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Macroeconomic Factors: What Are They?

Macroeconomic factors are critical economic concerns that significantly impact economies. Common macroeconomic factors include the money supply, inflation, unemployment, gross domestic product, the business cycle, and government debt.

Key Takeaways

  • A macroeconomic factor is a trend, condition, pattern, or event affecting a broader economic aspect.
  • Inflation, interest rates, gross domestic product (GDP), unemployment level, and federal income are few types of macroeconomic factors.
  • We can have either positive, negative, or neutral macroeconomic factors.
  • Macroeconomic factors influence the business cycle immensely.
  • Macroeconomic factors impact countries and businesses alike.

Table of Contents

Macroeconomic Factors Defined

A macroeconomic factor is a trend, situation, or event that impacts a large section of the economy instead of just a small population. Unemployment rates, inflation, economic output, level of government debt, and money supply are some of the significant macroeconomic factors. The interaction between different macroeconomic factors is a field of in-depth research for policymakers and economists. Governments, businesses, banks, and individuals study macroeconomic factors closely.

Studying macroeconomic factors helps policymakers build predictive models that project future unemployment, inflation, or demand and supply. These projections help governments, firms, and consumers with decision making.

Macroeconomic factors are essential for investors too. Analysis of the macroeconomic factors that significantly impact the business environment can help the investor assess whether the prevailing situations are favorable to capital markets.

Types of Macroeconomic Factors

Positive

Positive macroeconomic factors help an economy or a group of economies to prosper and progress. These are a group of events that boost economic stability and expansion. For instance, any occurrence that leads to a rise in demand for goods and services on a broad scale is a positive macroeconomic indicator. As consumer demand grows, domestic and overseas producers earn increased revenue, which will foster a more robust business environment. An upbeat sentiment in businesses and a rise in demand spur employment and economic growth eventually.

Neutral

Not every economic development has positive or negative implications. Specific economic shifts are neutral, and their impact depends on a lot of factors. Sometimes it is the objective of the economic factor that influences the exact implications—for example, trade regulation policy across the borders.

A regulatory policy can have positive and negative effects, such as removing or adding duties to various imports. Thus, we can see that a single event can have myriad implications depending on how the economy and multiple stakeholders respond.

Negative

The macroeconomic factors that result in adverse consequences for the nation are termed as unfavorable. These factors jeopardize the growth prospects of the economy. Negative macroeconomic factors can be voluntary or imposed. Involvement in a civil or international war or political instability is one factor where a nation is voluntarily involved.

Natural disasters such as earthquakes, flooding, cyclones, or economic catastrophes such as the sub-prime crisis of 2008, create a domino effect across economies. These are involuntary factors that are beyond anybody’s control yet have far-reaching negative implications for an economy.

Macroeconomic Factor Cycle

Macroeconomic factors follow a cyclical approach. The positive macroeconomic factors boost the economy resulting in higher demand and increased production. This leads to a price rise, and consumers get selective about their purchases. Demand declines relative to the supply, and a downward spiral in the economy begins. Sometimes the growth spurred by positive macroeconomic factors can also be followed by negative factors.

List of Macroeconomic Factors

  • Interest rate trends
  • Inflation trends
  • GDP and broad economic growth
  • Corporate Earnings
  • Business Cycle
  • Economic growth
  • Monetary policy
  • Fiscal policy
  • Unemployment rate
  • Balance of Trade
  • Balance of Payments
  • Industrial Production
  • Supply & Demand
  • Retail Sales
  • Industrial Production

Macroeconomic Factors & The Business Cycle

The business cycle, also known as the boom and bust cycle, is a rotational economic growth cycle.

In the boom cycle, the economic output increases, jobs are plentiful, and consumers and businesses are happy. In contrast, in the bust cycle, economic growth drops, there is widespread unemployment, and stock prices typically fall.

Boom and bust cycles are natural occurrences in a capitalist economy. While the duration of each phase might differ, the pattern of the cycle nearly remains the same. The long-term nature of the economy is to grow. However, it is alternated by cycles of boom and busts due to a blend of many macroeconomic factors. Let us look at the two most critical macroeconomic forces of demand and supply.

When an economy expands, there is robust consumer demand, and there is enough employment to sustain the growing economy. To respond to the increasing demand, enterprises hire more workers to ramp up production. This boosts employment further. However, this cycle of economic strength doesn’t continue forever. Since production is now at or near full capacity, a slight decline in demand would cause supply build-up. Gradually, slowing demand causes an excess supply situation, and the economy begins to shrink.

This is the point at which the reverse cycle begins. Due to less supply, there is lower production, and hiring is limited. Two situations arise as a result of this. Cyclical unemployment is on the rise, and credit supply to companies shrink. Banks’ interest income declines, and to safeguard the capital, they raise their reserve requirements. Lesser disposable income and little money in circulation mark the onset of the bust cycle.

