Macroeconomic Impact On Business Operations
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In the following text, readers will form an understanding of what monetary policy is and the effect monetary policy has on macroeconomic facts such as gross discount products (GDP), unemployment, inflation, and interest rates. The text will also explain how money is created and give a combination of monetary policy that will best achieve a balance between economic growth, low inflation, and a reasonable rate of unemployment.
Monetary policy is the process governments and central banks use to manipulate the quantity of money in the economy to achieve certain macroeconomic and political objectives. The objectives are economic growth, changes in the rate of inflation, higher level of employment, and adjustment of the exchange rate. Monetary policy is categorized into two types; concrationary and expansionary. Concrationary (tight) monetary policy aims to reduce the amount of money circulating through the economy, and reduce short-term economic growth in exchange for higher (hoped-for) long-term growth. Expansionary (lose) policy, on the other hand, aims to increase the money supply and increase short-term economic activity at the expense of long-term economic activity. (Nematnejad, Aaron, 2008)
The primary measure of the economyÐ²Ð‚™s performance is the annual total output of goods and services, or as the process is called, the aggregate output. Aggregate output is labeled gross domestic product (GDP): the total market value of all final goods and services produced in a given year. (McConnell and Bure, 2004). The monetary value of all the finished goods and services produced within a countrys borders in a specific time frame, though GDP is usually calculated on an annual basis. It includes all private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.
GDP = C + G + I + NX
“C” is equal to all private consumption, or consumer spending, in a nations economy.
“G” is the sum of government spending.
The gross discount product is commonly used as an indicator of the economic health of a country, to gauge a countrys standard of living. Critics of using the gross discount product as an economic measure say the statistic does not take into account the underground economy – transactions that for whatever reason, are not reported to the government. Others say that the gross discount product is not intended to gauge material well-being, but serves as a measure of a nations productivity, which is unrelated. (Heakal, Reem, 2008)
The unemployment rate tells macroeconomists the percentage of the total workforce that is unemployed, however, the people are actively seeking employment and willing to work. Measuring the employment rate is done by first determining who is eligible and available to work; these people are considered potential members of the workforce or group one. Group two is comprised of those people not employed but not seeking work. The third group is called the labor force; in 2002 this was approximately 50% of the population. (McConnell & Brue, 2004) Macroeconomists agree that when the economy has experienced growth from time to time, which is identified in the gross discount product growth rate, unemployment levels are seemingly low. The reasoning behind this is the rising of gross discount product levels. Knowing if the output is higher the more laborers are needed to keep up with the higher levels of production. However, when the levels of gross discount products are low, the rate of unemployment rises and potential goods and services are lost.
The third main factor that macroeconomists look at is the inflation rate, or the rate at which prices rise. Inflation is primarily measured in two ways: through the Consumer Price Index (CPI) and the Gross Discount Product deflator. The Consumer Price Index gives the current price of a selected basket of goods and services that is updated periodically. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living. The GDP deflator is the ratio of nominal GDP to real GDP. The GDP deflator shows how much a change in the base years GDP relies upon changes in the price level. This is also known as the Ð²Ð‚ÑšGDP implicit price deflator.Ð²Ð‚Ñœ (Hekal, Reem, 2008)
The most powerful weapon in the FedÐ²Ð‚™s arsenal is the ability to influence the direction of interest rates. Interest rates are the yearly prices charged by a lender to a borrower in order for the borrower to obtain a loan. This is usually expressed as a percentage of the total amount loaned. When interest rates are low, capital is easier to acquire. This can spur economic development because, human nature being what human nature is, the more cash that is available to spend, the more likely the item being purchased will be purchased with cash at that moment; however, this leads to inflation, as businesses realize they can charge higher prices for their goods and services. Suddenly, everything cost more. (Kennon, Joshua, 2008) With the increase in prices the need for more money becomes a huge demand for the consumer.
The matter of money creation is poorly understood. A common misconception is that banks or governments create money. Governments only borrow money into existence from the banks. Banks can and do manage and redistribute money and wealth. Only people and natural resources represent potential wealth. Only people can, by their labor, produce useful wealth, which can be traded, either 1) directly by barter, 2) through the use of currency, or 3) through the creation of money. Remember, all people who buy or sell are producers or consumers, are traders. (Kurmm, Paul, 2007)
Money is created when a trader makes a commitment, by buying goods or services from other traders, to place goods or services in the marketplace of equal value. In making purchases, traders borrow against their future production if they do not currently have a trading surplus. Money is created as evidence of that debt. Putting goods and services back on the market repays the debt and extinguishes the money. In other words, money is borrowed into existence and is extinguished as the loan is repaid. The effective lender, or guarantor of a loan is all the traders who trade with the borrower in short the community; the market. (Kurmm, Paul, 2007).
Another way of explaining how money is created is, if a bank makes a loan, nothing is lent, for the simple reason that nothing of substance