The economic environment describes a diversity of factors that influence the performance of an economy. These factors influence both the macro-economy at the national and global level and micro-economy at the household and business levels. Some factors of economic environment include interest rates, inflation and deflation, wealth and income, as well as the government's monetary and fiscal policies. These factors have both advantageous and disadvantageous effects on the economic environment of a nation or business.
Inflation and Deflation
Inflation is the rise in the cost of goods and services which then results in a fall in the purchasing power of a monetary unit, such as the dollar. High levels of inflation affect the economic environment negatively because consumer spending on goods and services declines. Low consumer spending slows down the economy and makes the economic environment unsuitable for business due to the low demand of goods and services. Deflation is a general decline in prices due to the reduced purchase of goods and a decline in the supply of money and credit for individuals and businesses. Although deflation may benefit consumers due to lower prices in commodities, it may increase levels of unemployment due to a decline in government and business spending.
Interest rates in the U.S. are set by the Federal Reserve. Interest rates influence the economic environment as these rates determine the flow of money into businesses and the economy as a whole. Higher interest rates reduce the demand for credit by consumers and businesses as well. Consumers are therefore not able to demand commodities produced by businesses, and businesses are not able to borrow in a sustainable way to expand their operations. On the other hand, lower interest rates have the advantage of lowering the cost of borrowing, therefore enabling businesses to expand.
High employment levels have a positive effect on the overall growth of an economy. High employment propels productivity within the economic environment and also increases the levels of consumer spending. Businesses are able to perform better in an economic environment in which there is a sustainable demand for goods and services. Conversely, high unemployment is a poor reflection of an economy’s performance. High unemployment slows down the economy and businesses due to a decline in consumer demand for goods and services.
Foreign Exchange Rates
Exchange rates are the price of a national currency in respect to foreign currencies. Exchange rates have a profound effect on a nation’s economic environment. The strength of the U.S. dollar has benefits for consumers but may be disadvantageous for businesses. A dollar with a high exchange rate reduces the domestic prices for domestic goods. Low prices are beneficial for consumers but not entirely so for businesses. Lower exchange rates are unfavorable for domestic businesses because these rates lower the prices of imports into the country. Consumers then buy these imports due to their lower prices compared to similar local commodities.