Macroeconomic Effect on Business Operations

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Date Submitted: 09/02/2011 12:37 PM

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Macroeconomic Effect on Business Operations

In 1788, the fourth President of the United States, James Madison along with Alexander Hamilton wrote “If men were angels, no government would be necessary.” In other words, angels are seen as honest and righteous, so if government was seen in this light the United States would not necessitate a need for government. The human race would do exactly what it was supposed to do. However, this is not the case. One of the methods the United States government uses attempting to control the economy is its monetary policy. In this paper the identify tools are used by the Federal Reserve Board (FRB) to control the money supply and explain how these tools influence the money supply and in turn affect macroeconomic factors in the real-world. Included also is an explanation on how the FRB’s control on money supply effects the monetary policy simulation.

Tools used by the Federal Reserve

The Federal Reserve exercises considerable control over the demand for and supply of balances that depository institutions hold at the Reserve Banks. In so doing, it influences the federal funds rate and, ultimately, employment, output, and prices (Federal Reserve System, 2011, p. 3). The three main tools used by the FRB to control money supply are altering Reserve Requirements (RRR), adjusting the Discount Rates (DR), and Open Market Operations (OMO).

                OMO describes the buying and selling of U.S. government securities and it is the most common tool used. In an article by Daniel Thorton, he argues that Open Market Operations appears to be a relatively unimportant source of liquidity to the federal funds market (Thorton, 2007, p. 1). He goes on to conclude that contrary to conventional wisdom—that the Fed controls the federal funds rate through open market operations—I find little support of an important liquidity effect at the daily frequency (Thorton, 2007, p.568-569). However, the research that supports this paper is of the belief...