Macroeconomic Impact on Business Operations

Macroeconomic Impact on Business Operations Free Online Research Papers Macroeconomic Impact on Business Operations The Federal Reserve Board uses tools to control the money supply in the United States, which are open-market operations, the reserve ratio, and the discount rate. These tools influence the money supply and affect macroeconomic factors, which I will discuss in detail. I will also explain how money is created in a macroeconomic system, and recommend monetary policy combinations to best achieve a balance between economic growth, low inflation, and a reasonable rate of unemployment. Feds Tools of Monetary Control The Fed has three tools that are used for monetary control in altering the reserves of commercial banks. The money supply is the total amount of currency plus deposits held by the public. These tools can alter economic growth, change the rate of inflation, the level of employment, and adjust the exchange rate, by expansionary or contractionary monetary policy. Open-Market Operations The amount of money circulating in the economy can be adjusted through open-market operations, specifically with selling and purchasing of U.S. Treasury and federal agency securities bonds in the bond market. The Federal Open Market Committee (FOMC) will decide on a short-term objective for open market operations. This objective can be a chosen quantity of reserves, or a desired price (federal funds rate). The federal funds rate is the interest rate at which commercial banks lend balances at the Federal Reserve to other depository institutions overnight. †If the Fed believes that the economy is overheating (if the supply of money is outpacing production of goods), it will raise interest rates and bring money supply down to what it perceives to be the â€Å"equilibrium† level. With the same thought, if the Fed believes economic growth is outpacing money supply (causing deflation/less inflation), it will reduce interest rates. When interest rates are lower, it’s che aper for individuals to take out loans to start new businesses or buy goods and services. This also discourages them from keeping their money in a bank account, because they would make less interest† (NematNejad, 2007). The open-market operation is considered the most common tool used by the Fed, because bonds are bought and sold every week day in New York City. The Reserve Ratio The Fed has control over the reserve ratio, which determines the lending ability of commercial banks. The reserve ratio stipulates how much a bank is required to keep in reserves relative to what is in deposits. If a bank has a reserve ratio of 15%, the required reserve on $10 million in deposits is $1.5 million. The required reserve ratio is dictated to be certain banks do run out of cash on hand to meet the demand for withdrawals. The money not required in be on hand is then loaned out to customers, which in turn, increases the money supply. The Discount Rate The Federal Reserve Bank is a lender of money to commercial banks. When commercial banks borrow from the district central bank with a promissory note, the interest charged is referred to as the discount rate. The borrowed money will then increase the commercial bank’s reserve, which increases their lending ability. The discount rate is determined by the Fed, and this will be the cost of attaining the reserves. If the Fed were to lower the discount rate, more commercial banks would be inclined to borrow to obtain additional reserves, which would lead to more money in the economy. The same works in reverse for decreasing the money supply. Creation of Money Using the tools previously identified, the Fed can increase the supply of money, in other words, create money. During a period of expansionary monetary policy, decreasing the reserve ratio will result in more money commercial banks are able to lend to customers. By lowering the discount rate, the Federal Reserve Bank will lend more money to commercial banks. With commercial banks increasing reserves, the amount available for lending increases, which results in increases in the money supply. The open-market operation of buying and selling of government bonds is the most commonly used tool the Federal Reserve Bank uses to create money. If the economy is showing signs of recession and unemployment, the Fed will buy securities to increase commercial bank reserves. By increasing the commercial bank reserves, as previously discussed, the lending of the reserves will result in the creation of money. The goals of reaching low inflation, economic growth and a reasonable rate of inflation may sometimes conflict with one another. â€Å"One kind of conflict involves deciding which goal should take precedence at any point in time. For example, suppose theres a recession and the Fed works to prevent employment losses from being too severe; this short-run success could turn into a long-run problem if monetary policy remains expansionary too long, because that could trigger inflationary pressures. So its important for the Fed to find the