Macroeconomic Impact On Business Operation

Macroeconomic Impact on Business Operations

"Money, get away. Get a good job with good pay and you're okay. Money, it's a gas.

Grab that cash with both hands and make a stash. New car, caviar, four star daydream, Think I'll buy me a football team." This is the first verse of Pink Floyd's song, Money. It informs us that by having a good job and increasing one's wealth one can purchase a new car, enjoy fine dining or even purchase a soccer team. Hearing the lyrics to the song, a small child asked, "Where does money come from? Dad says, 'It does not grow on trees...'"

The easy answer to the child's question is one works for it. However, the literal answer is much more complex. One must look at macroeconomics and its exploration of trends in the nation economy as a whole considering an aggregate of economic factors. To answer the question one must defined the creation of money, identify any tools used to control the money supply, and explain the influence of the tools on that supply and any macroeconomic factors. In understating these concepts, one can recommend a monetary policy that best achieves a balance between economic growth, low inflation, and unemployment.

What is Money?

Some view money simply as a tool used to facilitate transactions. If that was the case, only things readily accepted in exchange for goods, services and other assets need to be considered. Many things - shells, stones - have served this function. In the United States, money used in transactions is of three kinds - currency (paper money and coins); demand deposits (non-interest bearing checking accounts in banks); and other checkable deposits at all depository institutions. However, only the cash and balance held by the nonbank public are counted in the money supply. Deposits of the U.S. Treasury, depository institutions, foreign banks and official institutions, as well as vault cash are excluded (Federal Reserve Bank of Chicago, n.d.).

In the U.S. neither paper currency nor deposits have value as a commodity. Coins do, but at far less than their face value. Its value is the confidence people have that they can exchange it for other financial assets and real goods and services.

This value is derived from its scarcity in relation to its usefulness. Money's usefulness is its ability to command other goods and services and allows the holder to do so constantly. Control of the quantity of money is essential if it value is to be keep stable. Money's real value is measured only in terms of what it will buy.

How is Money Created

The United States uses a fractional reserve banking system. In this system only a fraction of the total money supply is held in reserve as currency. The system has two significant characteristics: money creation and reserves and bank panics and regulation (McConnell & Brue, 2004, p. 253).

The actual process of money creation takes place primarily in banks, principally commercial banks. To begin this analysis, one must look at the bank's balance sheets. A balance sheet is a statement of assets and claims against the assets - liabilities and net worth. The checkable liabilities of the bank are money. These liabilities are customers' accounts. They increase when customer deposit currency and checks and when the proceeds of loans made by the banks are credited to the borrowers' accounts (Federal Reserve Bank of Chicago, n.d.). Banks can build up deposits by increasing loans and investments so long as they keep enough currency on hand to redeem whatever amount the holder of deposits want to convert into currency. This attribute was discovered centuries ago by goldsmiths.

As early bankers, they initially provided a safekeeping service, while making a profit from vault storage fees. On receiving a gold deposit, the goldsmith issued a receipt to the depositor. Soon everyone found it was easier to use the deposit receipt directly as a means of payment. These receipts, which became know as notes, were acceptable money since whoever held them could go to the "banker" and exchange them for metallic money or gold. It was soon discovered that it was possible to make interest-bearing loans merely by giving a promise to pay, or bank notes, to the borrower in excess of the gold held (McConnell & Brue, 2004, p. 253).

As stated before, the bank must keep available sufficient money to make payment on demand. It must be prepare to convert deposit money into currency for those depositors requesting it. It must make remittance on checks written by depositors and presented for payment by other banks. Finally, it must maintain legally required reserves, in the form of vault cash and or balances at its Federal Reserve Bank (Fed), equal to a prescribed percentage of its deposit. This helps the Fed control the lending ability of commercial banks - by preventing banks from overextending or under extending bank credit (McConnell & Brue, 2004, p. 256)

Granting loans is not the only method of creating money. Banks can also create money by purchasing government bonds from the public - adding the security to its asset while increasing the dealer's checkable deposit.

Thus far, this paper has concentrated only the creation of money. Given that the bank can create money, it can also destroy it. Money is destroyed when a loan is repaid, or when government securities are sold by the bank. In the case of a loan, the repayment causes a decline in the money supply by reducing the loan asset of the bank while increasing its cash or reserves asset. For the securities, the sale of the security reduces the banks securities asset and increases its cash or reserves asset. Remember currency held by a bank is not part of the money supply (McConnell & Brue, 2004, pp. 259 - 260).

Previously, it was mentioned that a fractional reserve system of banking has two characteristics. One being money creating and reserves. The other being bank panic and regulation. Giving the history of the fractional reserve banking, banking operating on this basis are vulnerable to "panics" and "runs." If a banker issued a note equal to twice the value of his reserves, he or she would be unable to convert all the notes in the event all the holders appeared at the same time demanding currency or gold. To prevent this, the U.S. government conducts periodic bank examinations to ensure prudent practices and insures individual deposits in the banks up to $100,000.

Tools of Monetary Policy

Table 1 is the most current Federal Reserve Banks' consolidated balance sheet. I can be used to explore how the Fed can influence the money creation

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