Macroeconomics

Macroeconomic Impact on Business Operations

“Job Weak, Unemployment Soars, More Cuts coming, and Bankruptcies Jump 40%.” These are typical headlines we see in the newspaper, internet, and journals. We also hear these in news, radio stations and office chats. These are valuable information that economists use to analyze economic situation of the country. These can also be information that individual use to guard their spending. Information like these provides major decision for individual and for the country as a whole.

For a country to be progressive, economic decision is of prime importance. Achieving full economic stability is dependent on a lot of factors. Two of the most widely used key indicator in economic decision is the country’s fiscal and monetary policy.

Monetary policy affects all kinds of economic and financial decisions people make in a country, whether to get a loan, build a new house, buy a car or to start up a business, whether put to savings in a bank, invest in a stock market, or invest in a capital asset. Because dollar is use as the standard unit of currency in international market, monetary policy of the United States has significant economic and financial effects on other countries. Just like monetary policy, fiscal policy also affects decisions people make in their finances. Both monetary and fiscal policies are controlled by the government to manage the supply of money, or trading in foreign exchange market.

Monetary Policy and Tools that Control the Supply of Money

“The Federal Reserve System is the central banking system of the United States. Created in 1913 by the enactment of the Federal Reserve Act, it is a quasi-public banking system composed of (1) the presidential-appointed Board of Governors; (2) the Federal Open Market Committee; (3) 12 regional Federal Reserve Banks located in major cities throughout the nation acting as a fiscal agent for the US treasury, each with its own nine-member board of directors; (4) numerous private U.S. member banks, and (5) various advisory council” (Federal Reserve System, 2007).

The most important policy making body of the Federal Reserve System is the Federal Open Market Committee. The Federal Open Market Committee composed of the seven Governors, the President of the Federal Reserve Bank of New York, and four other Reserve Bank presidents that serve on a rotating basis. The Federal Open Market Committee can affect monetary policy through the use of three tools (American Government and Politics Online, 2004).

“Open market Operations consist of buying of government bonds from or the selling of government bonds to, commercial banks and the general public” (McConnel-Brue, 2004, p. 270). Buying of bonds from commercial banks or the public increases the reserves of the commercial banks. The increase reserve of commercial banks increases their ability to lend to the public and thus increases the nation’s supply of money. Selling of securities on the other hand reduces commercial bank’s reserve, and thus reduces the nation’s money supply (McConnel-Brue, 2004).

Reserve Ratio is the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. Within limits specified by the law, the Board of Governors has the sole authority over changes in reserve requirements. Depository institutions must hold reserve in the form of vault cash or deposits with the Federal Reserve Bank (Reserve Requirements, 2007). Reserve ratio affects the money supply in a country, lowering reserve gives up portion of the money tied up as reserve which enhances the ability of banks to lend money. This also in effect increases the nation’s supply of money. On the other hand, increasing the reserve ratio decreases the bank’s ability to lend money, and thus decreases the nation’s supply of money (McConnel-Brue, 2004).

Discount Rate is the rate at which member banks may borrow short term funds directly from Federal Reserve Bank. The discount rate is one of the two interest rate set by the Federal, the other being the Federal funds rate (Discount Rate, 1997). “The Fed has the power to set the discount rate at which commercial banks borrow from the Federal Reserve Banks. From the commercial banks’ point of view, the discount rate is a cost of acquiring reserves. Lowering of the discount rate encourages commercial banks to obtain additional reserves by borrowing from the Federal Reserve Banks. When the commercial bank lends new reserves, the money supply increases” (McConnel-Brue, 2004, p 275). On the other hand an increase in the discount rate results in the opposite.

Monetary policy is one of the most widely used tools to influence the country’s economy. Using its monetary authority to control the supply and availability of money, a government can influence the overall level of economic activity to achieve its goal of full employment, economic growth and price level stability.

Macroeconomics Indicators

Macroeconomic indicators are statistical information that reflects economic situation of a country. Macroeconomic indicators are guidelines by which the Fed’s decision for monetary policy is based. The three most widely used macroeconomic indicators are GDP, unemployment rate and price index.

Gross Domestic Product is one of the primary indicators used to gauge the health of a country’s economy. GDP represents the total dollar value of all goods and services produced over a specific time period (What is GDP, 2007). Since GDP represents dollar value, it can be used as a tool for measuring monetary policy. GDP increase when interest rate and reserve ratio decreases. GDP increases when Federal Reserve buys bonds. Decrease in interest rate and reserve ratio will increase the supply of money which can then trigger investment spending and in effect increases GDP ((McConnel-Brue, 2004).

Inflation is simply rise in prices. Over time as the cost of goods and services increases, the value of dollar is going to go down, decreasing the buying power of the dollar. High rates of inflation are caused by the increase in the money supply (Inflation, 2008). Inflation is regarded as too many dollars chasing too few goods. By increasing reserve ratio and discount rate, and by selling bonds, supply of money decreases triggering a decreases in spending and aggregate demand. With less supply of money, and less demand, inflation declines (McConnel-Brue, 2004).

Unemployment is one of the primary indicators used to gauge the health of a country’s economy. Unemployment is a state at

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