Macroeconomic Impact On Business Operations

Macroeconomic Impact on Business Operations

Introduction

The monetary policy consists of three tools used by the Federal Reserve, also known as the Fed, to control the money supply; open-market operations, reserve ratio, and the discount rate. These tools influence the money supply and in turn affect macroeconomic factors such as the gross domestic product (GDP), the unemployment rate, the inflation rate, and the interest rate. ЃgMost economists believe that monetary policy influences economic activity and prices by affecting the availability and cost of money and credit to producers and consumers.Ѓh (Meulendyke, 1998, p. 189). The goal of the Fed is to use the correct combinations of monetary policies to achieve a balance between economic growth, low inflation, and a reasonable rate of unemployment.

Federal Reserve Tools

Open-Market Operations

The Fed uses the publicly traded (open) market to buy and sell government securities to and from commercial banks and the public. There are three common types of government securities; bonds, notes, and bills issued by the U.S. Treasury and managed through the Fed. The Fed issues new treasury bonds and notes through the Treasury Direct program and issues new treasury bills (T-Bills) at auction at any Federal Reserve Bank. The FedЃfs open-market committee (FOMC) meets regularly to evaluate the economy and decide whether to buy or sell securities therefore, changing the supply of money in circulation. ЃgOpen-market operations are the FedЃfs most important instrument for influencing the money supply.Ѓh (McConnell & Brue, 2004, p. 270).

Influences

The Fed uses the open-market operations tool frequently to influence the economy in the direction the FOMC has decided. The GDP, inflation rate, and unemployment rate are key macroeconomic indicators affected by the decisions of the FOMC. When the FOMC decides to buy securities the committee is trying to boost the economy. The GDP Ѓgthe total market value of all final goods and services produced in a given yearЃh (McConnell & Brue, 2004, p. 112) will increase as money enters the economy and businesses borrow that money to produce and sell products. The more money that enters the economy the more the inflation rate will rise because there is an excess amount of money compared to the supply of goods and services created. The unemployment rate will decrease because the money enters the economy stimulating businesses to borrow and purchase the resources (people) to produce products.

On the contrary, when the FOMC decides to sell securities the committee is trying to slow down the economy by taking money out of circulation that would otherwise be available for use in the economy. The GDP will decline as there will be less money to produce goods. The inflation rate will also decline as there is less money available compared to the supply of goods and services created. The unemployment rate will increase because businesses will not produce as much since there will less money to borrow.

Reserve Ratio

The Fed also uses the reserve ratio to control how much money is available to the economy. The Fed requires every bank that is a member of the Federal Reserve System to keep a percentage of deposits on hand and available to its customers. That percentage is set by the Fed and is typically around 10% of the total banks deposits. Therefore, Ѓgthe Fed can also manipulate the reserve ratio in order to influence the ability of commercial banks to lend.Ѓh (McConnell & Brue, 2004, p. 273). Adjusting the reserve ratio along with buying and selling securities on the open-market the Fed can manipulate the economy in any direction it desires.

Influences

Increasing the reserve ratio has a similar effect of selling securities on the open-market. Both of these actions result in less money available for banks to lend to its customers. Therefore, the GDP declines because there are fewer funds available to create products. Inflation also declines since there is less money available compared to the supply of goods and services created. Conversely the unemployment rises because there is less money available and businesses make less and need fewer people.

Decreasing the reserve ratio has a similar effect of buying securities on the open-market. Both of these actions result in more money available for banks to lend to its customers. Therefore, the GDP increases when more funds are available and production rises. Since production increases the need for more workers increases and therefore, the unemployment rate decreases. Whenever the GDP increases inflation is bound to follow. ЃgIncreasing the money supply will increase the rate of inflation. HereЃfs how: when the amount of money in the system is increased, the nominal value of money remains the same, but, as more money chases the same quantity of goods and services, the real value of money is decreased. As a result, prices go up, thereby signaling greater inflation rates.Ѓh (University of Phoenix, 2007).

Discount Rate

The third tool used by the Fed to control the money in circulation is the discount rate (DR). The DR is the rate at which the Fed lends money to the banks. ЃgJust as commercial banks charge interest on their loans, so too Federal Reserve Banks charge interest on loans they grant to commercial banks. The interest rate they charge is called the discount rate.Ѓh (McConnell & Brue, 2004, p. 274). When banks are needing to borrow money to increase their ability to lend and create money they compare the DR charged by the Fed to the rate banks charge each other, the federal fund rate (FFR). The Fed cannot change the FFR directly but uses the DR along with the reserve ratio and open-market monetary policies to affect the FFR to meet its goals.

Influences

Increasing the DR will have a similar effect of selling securities on the open-market. The increased DR will make borrowing money from the Fed undesirable and therefore, reduce the amount of available lending funds banks can offer to its customers. Since there is less money to lend the result will be a lower GDP, lower inflation, and higher unemployment. The Fed would increase the DR when it wanted to slow down the economy.

Conversely, decreasing the DR will have a similar effect of buying securities on the open-market. The decreased DR will be an incentive for banking institutions to borrow more money at the cheaper rate. This will cause more money to be available to lend to its customers. Therefore, the GDP increases since businesses