Page 80 - Introduction to Business

54 PART 1 The Nature of Contemporary Business

National security, particularly after government through taxes, since private investors will not supply them. What we
the events of September 11, 2001, need to ask ourselves is, how do taxes affect economic goals such as real GDP
has been greatly enhanced through growth, inflation, employment, and exchange rate stability? Income taxes reduce a
various types of government
expenditures, including the funding person’s disposable income, which is the money left over after taxes are taken out
of vehicle searches to detect trans- of a person’s paycheck. As disposable income is reduced, you are forced to spend
port of illegal substances and less; this in turn reduces consumption expenditure at the national level and low-
ammunition. ers GDP growth. A lower GDP
growth rate means business
will hire fewer additional work-
ers. Reduced consumption will
cause inflation to drop. Con-
versely, if taxes are lowered, eco-
nomic growth and employment
will increase. More specifi-
cally, if taxes on businesses
are lowered, business people
will want to invest more in
plant and equipment to pro-
duce more goods and serv-
ices, thereby increasing GDP
level and growth. From this
brief discussion it is clear that
fiscal policy (i.e., government
expenditure and taxes) has a
disposable income The money left over significant impact on economic goals and business performance. Depending on
after taxes are taken out of a person’s which economic goal the government wants to impact, fiscal policy can be
paycheck
designed to have the appropriate effect.

Monetary Policy. The second major tool of macroeconomic management is
monetary policy A policy followed by monetary policy. Simply put, monetary policy deals with the control of money supply
the central bank (the Fed in the United in an economy. Central banks in various countries (the Federal Reserve System in the
States) to control the money supply in
an economy, and hence to manage United States, the Bank of Japan in Japan, or the European Central Bank in the case of
inflation, economic growth, the European Union) work through their commercial banking system to control or
employment, and the exchange rate manage their country’s money supply. A central bank’s primary objective is to make
sure that there is sufficient money (currency, checking deposits, and savings deposits)
available in the economy to promote economic (GDP) growth with low inflation.
When the money supply is excessive, interest rates will fall in the short term and con-
sumers and investors alike will be induced to borrow and spend freely on stereos, fur-
niture, cars, houses, plant, and equipment. This could become inflationary—too
much money chasing too few goods—in the long term. When the U.S. Federal Reserve
(Fed) wants to stamp out inflation, it will tighten (reduce the U.S. money supply) mon-
etary policy; this will raise interest rates in the short term and curb borrowing by con-
sumers and business. This will slow consumption and investment expenditure (and so
will slow GDP growth), reduce inflation, and also cause unemployment to rise. A major
objective of central banks in developed economies is to keep inflation under control
(i.e., low). Countries with low inflation will have stable currencies, which will make
investors, domestic and foreign, happy since they reduce foreign exchange risk and
increase investors’ confidence in that economy. Germany is an excellent example of a
country that has consistently followed tight monetary policy, which has resulted in low
inflation and a stable currency. The nature of monetary policy—the impact of money
supply on output, employment, inflation, and exchange rate—is a fascinating area of
research for economists and policymakers. Another monetary policy tool available

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