balance between its short-run goal of stabilization and its longer-run goal of maintaining low inflation† (Federal Reserve Bank of San Francisco, 2004). Recommended Monetary Policy Monetary policy has become the policy of choice when determining the levels of the money supply. The advantages over fiscal policy are the speed and flexibility, and the isolation from political pressure (McConnell and Brue, 2004). Using the open-market operation, the Fed can purchase or sell government securities daily to affect the money supply and interest rates without much delay. Working in combination with reserve requirements, and discount rates, the Federal Reserve Bank can manipulate the application of monetary policy to achieve a balance between economic growth, low inflation, and a reasonable rate of inflation. The easy money policy was applied to the recession of 1990. The decision to increase the supply of money increased the aggregate demand which resulted in the use of inactive resources. The decision to increase the money supply may have an adverse effect on the economy; excessive spending. Overactive spending may lead to an inflationary economy, which is remedied by selling securities, increasing the required reserve ratio, and raising the discount rate offered to commercial banks. The policy incorporating these actions is called a tight money policy. The reason for a tight money policy is to decrease spending and control inflation. To achieve an environment of a stable economy, finding the balance between easy and tight money policies is crucial. A quote from Milton Friedman (1968) states The first and most important lesson that history teaches about what monetary policy can do and it is a lesson of the most profound importance is that monetary policy can prevent money itself from being a major source of economic disturbance. Managerial Decision Making In the University of Phoenix simulation (2008), scenarios are presented to students regarding monetary policy. The student is allowed to make decisions which affect the Real Gross Domestic Product (GDP), inflation, and unemployment levels. In the first scenario, global developments have caused the economy to sag, and industrial production to slow. Although inflation looks to be under control, the Real GDP is falling, and unemployment is on the rise. The solution to this scenario can be a combination of increasing the Discount Rate (DR) Federal Funds Rate (FFR) percentage spread, raising the reserve ratio slightly, and selling approximately $750 million in government securities. The results of my choices were almost a 1% increase in the Real GDP, a tenth of a percent rise in inflation, and a 0.8% drop in unemployment. By selling securities, the supply of money goes up, along with inflation. The unemployment rate does the opposite of Real GDP. If investment and spending rises, demand rises, therefore, increasing the opportunities in the workforce. Unemployment will decrease with the rise of the Real GDP. Ideas from the simulation on how to use monetary policy tools of discount rate, reserve ratio, and open-market operations helps me understand how the supply of money is controlled. Conclusion The three tools of monetary policy include the open-market operations, the required reserve ratio, and the discount rate. Together, these tools will be applied to either expansionary or contractionary policy during times of recession or growth. The policies will influence those who can create money. As the Fed lowers the required reserve ratio, banks have more flexibility when lending money. Lowering the discount rate allows commercial banks to borrow more from the Federal Reserve Bank, which also increases the availability of money for lending. But the most commonly used tool is the open-market operation, where the government sells and buys securities to increase commercial bank reserves. The tool is used every day of the week. Monetary policy is the policy of choice, with its speed and flexibility, and separation from political pressure. The Fed can act quickly to respond to inflation, unemployment, and economic growth. References Brue, S.L., McConnell, C.R. (2004). Economics: Principles, Problems and Policies, 16e. The McGraw-Hill Companies Federal Reserve Bank of San Francisco. (2004). About the fed. Retrieved February 1, 2008, from frbsf.org/publications/federalreserve/monetary/goals.html Friedman, Milton, The Role of Monetary Policy, American Economic Review, 1968: p.12. NematNejad, A. (2007). Best way to invest. Monetary policy. Retrieved February 2, 2008, from bestwaytoinvest.com/monetary-policy. University of Phoenix, (2008). Economics for managerial decision making [Computer Software]. Retrieved February 2, 2008, from University of Phoenix, rEsource, Simulation, MBA501-Forces Influencing Business in the 21st Century Web site. Research Papers on Macroeconomic Impact on Business OperationsTwilight of the UAWIncorporating Risk and Uncertainty Factor in CapitalThe Effects of Illegal ImmigrationPETSTEL analysis of IndiaAnalysis of Ebay Expanding into AsiaOpen Architechture