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Effects on Macroeconomic Factors

Money, when used as a means of payment, is a medium of exchange that allows a more efficient distribution of goods and services. It also serves as a standard numerical unit by which the value of goods, services, and other transactions can be measured and compared to, as well as a store of value, where money can be stored and retrieved for future consumption. The amount of money available for purchasing goods or services in an economy is referred to as the money supply. The money supply affects many macroeconomic factors such as GDP, unemployment, inflation, and interest rate.

The amount of money a nation has, as well as the rate of its creation, therefore figures whether or not it would have a strong and stable financial system. Generally, in order to maintain a sound economy and maintain an optimal gross domestic product (GDP), a nation needs to maintain stable prices, keep inflation low, and moderate long-term interest rates. To achieve those ends and to ensure economic stability, the government makes use of various monetary policies that regulate the amount/availability of money (money supply). Policies that stabilize the money supply aims decrease inflation and increase employment rates.

A stable money supply means

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that the goods and services have optimal market value, translating to a higher GNP. The relationship of money supply and GDP is important because if the money supply grows at a faster rate than GDP, inflation is likely to follow. The government, particularly the Federal Reserve, thus aims to keep the creation or growth of money in line with GDP growth. Several economic theories hold that unemployment and inflation rates are caused by changes in the amount of money available in an economy. This means that controlling the money supply is a key to managing unemployment and inflation rates.

The money supply can be balanced through the buying and selling government bonds and securities. By buying securities, the government increases the money supply, thus lowering interest rates. Conversely, selling securities tightens the money supply. A tighter money supply lowers the level of spending of consumers and businesses. Tightening the monetary policy or limiting the total money supply available by raising interest rates is frequently employed to curb rising inflation rates. These policies also serve reduce unemployment rates and increase GDP.

On the other hand, increase in the money supply increases aggregate spending, creating an increase in prices and inflation. Higher costs excreted an upward pressure on the prices of goods and services, increasing the likelihood of inflation. When inflation pressures build up, spending restraints are encouraged. The government facilitates this by raising target interest rates, which will affect how much money member banks can lend. Since the rate of interest affects buying behavior, consumers will be more willing to borrow money to spend on goods and services.

Banks will also be able to lend more money to consumers and businesses should interest rates go down. The government can also increase the money supply by regulating reserve requirements of banks, and changing the interest rates imposed on member banks borrowing from the Federal Reserve.

Bibliography

A dictionary of business. (1996). Oxford: Oxford University Press. Stretton, H. (1999). Economics: a new introduction. Sydney, N. S. W. : UNSW Press. Droms, W. G. (1997). Finance and accounting for non financial managers: all the basics you need to know. Cambridge, MA: Perseus Books.

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