Macroeconomic Impact On Business Operations

Monetary policy is the process by which the government, central bank, or monetary authority manages the money supply to achieve specific goals--such as constraining inflation or deflation, maintaining an exchange rate, achieving full employment or economic growth. Usually the goal of monetary policy is to accommodate economic growth in an environment of stable prices. Monetary policy can involve changing certain interest rates, either directly or indirectly through open market operations, setting reserve requirements, acting as a last-resort lender, or trading in foreign exchange markets. Monetary theory provides insight into how to craft optimal monetary policy. [1.]

Monetary policy is generally referred to as either being an expansionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy has the goal of raising interest rates to combat inflation (or cool an otherwise overheated economy). Monetary policy should be contrasted with fiscal policy, which refers to government borrowing, spending and taxation. [1.]

There are many macroeconomic factors that the monetary policy effect. One of those factors are inflation. Webster defines inflation as a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services. Wages and prices will begin to rise at faster rates if monetary policy stimulates aggregate demand enough to push labor and capital markets beyond their long-run capacities. In fact, a monetary policy that persistently attempts to keep short-term real rates low will lead eventually to higher inflation and higher nominal interest rates, with no permanent increases in the growth of output or decreases in unemployment. As noted earlier, in the long run, output and employment cannot be set by monetary policy. In other words, while there is a trade-off between higher inflation and lower unemployment in the short run, the trade-off disappears in the long run. [2.]

It can take a fairly long time for a monetary policy action to affect the economy and inflation. And the lags can vary a lot, too. For example, the major effects on output can take anywhere from three months to two years. And the effects on inflation tend to involve even longer lags, perhaps one to three years, or more. [2.]

Monetary policy also affects inflation directly through people's expectations about future inflation. For example, suppose the Fed eases monetary policy. If consumers and businesspeople figure that will mean higher inflation in the future, they'll ask for bigger increases in wages and prices. That in itself will raise inflation without big changes in employment and output. [2.]

With dealing with monetary policies, research has shown that unemployment decreases. Recent monetary policy has helped control inflation which, in turn, has kept unemployment rates low. The wider economic community is reluctant to accept that monetary policy affects the underlying natural rate of unemployment. Unions may need to change their stance on interest rate control and its perceived negative impact on employment rates. The studies, reveal that wage rises have a greater detrimental impact on employment levels when monetary policies are aimed at stabilising inflation. Policy makers are assumed to be far more concerned about inflation and output. A stronger preference for low inflation, for example by targeting, results in lower unemployment rates. If this is the case, and the research strongly suggests it is, supporting monetary policy which seeks to control inflation, would be in the greatest interest of foreign trade.[3.]

Interest rates play a major part in monetary policies. For the most part, the demand for goods and services is not related to the market interest rates quoted in the financial pages of newspapers, known as nominal rates. Instead, it is related to real interest rates--that is, nominal interest rates minus the expected rate of inflation. [2.]

Long-term interest rates reflect, in part, what people in financial markets expect the Fed to do in the future. For instance, if they think the Fed isn't focused on containing inflation, they'll be concerned that inflation might move up over the next few years. So they'll add a risk premium to long-term rates, which will make them higher. In other words, the markets' expectations about monetary policy tomorrow have a substantial impact on long-term interest rates today. Researchers have pointed out that the Fed could inform markets about future values of the funds rate in a number of ways. [2.]

In the short run, lower real interest rates in the U.S. also tend to reduce the foreign exchange value of the dollar, which lowers the prices of the U.S.-produced goods we sell abroad and raises the prices we pay for foreign-produced goods. This leads to higher aggregate spending on goods and services produced in the U.S. [2.]

Another factor is gross domestic product or GDP. GDP is one of the ways for measuring the size of its economy. The GDP of a country is defined as the market value of all final goods and services produced within a country in a given period of time. It is also considered the sum of value added at every stage of production of all final goods and services produced within a country in a given period of time. The major advantages to using GDP per capita as an indicator of standard of living are that it is measured frequently, widely and consistently; frequently in that most countries provide information on GDP on a quarterly basis, widely in that some measure of GDP is available for practically every country in the world, and consistently in that the technical definitions used within GDP are relatively consistent between countries. [4.]

The major disadvantage of using GDP as an indicator of standard of living is that it is not, strictly speaking, a measure of standard of living. GDP is intended to be a measure of particular types of economic activity within a country. Nothing about the definition of GDP suggests that it is necessarily a measure of standard of living. [4.]

The argument in favor of using GDP is not that it is a good indicator