Macroeconomic Impact on Business Operations Term Paper

Pages: 5 (1479 words)  ·  Style: APA  ·  Bibliography Sources: 3  ·  File: .docx  ·  Topic: Economics

Macroeconomic Impact on Business Operations

1a) the main tool used by the Federal Reserve to control money supply is interest rates. The main rate the Fed changes is the overnight bank rate, also known as the federal funds rate. This either lowers or raises the cost of money to banks. A lowering of the rate increases the profit margin on a new loan, which encourages banks to lend more money, thus putting it into the economy. A raising of the rate discourages lending, tightening the money supply.

The Fed also controls money supply through what is known as open market operations. This involves the purchase of U.S. government securities from financial institutions. The Fed essentially creates a credit on the bank's balance sheet to pay for these securities. This gives the bank new liquid reserves, which it can then lend out.

The third way in which the Fed controls money supply is through fractional reserve requirements. The reserve is a portion of each deposit that is held back. The remainder is what the bank is allowed to lend. Thus, a change in the fractional reserve requirement increases or decreases the amount of total deposits that the bank is allowed to lend. Because banks lend to other banks, the amount that is allowed to be lent is multiplied fivefold.

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1b) Interest rates do not create money per se, they merely stimulate either investment or savings in the marketplace. This impacts directly the amount of money that is being invested back into the economy. The reason for this is that money not spent - in other words money that is being saved - is money that is not being put to a productive economy purpose. Naturally, a certain amount of savings is healthy for an economy because the ideal situation is that a society's consumers and corporations are in sound fiscal shape. However, savings do not stimulate growth, spending does.

TOPIC: Term Paper on Macroeconomic Impact on Business Operations Assignment

On a macroeconomic level, this is reflected in the federal funds rate, which impacts interbank lending. When the federal funds rate increases, the spread between the cost of money for banks and the amount they charge their customers to borrow increases. This encourages lending, which in turn puts more money into the economy. When the federal funds rate decreases, the spread for banks does as well, discouraging them from putting more money into the economy.

Whereas the federal funds rate affects the likelihood of banks to lend out existing money, open market operations create new money. They increase the liquid reserves of banks, so that the banks have more money to lend.

Reserve requirements also affect the amount of money that banks can lend, but rather than dealing with new money, they affect the amount of existing money that is legally available for lending.

Once money enters the marketplace, it impacts every macroeconomic factor. It affects unemployment in that if the economy is recording growth, then investments can be made into expansion and diversification. This in turn creates jobs. The economy is unlikely to grow in an environment when savings rates are high, so in such situations fewer jobs are created, putting upward pressure on unemployment rates.

Inflation is also impacted by money supply. If growth becomes overheated, that is to say the economy grows at a rate where demand outstrips the ability of the economy to provide supply, then an inflationary environment is created. This drives price increases that in turn stifle growth, because the value of money is diminished. The Fed uses the money supply to keep inflation in check - if inflation starts to set in, rates are increased thereby discouraging investment. The net result either way is that for a time investment is discouraged, but the difference is that the Fed maintains control over this key macroeconomic factor. Inflation can get out of control, and when this happens there is a risk of catastrophic damage to the economy, even total collapse. But if the Fed has control over inflation, this will not happen. Moreover, the economy can be stimulated if need be simply by lowering rates again.

The GDP is also affected. When money enters the economy, it is used to purchase goods and services, increasing the GDP. When the money supply is tightened, the GDP can drop, because money is effectively being taken out of the economy. GDP increases and decreases multiply as well. If new money is used to purchase a good or service, the… [END OF PREVIEW] . . . READ MORE

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Macroeconomic Impact on Business Operations.  (2008, April 3).  Retrieved September 24, 2021, from https://www.essaytown.com/subjects/paper/macroeconomic-impact-business-operations/9870457

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"Macroeconomic Impact on Business Operations."  3 April 2008.  Web.  24 September 2021. <https://www.essaytown.com/subjects/paper/macroeconomic-impact-business-operations/9870457>.

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"Macroeconomic Impact on Business Operations."  Essaytown.com.  April 3, 2008.  Accessed September 24, 2021.
https://www.essaytown.com/subjects/paper/macroeconomic-impact-business-operations/9870457.