Interest rates can hurt the decisions taken by firms. For instance if we assume that the prices of trucks are increased by Big Drive Auto. In this case, if the interest is lowered than its previous year, it will drive down the prices of the vehicles. Intuitively it can be seen that as there is an increase in interest rates, there will be a negative demand for borrowing money as borrowing will become dearer. This will lower aggregate demand. As there is a fall in aggregate demand, there will be a decline in the demand for goods in the market, which will be reflected through less demand for products in the market. In effect, firms will face less demand, which will force them to drive down their prices. This effect has been continuously seen in the case of Big Auto Drive. As the interest rates fell (FRB, 2009) there has been a decline in the Price Indexes for Gross Output by Industry (BEA, 2009).
Table shows the correlation between interest rates and gross output in motor industry in the US. The correlation table shows that there is a negative relation between gross output and interest rates. An intuitive explanation for this is that as interest rates increases, there are fewer takers of loans from banks as the bank rates also increases and loans become dearer. This reduces the flow of money in the economy and consequently firms invest less leading to lower output by firms. Thus, higher interest rates increase the cost of operating a business and vice versa.
|Interest Rates||Gross Output by Industry|
|Gross Output In Motor Vehicle industry||-0.207966777||1|
Table 1: Correlation Between Interest Rates And FGross Output
A yield curve is a line that measures the ratio of interest rates and the time of maturity of a debt in a country. In other words, it is “the spread between the interest rates on the ten-year Treasury note and the three-month Treasury bill” (Estrella & Mishkin, 1996). This provides a beneficial tool for forecasting (Estrella & Mishkin, 1996). The current US yield curve is upward sloping with diminishing marginal increases implying as we move right, the curve becomes flatter. This indicates that the market is expecting risk-free interest rates in near future. This is because there are longer-term bonds have higher rates than the lower ones, indicating that there are expectations of interest rates in long-term is expected to decline and there is greater demand for long-term bonds.
Table 2 is a correlation analysis of vehicle sales (in thousands) for Big Drive Auto and interest rates. The correlation we get is positive. Intuitively it can be said, that as there is an increase in interest rates, the aggregate demand shrinks in the economy because loans become dearer. This reduces the aggregate demand in the economy, which is demonstrated through a negative relationship between interest rate and gross output of motor vehicles in the economy. Further, the correlation between interest rates and vehicles sales for Big Auto Drive shows that there is a negative relation indicating when there is an increase in interest rate, i.e. a restrictive monetary policy, the demand for vehicles reduces.
|Interest Rates||Vehicle Unit Sales (thousands)||Gross Output by Industry||Service Revenue (thousands of constant dollars)|
|Vehicle Unit Sales (thousands)||-0.45009||1|
|Gross Output by Industry||-0.20797||0.91965||1|
|Service Revenue (thousands of constant dollars)||-0.27541||0.642251||0.533926||1|
Table 2: Correlation Analysis
Other variables on which business planning is dependent are exchange rates. This is because today all businesses shave become increasingly global which increases the interaction of the firm with foreign companies. A strong exchange rate always gives the advantage of reducing the cost of production and vice versa. Further, if the exchange rate change is predictable and stable then the risk of exchange rate risk reduces considerably.
BEA. (2009). Industry Economic Accounts. Bureau of Economic Analysis. Web.
Estrella, A., & Mishkin, F. S. (1996). The Yield Curve as a Predictor of U.S. Recessions. New York. Web.
FRB. (2009). Federal Reserves Statistical Release . FRB: Statistics and Historical Data. Web.
U.S. Treasury. (2009). Daily Treasury Yield Curve. U.S. Treasury. Web.