External environment

Introduction

No business can isolate itself from the external economic environment. Business has to take account of government economic policy, regulations and the state of the economy. In this section, the Virtual Bank advises you on how to make the best of all these factors. We explain relevant concepts and theories and also give you some worksheets to see how well you understand them all.

Follow the links below to the area you would like to look at in more detail:

Government policy - in this section we look at the different types of government policy, fiscal policy, monetary policy and supply-side policy.
Role of the US Federal Reserve Bank - in this section we look at how the Federal Reserve manages interest rates in the economy and the effects that these changes may have on businesses.
Economic indicators - what do all the different economic indicators mean and how important are they to businesses?

Each section has explanations of relevant theories and worksheets to help reinforce understanding.

The US Federal Government and US Banking

The United States is a large country, both geographically and economically. The US commercial banking system developed with a strong bias toward service of local communities. For many years the US had a unit banking system consisting of separate stand alone banks in almost any community of any size. A commercial bank in one state could not legally own other banks in the same state or in other states. As a result the US developed thousands of small community based banks. The biggest banks were in the major money centers, especially New York City, but because of the pronounced local bias, even the largest NYC banks were smaller than banks found in other countries. This was true despite the overall size of the US economy.

This local bias created a number of banking problems for which banks would often devise their own solutions. The multiplicity of small banks brought about a check clearing / payments problem. To resolve this issue, larger, correspondent banks would join forces with respondent banks to provide common clearing services. Similarly a growing business in a regional part of the US would often have difficulty finding a bank big enough to provide the periodic loans needed for effective business operation. Again local banks would work together with banks in larger cities to divide up responsibility for large commercial loans. Only since the 1980s has the US Government allowed the development of bank and financial holding companies. This change has been combined with new laws allowing banks to offer a much wider range of financial services. As a result the US banking business has been going through a period of major consolidation and change.

Part of the reason for the initial bias in the US for local, unit banking was the very process used by the States to create the US Federal Government. The US was initially a loose grouping of thirteen independent colonies. The federal government was created only when the colonies recognized the need to come together to create a central, federal government. In the process the colonies became states that retained a significant amount of political independence, including the right to charter and separately control state banks. This was one reason for the large number of local banks. In addition, the federal government was created with three separate, independent branches, legislative, executive, and judicial. As a result there was a separation between the executive branch headed by an independently elected president, and the legislative branch, something not found in countries with parliamentary governments.

The ingrained fear in the country of a strong central government and the tradition of separating powers between states and the central government, and between branches of the federal government, undermined early attempts to develop central banking in the US. For much of the 18th and 19th century each state tried to control banking within its own borders. Several attempts were made to develop a central US bank but there was always an ingrained fear that a central bank would make the federal government, especially the executive branch, too strong. It was only in 1913 that business need and political willingness combined to bring about the US Federal Reserve Banking System. Even then operations and responsibility were split between a central Board of Governors appointed to 14 year terms by the President and approved by the US Senate, and a group of twelve independent District Federal Reserve Banks owned by the local commercial banks. It was a creation that only a political scientist could love and fortunately Woodrow Wilson, just such a political scientist, had been elected president. The long terms and public / private components provided the new Federal Reserve with independence of shortsighted politics. Because of the complexity of the US banking system, the Fed was given responsibilities not found in other central banks. Overall the Fed has come to work well. Much of the history of the US banking system in the last century has been the history of the US Federal Reserve. This Virtual US Bank of Biz/ed is the story then of commercial banks and central banking in the United States.

What Is Money Anyway and Is a Billion Really a Billion?

In addition to differences brought about because of size and political tradition, the student of banking and business in other countries should be prepared to find a number of differences in US banking. For example the US Federal Reserve focuses on managing M1 and M2 and only recently dropped consideration of M3. The Bank of England focuses on managing what they identify as M0 and M4. Meanwhile the election for the US president takes place on a fixed schedule every four years, leading some to identify a pattern of economic trends brought about by the timing of the election. Even at the level of simple mathematics, in the UK a billion is 1,000,000,000,000 while in the US a billion is only 1,000,000,000. Serious students should enjoy identifying such nuances, always being ready to compare and contrast.