Macroeconomic Impact On Business Operations

Macroeconomic Impact on Business Operations

The Federal Reserve is able to determine the monetary policy for the entire nation. This monetary policy affects today’s business and is based on a number of macroeconomic factors which show the direction in which the monetary policy is heading. By carefully reading the signs of the macroeconomic factors the Federal Reserve is able to determine the best possible monetary policy in a given situation.

In the first section of this paper is explained the way money is created and injected to the U.S. money supply and an explanation of the monetary policies and how these policies are executed. The second part shows how the chosen monetary policy influences the macroeconomic factors and how this was shown in the simulation. The third section is about the influence the U.S. economy has on the European and if this can be avoided.

Money Supply

The Federal Reserve is the central bank in the United States and is called a banker’s bank and the Federal Reserve is the only bank in the U.S. who is able to pay their bills by issuing their own bank notes (Valentinyi, 2003). The Federal Reserve is able to influence the amount of money that goes around in the economy and the major tools for achieving this are the tools of monetary policy. These tools are (1) open-market operations, (2) the reserve ratio, and (3) the discount rate.

Open-market operations (1) is the most effective tool the Federal Reserve can be used to affect the amount of money in the economy immediately because this has direct impact on the reserves of commercial banks. The Federal Reserve can take two kinds of actions to influence the money supply and these actions are (1) selling securities or (2) buying securities. Both these actions can be done with either commercial banks or the public. The action taken depends on what the Federal Reserve is trying to achieve. When trying to decrease the money supply the Federal Reserve will sell securities and when trying to increase the money supply it will buy securities.

Assuming that the Federal Reserve wants to decrease the money supply it will do this by selling securities to the bank and the public. When commercial banks buy securities from the Federal Reserve this will immediately cut on their excess reserves, which means that they will have less money available to lend to the public. If the opposite is to be achieved then the Federal Reserve will start buying securities from commercial banks and the public. When doing so, the excess reserves from commercial banks will increase and this will enable banks to lend more money to the public.

The reserve ratio (2) is a way to influence the ability of commercial banks to lend to the public. The Federal Reserve will influence the money supply by either increasing or decreasing the reserve ratio. When an increase of the money supply is needed then the Federal Reserve will decrease the reserve ratio because this will increase the excess reserve from commercial banks. This will lead to opportunities for commercial banks to lend more money to the public which then will enlarge the money supply. If the opposite is wanted, a decrease of the money supply, then the Federal Reserve will raise the reserve ratio. This will diminish the excess reserve of commercial banks and therefore, the possibility to lend money to the public is reduced.

The discount rate (3) is the rate that is charged by the Federal Reserve to the commercial banks. Either an increase or decrease of the discount rate is usually followed by commercial banks (Peralte, 2007). This following of the Federal Reserve by the commercial banks is influencing the money supply. When the Federal Reserve increases the discount rate it means that the yield of the commercial banks will drop if they don’t charge their clients a higher interest rate and therefore, the commercial banks will almost automatically follow the development of the discount rate of the Federal Reserve. When the commercial banks have changed their rates it means that it will become more expensive for the public to purchase with loaned money. Because of the increase cost of lending this will decrease the money supply. Lowering the discount rate will make it less expensive for the public to purchase with loaned money and this will increase the money supply.

The above mentioned three instruments of monetary policy are used to stimulate the economy in times when the economy is facing recession and slowdown the economy when excessive spending pushes the economy into an inflationary spiral. Stimulating the economy is done through buying securities, lowering the reserve ratio, and lowering the discount rate and is called an easy money policy (expansionary). Slowing down the economy is achieved by selling securities, increasing the reserve ratio, and raising the discount rate and this is called a tight money policy (restrictive) (McConnel & Brue, 2004).

The effect of monetary policy on macroeconomic factors

Open market operations and adjusting the rate of the reserve ratio and the discount rate are measures to be taken when the Federal Reserve wants the economy to head into another direction. The state of the economy can be determined by looking at a number of macroeconomic factors. These factors are (1) GDP, (2) inflation, (3) unemployment and (4) interest rates.

In times when the GDP is low and the unemployment is going up action is need because these are clear signs that the economy is heading towards a recession. To avoid this, the Federal Reserve is enforced with the above mentioned measures, and by using these effectively the possibility of heading into a recession can be sized down to an acceptable level. The chosen monetary policy should ease (expansionary) the money supply in order to boost the economy and steer away from a possible recession.

When the GDP is heading down the Federal Reserve should take action by applying easy money policy. In the simulation (University of Phoenix, 2008) there was a moment when there was an Asian import threat. This thread could be attacked by increasing the spread between the DR-FFR, decreasing the RRR, and buying securities in order to get more money in the economy. The effects of these taken measures were that GDP performed better than first estimated. These measures also have a positive effect on the trade balance since they are compatible with achieving each other (McConnell & Brue, 2004).

When the economy is sluggish due to a raise of the price of raw materials then inflation might occur in the form of the cost-push inflation. This kind of inflation will have a negative effect on consumption because