Macroeconic Impact on Business Operations

Running head: MACROECONOMIC IMPACT

Macroeconomic Impact on Business Operations

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University of Phoenix

MBA / 501

Macroeconomic Impact on Business Operations

The following analysis will be conducted on the Macroeconomic Impact on Business Operations. This analysis was conducted to observe the affects of monetary policy on macroeconomic factors that influence GDP, unemployment, inflation, and interest rates. It will also identify tools used by the Federal Reserves to control money supply, explain how these tools influence the money supply and macroeconomic factors, elucidate how money is created, and give a recommendation on monetary policy.

Tools used by the Federal Reserves to Control Money Supply

The Federal Reserves has an immense impact on the macroeconomic business operations of the government. The three sets of tools that allow the Chairman of the Federal Reserves to steer, influence, and control money supply are going to be identified in detail in this analysis.

Banks borrow money in order to lend money, and money stimulates the economy, and the Spread between the Discount Rate (DR) and the Federal Funds Rate (FFR) is one of such tools that provide this type of control. The two main sources to borrow money from are the Federal Reserves and other banks. If the Federal Reserves charges a DR lower than the FFR (which is offered by banks), then the bank would be inclined to take advantage of this discount. So, if the DR decreases the spread between DR and FFR increases, this simply has the affect that banks will likely borrow more money from the Federal Reserves instead of other banks. At the same time, this influences the macroeconomic business operations of the government, since the total amount of money in the system is increased, and this allows more consumers to borrow money to spend more money. This is a typical multiplier effect scenario. However, if the DR increases, the spread will end up positive, and banks will borrow from other banks. This situation will have no effect on the money supply, and the Chairman will lose an important tool that controls money supply. For this reason, the individual chosen as Chairman of the Federal Reserves has to have these fundamentals in economics, or else it would have an adverse effect on the economy as a whole.

The Required Reserve Ratio (RRR) mandated by the Federal Reserves is another of the tools used to control money supply. Banks are required to hold a percentage of the deposits as a reserve. Banks can hold these reserves either in their vaults or with the Fed. If the so called ratio is, in example, decreased, banks can then hold a lesser amount as a reserve and lend out to their customers more money, thus increasing the money supply in the economy. On the other hand, if the RRR is increased this will decrease the money supply in the system, and banks end up draining the system.

Open Market Operations is the other tool used in this analysis to control the money supply. The open market operations consist of buying and selling government securities, such as Treasury Bills, and bonds to commercial banks and the public (McConnell & Brue, 2004). The sale of these instruments can if sold drain the money out of the system, and if bough it can release money back into the system. If the later occurs, the expectation of money released back into the system is usually higher then the original contribution due to the multiplier effect.

The Federal Reserve Act, Section 2A-Monetary Policy Objective states that “The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates” (Federal Reserve, 2003). This objective can be accomplished by means of the three tools used to control the money supply: the discount rate, reserve requirements, and open market operations. The Board for the Federal Reserve System controls the money supply indirectly by controlling the banks’ ability to create credit through the discount rate and the reserve requirement, while the Federal Open Market Committee controls the money supply directly through open market operations. Of the three tools, open market operations are the Federal Reserve most important instrument for influencing the money supply (McConnell & Brue, 2004).

How the Tools Influence the Money Supply and Macroeconomic Factors

Various factors affect money supply. In this analysis only three major ones will be taken in consideration. These are: Real Gross Domestic Product (GDP), Inflation Rate, and the Unemployment Rate.

As the money supply in the system increases, the more it stimulates both investors and industrial/consumer demand. Real GDP also increases with the increasing of money supply. Therefore, consumer spending and investments come to a hold the lower the real GDP is, due to the draining of money supply in the system. This can happen during a time in which the government is increasing expenditures for defense purposes, relations of trade embargoes improve (in example the U.S. and a foreign market), or if the President implements a tax cut.

The inflation rate increases as the money supply increases. This happens due to too many people chasing too few goods. The value of money though remains the same, but prices increase. This signalizes a greater chance for inflation rates. Tax cuts can also have an adverse affect on inflation.

The unemployment rate is inversely related to the GDP, such as when increased spending creates more opportunities for employment. The workforce tends to experience more unemployment as the demand for products and goods comes to a halt, and this puts pressure on the economy, making the unemployment rate go up, as well the money supply is less, since less spending is being done by the government. The same can happened when cheap imports from