a white paperDefinition of Export QuotasGenetic EngineeringBionic Assembly System: A New Concept of SelfResearch Process Part One Macroeconomic Impact on Business Operations Free Online Research Papers Macroeconomic Impact on Business Operations Monetary policy is a strategy that is used by the federal government to influence the economy. Having monetary authority allows the government to control the supply and availability of money (Federal Reserve, 2009). Along with the monetary policy, political objectives have a strong influence on the economy and its growth. The main goal of our government is to implement â€Å"macroeconomic stability†, which includes low unemployment, low inflation, and steady economic growth (The Financial Pipeline, 2009). This paper will discuss how money is created, and how factors such as GDP, economic growth, inflation, and unemployment are affect by the monetary policy. Money creation is a tool that is used to produce or issue money. The process of money creation takes place in three ways. The first step is by manufacturing and distributing paper currency or metal coins. Second, money is distributed through debt, lending, and government policies. The regulation, production, and the redemption of money are regulated through the Federal Reserve (Federal Reserve, 2009). The Federal Reserve determines the operation of financial markets and the purchasing power of money throughout the U.S. economy. Within the Federal Reserve is the regional bank, which in turn measures the money supply. These regional banks within the Federal Reserve are private banks that control the issuance of â€Å"debt-backed† money to the government (The Financial Pipeline, 2009). The Federal Reserve is responsible for implementing monetary policies that help regulate the economy. The Federal Reserve conduct’s the nation’s policy by influencing monetary and credit policies. They also supervise and regulate the banks in order to ensure the consistency and safety of the nation’s financial system. Lastly, the Federal Reserve provides financial services to depository institutions, and foreign official institutions. It also plays a major role in the operation of the U.S. payment system (Federal Reserve, 2009). In order to stimulate the economy, the Federal Reserve implements the federal funds, which are the reserve balances that private banks keep at their local Federal Reserve Bank. The reason for keeping money at the Federal Reserve Bank is to maintain a strategy that allows for private banks to loan money to one another. This financial market system plays a vital role within the Federal Reserve because it influences the use of monetary policy. This action in turn influences the use of monetary policy and it determines the amount of money that the private banks charge each other for the lending of those federal funds (Federal Reserve, 2009). The Federal Reserve consists of 12 Federal Reserve Banks. These 12 banks distribute banking services to depository institutions and also to the Federal government. These banks are also responsible for maintaining accounts, providing various payment services that include collecting checks, electronically transferring money, and lastly distributing and receiving currency and coin (Federal Reserve, 2009). When it comes to retail, the Federal Reserve provides a series of financial services that deal with wholesale payments. According to Ghatak Sanjers (2007), retail payments are small dollar amounts that include a depository institution’s retail clients, which consist of small and large businesses. Wholesale payments are reserved for large dollar amounts, these depository institutions are typically for large corporations. Monetary policy has a strong influence on the economy when it comes to inflation. In our economy there are two types of inflation, which are monetary inflation and price inflation. Monetary inflation deals with an increase in the money supply. Price inflation deals with the steady increases of the level prices, which in turn determines the value and purchasing power of money (Steele, 2008). If there is a fast increase in money and credit over a certain period of months, it will usually result in price inflation. According to Ghatak Sanjers (2007), when it comes to price inflation a dollar buys less and less over time. Monetary and price inflation can have a negative impact on the economy. Lenders lose money because the value of a dollar isn’t worth as much, businesses struggle with projecting future plans and, in turn lead to decrease in projects. Mortgage companies really suffer from inflation, because monetary inflation increases long-term interest rates (The Financial Pipeline, 2009). Those long-term interest rates typically leads to a decrease in consumer spending because people are less likely to make major purchases such as homes and cars, b ecause of high interest rates. The overall goal of implementing monetary policy within the U.S. economy is raising or lowering interest rates based on the demand for goods and services (Steele, 2008). Changes with