Question

Macroeconomic Impact on Business Operations

In a 1,400-2,100-word APA-formatted analysis, discuss monetary policy and its effect on macroeconomic factors such as GDP, unemployment, inflation, and interest rates.

a. Explain how money is created

b. What are the tools used by the Federal Reserve to control the money supply?

c. How do these tools influence the money supply and in turn affect macroeconomic factors

d. Which combinations of monetary policy help you to best achieve a balance between economic growth, low inflation, and a reasonable rate of unemployment?

Answer 1

Monetary Policy and its effect on macroeconomic factors

A monetary operations in a country requires proper system to control its optimum operation. Several economists believe that the long-run effects of money is laid on prices, but it is also proven by researches that in the short run monetary disturbances have impact on real variables such as output.

• Monetary policy and Price stability

The primary objective of a market-based economic system is price stability. the inflation rate is affected by monetary policy but is of uncertain duration and variable intensity, which brings the role of central bank's to control inflation. For all the developing nations it is important to control inflation and strive for price stability for economic growth. Inflation raises both income inequality and poverty which hinders the smooth functioning and growth of the economy.

• Foreign trade and economic growth

Modern growth theories suggests that developing countries can improve their economic growth rate by adopting foreign-capital-based development strategy. developing countries do not have enough money flow to support investment and economic growth rates. this can be achieved by attracting foreign capital inflows or also known as external borrowing of money to support the domestic resources of the country. A sound foreign trade policy can help a country to accelerate its economic growth rate.

• Interest rates and monetary policy

The restrictions or expansions of funds in the market can directly influence inflation, purchasing trends and also production levels. the central banks controls the money in the market by increasing or decreasing the discount rate, repo rate and reverse repo rate. Such actions will lead to either reduced money supply in the market or surplus of the money.

• GDP and Monetary policy

Increase in capital within an economy impacts the aggregate spending or aggregate investment. this proves that there is a significant relationship between aggregate demand and monetary policy. Contractionary monetary policy decreases money supply which leads to an equal decrease in the nominal output or better known as Gross Domestic Product (GDP) and vice-versa.

a) Creation of Money

The creation of money or the amount of money created largely depends on the country's monetary policy. It is controlled by setting interest rates. With the help of interest rates the central bank controls the contraction and expansion of money supply in the market. A lower interest rates attracts the businessman to lend money from the bank which in-turn brings more cash flow in the market.

b) Tools used by federal reserve to control money supply

The main instruments of monetary policy are

• Bank rate - it refers to the rate of interest at which the Fed bank rediscounts approved bills of exchange. when the central bank increases the bank rate, credit becomes expensive for commercial banks and they increase the interest rates which ultimately makes loans a less attractive option.
• Open market operations - this includes the direct sale and purchase of securities by the central bank, such as govt. securities, foreign exchange etc. When a central bank offers securities for sale, the quantity of money and credit is contracted.
• Reserve ratios - there are two major ratios: Cash reserve ratio (CRR) and Statutory liquidity ratio (SLR)

CRR refers to liquid cash which has to be maintained by bank with the central bank as a certain percentage of their demand and liability. Increasing the CRR reduces the upward pressure on inflation.

SLR is the percentage of demand and time maturities that bank have in any or combination of Cash, Gold and Unencumbered approved securities.it is maintained to control the expansion of bank credit.

c) Monetary policy tools influencing money supply

As explained above, all of these tools affect the money supply in the market in one way or the other. all these measures are taken for contraction or expansion of money supply in the market. the macro economic factors such as GDP, Inflation, Unemployment can all be treated with the optimum supply of money in the economy. therefore all these tools not only helps the central bank in controlling the money supply but also helps the country in managing its economic growth and poverty alleviation.