Macroeconomics in Finance involves the study of macro or big sections of an economy. Here in this blog, we will develop an understanding on the two broad studies of economics – Micro and Macroeconomics; the role economics plays in influencing business and financial decisions; what all an investor should include and study in a macroeconomic overview; what defines a macroeconomic indicator as favorable or unfavorable; primary sources for collating macroeconomic data; key definitions and points to remember; and a detailed illustration
Let’s start by defining and looking at the key differences between Macro and Microeconomics. Macroeconomics is a branch of economics that studies how an aggregate economy behaves. On the other hand, Microeconomics analyzes the market behavior of individual consumers and firms to understand the decision-making process of firms and households. Macroeconomics studies economy-wide variables, such as inflation, price levels, growth rate, national income, gross domestic product, and unemployment. On the contrary, Microeconomics studies the smaller picture and focuses on the concepts of supply, demand, and prices.
Next, we will study the role economics plays in Financial and Business decision-making. Macroeconomic factors, such as the rate of inflation and interest rate, determine the terms on which a firm can raise funds. Other macroeconomic indicators, such as growth rate of the economy, savings rates, political and tax environment, and credit rating, have a firm bearing on the overall investment and business climate
Moving on, let’s take a closer look on the different demographic and macroeconomic indicators that an investor or an analyst should give some thoughtful consideration. A deep dive into both the demographic and macroeconomic set up of the country is important. Key demographic variables include the population and population growth of a country, age composition or working age population, literacy, urbanization, and life expectancy rates. Some of the important macroeconomic indicators include GDP growth rate, exchange rate and currency movement, political environment, Debt-to-GDP ratio, industrial sector growth, and consumer expenditure.
Next, let’s focus on the key metrics or numbers that define an economic variable as favorable or unfavorable. Let’s walk through a couple of example together – a Debt-to-GDP ratio of less than 50% is termed favorable, between 50 and 70% is considered moderate, and unfavorable above 70%. Similarly, real GDP growth rate between 5% and 7% is regarded as favorable, between 2% and 4% is termed moderate, and less than 2% is unfavorable.
Here in this slide, let’s look at some of the data sources that give us reliable estimates for all the macroeconomic indicators. Some of the popular sources include IMF, World Bank, FAO Stat, and US EIA.
A user should be mindful of certain key definitions and differences while populating the indicators. Some of the key definitions include:
- The difference between Real and Nominal GDP. Real GDP is a macroeconomic measure of the value of economic output adjusted for price changes (i.e., inflation or deflation). Nominal GDP is the gross domestic product evaluated at current market prices, GDP being the monetary value of all the finished goods and services produced within a country’s borders in a specific time period.
- The difference between wholesale and consumer price inflation. To put it in layman’s term, wholesale price index is a measure of supply inflation, and consumer price index is a measure of retail inflation.
- Interest rate – Interest rate for a country is typically the Bank Rate (Base Rate or Central Bank Rate), set by the central bank for charging commercial, depository banks for loans to meet temporary shortages of funds, e.g., Reserve Bank of India regulates and releases the bank rate for India.
Finally, let’s go over an illustration together, which has been picked from a detailed Macroeconomic overview presentation on Indonesia, prepared by the Cians Research Team.
We hope the blog helped clarify the concept. Do give your valuable feedback in the comments section below.