interest rates affect the demand for goods and services by determining borrowing costs, the availability of loans, the income of households, and foreign exchange rates. Long term interest rates are a reflection of the financial markets expectations of what the federal government will do in the future (The Financial Pipeline, 2009). When it comes to the concern of inflation the financial markets add a risk premium to long-term rates, which in turn will make interest rates higher. If there is a decrease in interest rates, the cost of borrowing is lower, which is good for business growth. It is also good for economic growth, because it leads to an increase of supply and demand. Another result of lower rates is valuable bonds and higher stock prices. Individuals, who have stock that is valued high, are more likely to spend more, and businesses are more willing to invest. Monetary policy affects inflation by the demand to enforce labor and capital markets beyond their abilities (Federal Reserve, 2009). If the monetary policy is persistent with maintaining low short-term rates there will be an increase in interest rates, which in turn could deter spending. So in order to deal with inflation, the goal is to decrease the money supply in the economy. Reduction of excess money would lead to a decrease in aggregate demand, and would help reduce the level of price inflation (Ghatak Sanjers, 2009). Monetary policy also plays a critical role on employment and the labor market. The federal government structures the labor market through paying unemployment insurance benefits, determining the minimum wage, raising or lowering income taxes, and lastly setting the rules and guidelines for labor unions to operate. Also employment, is influenced by government investment and the infrastructure, this includes schools, roads, and parks. These places have an effect on the amount of money paid to the labor force. The government’s monetary policy has an effect on the cost and availability of money and credit through the demand for labor. When there are high levels of unemployment, the Federal government must be consistent in order to ensure the demand for money is growing fast enough (Ghatak Sanjers, 2009). One strategy for the government is to try to lower the unemployment rate by stimulating the growth of the money supply. An outcome of this strategy could possibly be a boos t in economic activity, but it doesn’t stabilize the rate for high unemployment. Even though bringing more money into the economy sounds like a legitimate reason to help a weakening economy, though it doesn’t mean it is a reasonable cure. Higher wages and prices could mean an unreasonable change in economic growth, which in turn can lead to inflation and businesses could stop hiring (Steele, 2008). By the federal government establishing the monetary policy, they are constantly looking for ways to keep the unemployment and inflation levels low. When there is a steady economy, reducing doubt in the marketplace is crucial for companies and its workers. This way more businesses and investment decisions can be made, which can lead to the hiring of more employees. Having stability allows the economy to grow and produce at high levels. Currently, the nation’s unemployment rate is at 9.8 percent. According to The Financial Pipeline (2009), many Americans have become frustrated when it comes to looking for work. In the U.S. employers cut 263,000 jobs last month and there were more than 200,000 layoffs for the month of August. Since the recession began there has been a loss of more than 7.2 million jobs. Those numbers are terribly high, and could possibly get worse. The high loss of jobs will affect consumer spending negatively. In order for the unemployment rate to improve, the industries of renewable energy, healthcare, and construction will have to experience a steady rate of growth (Ghatak Sanjers, 2009). Overall, in order to have a balance of a healthy economy and steady employment there has to be a steady pace of revenue, strong interest rates, and economic growth. The monetary policy is a reflection of the government’s ideal of regulation and trade within the economy. References Federal Reserve. (2009). Federal Reserve Bank of San Francisco. Retrieved from www.frbsf.org Ghatak, S., Sanjers, W. (2007). Monetary policy rules in transition economies: the impact of ambiguity. International Journal of Development Issues, 6(1), 50-55. doi:Cengage Learning Steele, D. (2008). The alliance takes on the reserve bank and its effect on jobs. Monetary Policy and Employment. Retrieved from www.jobsletter.org.nz/jbl08410.htm The Financial Pipeline. (2009). Monetary Policy. Retrieved from www.finpipe.com Research Papers on Macroeconomic Impact on Business OperationsTwilight of the UAWPETSTEL analysis of IndiaQuebec and CanadaThe Effects of Illegal ImmigrationAppeasement Policy Towards the Outbreak of World War 2Analysis of Ebay Expanding into AsiaIncorporating Risk and Uncertainty Factor in CapitalThe Project Managment Office SystemDefinition of Export QuotasGenetic Engineering