Macroeconomic Impact On Business Operations

Macroeconomic Impact on Business Operations

Currency maintains its value because people will accept it in exchange for goods and services. They accept it because they know they will also be able to exchange it for goods and services.

In addition to functioning as a medium of exchange, money also serves as a unit of value-a single measure for assessing the value of all the various goods and services produced and sold in an economy. Moreover, money is also a store of value- a way of accumulating wealth so it can be used at a later date. Stocks and bonds serve a similar function because they can be quickly converted to money. In essence, money is the most readily available form of wealth.

Economists have many definitions of money or, more accurately, the money supply. The money supply includes money as one usually think of it, plus various bank deposits and financial instruments. The fact that money is both a medium of exchange and a store of value points to one of the major type of demand for money: Asset demand.

Asset demand is the amount of money that people in an economy wants to hold as money, usually in bank accounts or in the form of near money, such as shares in money market funds.

As the newly appointed Chairman of the Fed, one of my key focus areas would be to control the nation's economy by choosing an appropriate monetary policy. Monetarists believe that changes in the money supply are the most important factor determining the level of GDP, and that the Feds should permit steady, non-inflationary growth in the money supply. (Siegel, G.2006)

The Federal Reserve System ("the Fed") is the central bank of the United States. The Fed oversees and regulates the commercial banking system and formulates and implements monetary policy. The goal is to keep the economy on a path of steady growth, with low inflation and low unemployment being the major keys underlying this growth. Failure to maintain the economy on a path of steady growth and low inflation will eventually lead to quarters of recession.

The banking system makes it possible for the Fed to change the money supply. Banks in the U.S. practice what is known as fractional reserve banking, as system that emerged when early bankers realized that only a small percentage of deposits would be withdrawn on a given day. For instance, if the bank had total deposits of $100 million dollars, perhaps the most they would see withdrawn on a given day would be $10 million. This would leave the bank with $90 million available to lend to borrowers. Depositors know their money is being loaned out, and they are comfortable with that.

Reserve requirements are funds-in the form of cash and other liquid assets-that a bank must, by law, keep in its vaults or on deposit with the nearest Federal Reserve Bank. The reserve requirements are a percentage of the bank's demand deposits and occasionally, time deposits. Currently the requirement is 10 % of demand deposits.

As Fed Chairman, the use of moral suasion, lowers the reserve requirement, banks have more money to lend. A lower reserve requirement increases the supply of loanable funds and speeds up the growth of the money supply. That is because having to keep less money in the vault or at the Federal Reserve Bank, means more money available for banks to lend. If the supply of loanable funds increases, then interest rates decrease, and demand for loans increases. This is called loose, or easy, monetary policy and it is used to expedite the growth of the economy and combat unemployment.

The Fed's main tools of monetary policy: Open Market operations, changes in the discount rate and changes in the reserve requirements. The Fed does not "control" the money supply, let alone the economy. Instead, using these tools, the Fed influences the demand for and the supply of funds that banks must have on deposit at the Federal Reserve Banks. This, in turn, influences the federal funds rate, which in turn influences other interest rate, the availability of money and credit, and ultimately the economy. The Fed also uses these tools to influence the number of excess reserves-that is, the amount of loanable funds-in the banking system.

Open market operations refer to purchases of U.S. government securities from financial institutions and sales of U.S. government securities to financial institutions by Federal Reserve. Decisions about the purchase of securities in the open market are based on a directive from the Federal Open Market Committee (FOMC). Open market operations enable the Fed to increase the supply of reserves in the banking system. Purchases of securities by the Fed increase the supply of excess reserves. The money moves from the Fed to the banks when the Fed pays for the securities. Banks obtain the money and the Fed receives the securities.

This puts money-in the form of excess reserves-into the banking system. Increasing the supply of excess reserves increases the supply of funds that banks can lend to one another. This, in turn, decreases the fed funds rate and accelerates the growth of the money supply.

Open market operations occur business day and give the Fed the optimal flexibility in implementing monetary policy. If the Fed wants to increase the money supply, it buys bonds because in order to buy bonds the Fed must pay cash, which then circulates throughout the economy. By buying bonds in this way, the amount of money out in circulation can be very precisely controlled. Thus the Fed can keep tight rein over interest rates.

Changes in the discount rate are used less often by the Fed. The discount rate is the interest rate that the Fed charges on loans to member banks. These loans made at the Fed's discount window, are privilege rather than a right- which the Fed discourages banks from using. Historically, the rate has changed infrequently. In fact, it often remains the same even when monetary policy changes. Moreover, it is usually lower than the Fed funds rate. But the Fed does not allow banks to borrow at the discount rate and loan the money out at a higher market rates. Lower Fed funds rate means the banks are more willing to loan money because they have met their reserves at the mandate level.

The Monetary Control Act (MCA) of 1980 authorizes the Fed's Board of Governors to impose a reserve requirement of 8 % to 14 % on demand deposits, and of up to 9 % on non-personal time deposits. In practice, the relationship between reserve requirements and money creation is weak. The requirements apply mainly to demand deposits, leaving other accounts beyond the Fed's influence. Moreover, the Fed permits banks to acquire needed reserves from the money markets, as long as they are willing to pay the prevailing federal funds rate.

As a result, the Fed rarely