Impact of Macroeconomic Variables on Financial Lending Sector

Abstract

The purpose of this paper is to show how economic principles are applicable in the business decision making process with an emphasis on a variety of macroeconomic variables. The financial crisis of 2007 explicitly indicates that the American banking system is vulnerable to financial shocks brought about by changes in external factors. The ability of banks to lend money to small and medium businesses can be examined through the analysis of these external variables. The following scenario is the proposed business whose owner requires advice on the various macroeconomic aspects that are in play before he takes the next step in funding the project. Cousin Edgar wishes to invest in the petroleum industry by purchasing four gas stations. He figures this investment will pay off because the American clientele have long accepted the high prices of gas products. He also reckons that the prices will continue to increase because of the high demand for gasoline across the world especially in countries such as India and China. Cousin Edgar is also convinced that he can make substantial financial gains from the selling of convenience goods at each station. He intends to get a loan from the bank so that he can finance his new business venture. However, before he takes the loan he needs to be aware of other macroeconomic factors that might have an effect on his bank’s ability to grant him funding for his startup business. These macroeconomic factors that should be taken into account for this specific organization include the GDP growth rate, loan interest rates, and level of unemployment in the country, the business cycle, fiscal policy, monetary policy, international trade and the demographics of the country.

GDP Growth Rate

The GDP growth rate is essentially a measure of the change in the gross domestic output. Lower GDP growth rates are a clear indicator that there is less probability that a loan application will result in the loan being approved by the financial institution. In addition to this, the negative effect of low GDP is stronger on businesses that have lower liquidity or capital (Iacoviello, 2014).

Business Cycles, Unemployment, Inflation

Business cycles refer to the fluctuations in economic activity across the country. Economic activity here includes production and trade. There is significant evidence that shows a strong correlation between loan approval and business cycles. Business cycles are primarily caused by the collapse of the established flow of resources between lenders and borrowers. The borrowers default on making payments and this results in them paying back less than what was initially agreed upon. During periods of recession, the banks, the major financial lenders, will reduce the supply of loans to all sectors of the economy (Jimenez et al., 2009).

On the other hand, inflation is seen to be harmful to the banking sector due to the adverse effects it has on the sector. This is the same case even if the rate of inflation is fairly modest. Inflation is responsible for reducing the overall amount of credit facilities available to the population. Higher rates of inflation decrease the real rate of return on assets thus discouraging savings but stimulate borrowing. Unfortunately, the new borrowers are more likely to default on their loans and this discourages banks from lending out money to the population as well as the fact that the loans provided have lower rate returns. Inflation and business cycles is a major contributor to systemic unemployment in a country (Azariadis & Smith, 1996).

International Trade

Banks play an essential role in international trade. Banks have gone to the extent of opening foreign subsidiaries in order to support the foreign businesses that deal in international trade. If the bank loan supply and demand decrease, then international trade will be adversely affected.

Monetary Policy and Interest Rates

Higher short term interest rates also have a negative impact on the ability of the financial institutions to provide loans to start up businesses. This is due to the fact that higher interest rate levels diminish the net worth of the borrowers. This makes borrowers less inclined to borrow funds from the banks. It also causes strain between the banks and the borrowers when it comes to repaying the loans. High interest rates are seen to decrease both the demand and supply of loans (Brunnermeier & Sannikov, 2010).

The Federal Reserve can also use monetary policies and interest rates in order to control inflationary pressures. Changing the interest rates will have an effect on the aggregate demand by influencing the demand for loans for both households and businesses. The open market operations policy is widely used in this regard (Goodfriend & McCallum, 2007). If the Federal Reserve views that the economy is increasing too fast, it will apply a restrictive monetary policy. This is achieved by increasing the interest rates to restrict inflation. If the economy is seen to be growing at an undesirable slow state, the Federal Reserve will use expansionary monetary policies by effectively reducing interest rates and enticing more people to borrow funds from banks and invest these funds (Claeys et al., 2008).

Fiscal Policy and Unemployment

An increase in unemployment in the country will definitely deter banks from providing loans to borrowers. This is due to the risk factor associated to lending funds to new business projects while many people are defaulting on their loans due to their lack of income. One of the main fiscal policy tools that the government uses to combat unemployment is taxation. High taxes will result in diminishing aggregate demand of goods and services which advertently leads to unemployment. By reducing the taxes, the government wants to reduce the level of unemployment in the nation. Lower taxes will ensure that people have enough disposable income to consume, hire new staff and expand their businesses or start new ones. Expanding their businesses might require the business owners to take loans from the banks (Kaplan, 2002).

Demographics

Demographics are the descriptions of the population; its composition and structure. The demographics of the population can influence the supply and demand of bank loans. Recognition of informal property rights is essential especially in poor communities. This is because such property can be used as collateral when applying for loans. Where such laws do not exist, it is difficult for these individuals to acquire loans that can be used to start and/or expand their businesses.

Recommendations and Justification

Cousin Edgar should take all these macroeconomic variables into account if he is intent on acquiring a loan to fund his new business venture. The GDP in the US is seen to be recovering from the last financial crisis although at a small rate. This, however, should not deter him from seeking a loan from the bank. He should also closely monitor the unemployment levels in the country and the monetary policies used to correct the problem. Restrictive or expansionary monetary policies will have an impact on the interest rates applied. He should be able to determine whether he can adequately pay back his loan under these interest rates. The demographics of his community, international trade and business cycles, will also determine the availability of the loans he wishes to acquire.

References

Azariadis,C., & Smith, B. D. (1996). Private information, money and growth: Indeterminacy, fluctuations and the mundell-tobin effect. , , 309-332.

Brunnermeier, M., &. Sannikov, Y. (2010). . Unpublished manuscript, Princeton University.

Claeys, P., Moreno, R., & Surinach, J. (2008). Fiscal policy and interest rates: the role of financial and economic integration.

Goodfriend, M., & McCallum, B. T. (2007). Banking and interest rates in monetary policy analysis: A quantitative exploration. , (5), 1480–1507.

Jimenez, G., Ongena, S., Peydro, J., & Saurina, J. (2009).The impact of economic and monetary conditions on loan supply: identifying firm and bank balance sheet channels.

Kaplan, J. (2002). The federal reserve and monetary policy.

Iacoviello, M. (2014). Financial business cycles. Retrieved from < https://www2.bc.edu/~iacoviel/research_files/FBC.pdf‎ >

Submitted by economics homework help services