Macroeconomics affects your annual pay rise, weekly shopping bill, the taxes/civic charges you pay, house prices and the interest rate your bank delivers or charges – and much more.
What is macroeconomics?
Macroeconomics is understanding how the global economy works. Macroeconomic analysis is used in many ways: from central banks setting interest rates, to corporations and organisations setting budgets or planning expansion.
Many tools and surveys are used in macroeconomic analysis, such as consumer and business sentiment and purchasing data, but they are all basically providing anecdotal evidence for the three main facets of economics:
- Growth – as measured by gross domestic product (GDP), which is the total economic output of a country
- Inflation – the rate at which prices rise
- Jobs – mainly looking at the rate of unemployment
These three tools help analysts interpret the general health of the economy, but the main driver of growth is consumer appetite for goods and services.
Macroeconomics on everyday life
Nothing has typified global consumer demand more than the evolution of the motor car.
The demand for transport predates the car by many thousands of years, but it is still the principles of demand that led to its creation: demands for faster, cheaper, more reliable ways of getting around.
Let's look at how demand affects the economy through the lens of a car manufacturer:
Periods of high demand
- More cars produced to satisfy demand
- Prices rise as raw material costs increase but consumers less sensitive on pricing
The car producer benefits by raising their production and pricing, which leads to higher profits. But the consumer loses out, having to pay more for their car.
The producer is contributing more to overall GDP, but their pricing policy is contributing to inflation.
Periods of low demand
- Lower production
- Lower prices to stay competitive and try to drive demand
The producer's production and profits suffer as consumer demand fades, which contributes less to GDP. If this is repeated across industry, economic growth and inflation slow down.
Nothing affects demand as much as unemployment. Even the fear of losing your job can have a severe impact on the way you spend.
Economists have found that unemployment is linked to economic growth, so in periods of strong GDP growth, unemployment is lower, while high unemployment is indicative of slow growth or recession.
The best case scenario is where there are:
- Few enough unemployed to make workers feel their job is safe
- Just enough unemployed to ensure a buoyant labour market with healthy competition for jobs
The first helps promote consumer spending; the second helps promote wage growth, which helps raise disposable income and further drive consumer spending.
Rising unemployment makes workers fearful that they could lose their jobs, and this fear turns them from consumers into savers. Savers are not good for economic growth.
The US economic analysis bureau defines its calculation of GDP as:
“The value of the goods and services produced by the nation’s economy less the value of the goods and services used up in production. GDP is also equal to the sum of personal consumption expenditures, gross private domestic investment, net exports of goods and services, and government consumption expenditures and gross investment.”
The absolute figure is quoted in government data but rarely used in macroeconomic analysis. Economists mainly use the percentage growth (or fall) to provide sets of historical data from which they can find patterns or estimate rates of future growth.
Recession is declared when there have been two consecutive quarters of decline in a county’s GDP.
There’s no denying it – inflation is both good and bad.
Too much is indicative of an overheating economy and prices rise too quickly, forcing companies to increase wages to compensate. Wage inflation adds to rising prices, and compels central banks to lift interest rates (monetary tightening) in a bid to slow the economy.
If central banks are forced down this road, they must tread carefully. Overzealous monetary tightening can result in an uncontrolled economic slowdown.
Too little inflation is indicative of a stagnant economy. Prices don’t rise, but wage growth is negligible and consumer demand remains flat.
The economic cycle
So far, we’ve only looked at elements of macroeconomic analysis in isolation. Anything that’s cyclical – imagine a single point on a wheel – has a high point and a low point. In the economic cycle, we call the high point ‘boom’ and the low point ‘bust’.
Let’s return to our motor manufacturer to explain this more clearly:
Aa period of high demand when the producer can lift the price of his cars, adding more to GDP but at the same time creating inflation pressure.
This results in higher prices for the carmaker’s steel, energy, labour and other resources that go into the manufacturing process.
Their choice is to raise prices further, creating more inflation and risking a fall in demand, or absorb the higher costs at the expense of greater profit.
Although sounding dramatic, this is usually just the gradual unwinding of the boom.
Prices become over-inflated, demand drops and our carmaker must lower prices to sell vehicles. Staff may have to be laid off during this period to lower costs, contributing to rising unemployment.
As sales continue to fall, the carmaker is contributing less to GDP and more to unemployment, but at least inflation should start to drop and raw materials become cheaper.
Boom economies can become dangerously over-inflated, at which point central banks or governments will intervene to put the brakes on by raising interest rates.
Macroeconomic analysis is important in many ways. By deciding where the carmaker is in the economic cycle, they can set annual budgets, announce staff pay rises or redundancies, make plans for expansion or plant renewal or just decide it’s time to hunker down.
Governments use this kind of analysis in the same way, on a grander scale and most central bank decisions are only arrived at after careful scrutiny of macroeconomic analysis.