Macroeconomic Impact on Business Operations

Abstract

This paper focuses on Monetary Policy, which centers on connections between money, banks, and credit to lenders. In addition, this paper will cover the effect on macroeconomic factors such as GDP, unemployment, inflation, and interest rates. Additionally, an explanation on money creation and the implications of making money gives an insight on Money Supply and Macroeconomic Factors. With many combinations of monetary policy, the paper covers the optimal balance between economic growth, low inflation, and a reasonable rate of unemployment.

Money is any object that functions as a means of exchange that society accepts social and legal payment for goods and services and in settlement of debts. Ludwig von Mises (1953) looks at the nature and value of money, and its effect on determining monetary policy. Included is his regression theorem, which tries to explain why money demands are its own right, as moneys at first glance do not serve a consumable need. Mises explained that moneys only could come about after there was a demand for the money commodity in a barter economy (pg.259). The private sector exerts enormous demand, which it largely financed out of the liquidation of its holdings of short-term government paper, which forces banks to call the activation of its liquid reserves. "The treasury, in order to repay this short-term paper, had to fall back upon money creation by borrowing from the banking system" (Holtrop, 1972, pg. 287).

Banks create money in an effort to attract borrowers to take out loans. This allows the Feds to increase money creation for many sources of financing for budget deficits in all transition economies. In economics, the gains from money creation come from seigniorage and inflation tax (Korosteleva, 2007, pg. 33). "In advanced economies, seigniorage is usually not a tool for financing government expenditures, but rather a consequence of induced changes in monetary policy (the range usually being 0.5-1.5 percent of gross domestic product (GDP)" (Cukrowski, 2006, pg. 56). Seigniorage, which is the income that the government collects from printing money, and inflation tax are look upon as forms of implicit inequitable taxation of the economy (Korosteleva, 2007, pg. 35). The GDP, which is a monetary measure, uses a comparison between the relative values of the vast number of goods and services produced in different years.

The Fed uses three tools of monetary to control over the reserves of commercial banks. One is Open market operations (OMO); the other is the reserve ratio; and the third is discount rate. In addition, monetary policy promotes growth and employment but not without jeopardizing the stability of the price level and the equilibrium in the balance of payments (Holtrop, 1972, pg. 310).

The Fed's open-market operations consist of the buying, selling government bonds and dispersing them to commercial banks and the public. Open-market operations are the Fed's most influential instrument for the money supply. "Open market operation (OMO) is one of the major instruments of conducting the monetary policy in both developing and developed countries. Using this instrument requires a well-developed secondary financial market. OMO can be implemented by using either government or central bank (CB) securities" (Sweidan and Maghyereh, 2006, pg. 13).

The Fed influences the reserve ratio in order to influence commercial banks to lend. Raising the reserve ratio increases the amount of required reserves banks must keep. Therefore, banks lose excess reserves; lose ability to create money by lending, which forces contract checkable deposits and the money supply. "The incremental cash reserve ratio immobilizes the excess liquidity from where it is lodged rather than the average ratio which impounds equally from both banks which are slower growing as well as banks which are faster growing. Again, the incremental cash reserve ratio avoids the jerkiness of the average ratio" (Tarapore, 2007, pg. 4).

One of the functions of a central bank is to be a "lender of last resort." Oftentimes, commercial banks have sudden and instantaneous needs for additional funds. In addition, commercial banks charge interest on their loans; therefore, Federal Reserve Banks charge interest on loans they grant to commercial banks. The interest rate, that commercial banks charge, is the discount rate (Theilman, 1977, pg. 241). "Discount rate, money market rate, and capital market rate all show large and very significant differences between the years without restriction during which they go down and the years of restriction in which they strongly go up" (Holtrop, 1972, pg. 303).

The National Bank of Georgia uses the monetary policy to focus on achieving economic growth with minimal inflation to manage the day-today operations (Cukrowski, 2006, pg. 76). Currency privatization allows for currency reform options, which include greater loan funds to the private sector, where they supply effective economic growth. Currency privatization allows stable money stocks and less potential for bank-run "contagions," which eliminates information imbalance (Selgin, 2005, pg. 148). In addition, arguments of currency privatization are just as good as dollarization at preserving a fixed exchange rate, and better than a currency board at disposing of money-creation surpluses in a way, that benefits the domestic economy. In addition, currency privatization may dominate these more familiar currency reform options (Selgin, 2005, pg. 142).

Inflation can increase real tax revenue by interacting with progressive tax rate structure (Brennan and Buchanan, 1981, pg. 80). When dealing with a declining inflation, McCarthy (2007) contends the following:

One is that although external factors have contributed to the disinflation of the 1990s, their contribution mostly has been modest. Thus, much of the decline in inflation during this decade has come from other, presumably more permanent factors, indicating that central banks may have been successful in reducing inflation expectations. Another implication is that fluctuations in exchange rates and import prices will have modest effects on domestic inflation in the industrialized world unless domestic policy mistakes are made. Therefore, even in a more integrated world economy, domestic policies still have a significant role in controlling domestic consumer inflation. (p. 533)