Federal). These three tools influence the demand for and supply of balances that depository institutions hold at the Federal Reserve Banks and in this way alters the federal funds rate (Federal). The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility (Discount). There are three discount programs offered: primary credit, secondary credit, and seasonal credit, each has its own interest rate (Discount). Under the primary credit program loans are extended for a short term to depository institutions (Discount). For those who are not eligible for the primary credit may apply for secondary credit to meet short-term needs or to resolve severe financial difficulties. Seasonal credit is extended to small institutions that have recurring intra-year fluctuations in funding needs, such as in agricultural or resort communities (Discount). The Federal Reserve board can increase or decrease the discount rate as necessary. When the rate is lowered the reserves in commercial banks increases and so does short-term lending (Ramblings). By raising the discount rate lending from the Federal Reserve is discouraged and commercial banks turn to each other to borrow funds