Macroeconomics: What You Need to Know

Macroeconomic Variables

Macroeconomics, as the word ‘Macro’ suggests means large, whereas ‘Micro’ means small. Macroeconomics studies the economy as a whole, whereas microeconomics studies firm/industry behaviours. If you have studied economics, you will know that there are some key variables. These are Gross Domestic Product (GDP), Inflation, Unemployment, Government Spending, Interest Rates and Exchange Rates. I will explain these in more depth.

 

GDP

Gross Domestic Product (GDP) is a measure of growth in an economy. It can be defined as the monetary value of goods and services produced by an economy. We can use a country’s GDP and compare it to others. GDP measures are provided quarterly by the Office for National Statistics (ONS).

 

INFLATION

Inflation can be measured through the Consumer Price Index (CPI). It is usually measured annually. Inflation has a close relationship with other variables; if GDP rises, unemployment falls and inflation rises.

Note that Aggregate Demand (AD) is how we show the relationship of GDP to price levels. Through the AD model, we can explain why high inflation is bad for an economy as high inflation indicates high prices. This will affect the economy significantly as people will be reluctant to buy and consume and consumption is a factor of AD. The Bank of England tries to monitor and maintain inflation at a 2% level, however this can be difficult due to its close relationship to other macroeconomic variables.

There are different types of ‘inflation’, such as stagflation and deflation. Deflation is where the inflation rate is below zero. Therefore deflation is negative inflation. There is also cost-push inflation and demand-pull inflation. As the names suggest, cost-push is caused by the costs of production as they increase, higher costs suggest prices will rise to accommodate for the increasing costs. Demand-pull inflation is caused by an increasing demand for goods and services produced by firms, an increase in demand suggests prices rise increasing the profits of firms. Cost-push and Demand-pull inflation are types of inflation which are covered more in microeconomics.

 

UNEMPLOYMENT

This variable measures the percentage level of the labour force which is unemployed. This rate also includes those who have been actively seeking unemployment for two weeks or more. Unemployment is undesired by the government as it means fewer people pay taxes, which pay for infrastructure such as new roads, and more money will need to be spent on unemployment benefits. There will also be a reduction in the supply of the economy as there might not be enough people producing goods and services, therefore the GDP will fall. There is also likely to be a reduction in the level of skill, particularly for those workers who ‘learn of the job.’ This can affect an economy’s competitive advantage, particularly if the economy has lost its area of specialization.

 

GOVERNMENT SPENDING

Government spending/consumption/investment may include spending on infrastructure as previously mentioned. There are often policies such as monetary and fiscal which can be used to impact the demand side (AD) of the economy. Government spending is a key component of fiscal policy. Increasing Government spending would be an expansionary fiscal policy and decreasing Government spending would be contractionary fiscal policy. Expansionary policies often lower unemployment, but they also increase inflation.

 

INTEREST RATES

nterests rates are the cost of borrowing, as well as what you receive for saving money. Interests rates are adjusted by the Bank of England’s Monetary Policy Committee (MPC). We can refer to the Bank of England interest rate as the base rate. This base rate determines what the Bank of England pays commercial banks which influences the rate commercial banks charge us to borrow and save. Interest rates are adjusted in order to help keep inflation low and stable, at the 2% target. As you can tell by the name MPC, interest rates are a key component of monetary policy. An increase in interest rates are associated with contractionary monetary policy, so they reduce inflation and aggregate demand. A decrease in interest rates is an expansionary monetary policy.

 

EXCHANGE RATES

Trade is a huge part of our world today. The majority of economies exchange goods and services on a global scale. The UK was a part of the European Union (EU), so we did not pay tariffs, however with BREXIT and the concerns about a trade deal, this macroeconomic variable is often in the news.

All open economies export and import goods which is influenced by the exchange rate. The nominal exchange rate is the number of units of the domestic currency that is needed to purchase a unit of the foreign currency. Therefore, it measures the relationship between the value of the two currencies. The real exchange rate is the ratio of a foreign price level and the domestic price level, multiplied by the nominal exchange rate. The real exchange rate measures the relative price of foreign and home goods.