Macroeconomic Factors Affecting Countries

Money Supply (Positively Significant)

Money supply is all the currencies and liquid instruments of an economy. Liquid instruments imply both cash and other types of deposits that can be easily accessed as cash. Money is used in almost all economic transactions. Hence it has an immense impact on economic activity.

Money Supply

Lowering interest rates and spurring investment is one of the most sought-after ways of boosting economic activity.

As the economy expands, the stock market booms with increasing stock prices, and companies issue additional capital through debt or equity. As the money supply continues to rise in the economy, prices rise, and output grows to full capacity. This phenomenon leads to inflationary winds and central banks begin to exercise contractionary policies like raising interest rates or reserve requirements for banks.

The decline in money supply or a slowdown in its rate of growth creates a diametrically opposite impact. There is a drop in economic activity, which results in disinflation or deflation.

As money supply has a substantial impact on the economic activity and price levels, the US Federal Reserve System utilizes it to create price stability.

The Federal Reserve uses three definitions of the money supply. They are:

  • M1: a measure of money’s function as a medium of exchange;
  • M2: a measure that reflects money’s role as a store of value also;
  • M3- a measure that covers all items that substitute cash closely.

Stronger Currency (Negatively Significant)

A country leverages a decline in currency value as an expansionary monetary policy. A weaker currency acts as a counter-cyclical measure when an economy is in recession or slowdown to boost demand for goods, economic output, profit, and employment.

Exchnage Rates

A weaker currency drives higher export sales, bringing about an improvement in the balance of trade. It also boosts output in export-oriented industries and results in what is known as the ‘supply-chain’ effect.

In brief, a depreciation in currency provides a competitive edge to a country and can bring about multi-dimensional and rapid growth in the economy. A cheaper currency can also lead to a higher value of profits for domestic businesses with overseas ventures.

However, there is one aspect that we need to understand at this point. A cheaper currency is not just about positive impacts, and it also has its share of drawbacks. A weak currency can create challenges for the government to fund budget deficits owed to international creditors. The depreciated currency also raises the cost of imports and leads to higher prices for foodgrains, raw materials, and imported technology. This can flare inflationary risks and have a far-reaching impact on long-run productivity potential.

Weak global demand can dampen the beneficial effects of a lower currency – it is then harder to export when key markets are in a recession, and overseas sales are falling.

If the demand for exports and imports has low price elasticity, a depreciated exchange rate may initially hurt the trade balance. This is known as the J-Curve Effect.

Inflation (Insignificant)

Inflation is a crucial macroeconomic factor to track. However, too much attention on inflation can focus away from the other vital factors driving economic growth directly. In most cases, the central banks have a very myopic view of economic growth and reiterate that keeping inflation low is the only way to foster employment and output. However, mainstream economic theory or other research studies do not find enough evidence to support the belief that improving or lowering inflation has a significant impact on the economy’s performance, apart from exceptional cases.

A study by Fortin (1996) and Akerlof et al. (1996) revealed that bringing inflation to near-zero levels causes downward nominal wage rigidity and deteriorates economic performance.

The modern economy has numerous goods and services whose prices are continuously fluctuating due to various factors. Bludgeoning all the price rises into a single inflation rate seems rather impractical, according to many experts. Moreover, if other economic variables do not move in tandem with inflation or recognize its impact on a retrospective effect, it creates further problems. Some of these issues are ambiguous price signals, redistribution of purchasing power, and long-term planning issues.

Macroeconomic Factors Affecting Businesses

Macroeconomic factors are not just for the government and policymakers. It is equally essential for businesses to assess macroeconomic factors. These factors can cause market fluctuations and impact businesses immensely. Thus during economic shifts, companies can make informed decisions and avoid crises. So, entrepreneurs and business owners who wish to scale up their companies without worrying about sudden economic upheavals should thoroughly understand macroeconomic factors.

Economic Growth Rate

Growth rate measured by gross national product (GNP) and gross domestic product (GDP) is critical. Businesses need to calibrate their operations to respond to the economic growth rate. If the growth is strong, it spurs a positive environment for firms as consumer demand is high, and increased sales lead to higher profits. However, it also means that businesses would have to scale up their production, labor force, and capital in meeting the surging demand. The reverse is true for situations when the demand is weak.

Interest Rates

For businesses that are capital-intensive or whose functioning depends a lot on credit, the interest rate is a critical macroeconomic factor to evaluate. Finance is the lifeblood of business, and to ensure smooth operations, companies need to keep a tab on interest rates. If the interest rate is high, the owner has to pay a higher amount, and vice versa. If a business owner is not prepared for the fluctuations in interest rates and the trade cycle, he can put his venture into a risky financial state.

Unemployment

Unemployment impacts a business in various ways. Companies may have difficulty selecting the right resources for the job due to insufficient applicants on the supply side. However, your hiring cost reduces, and you can offer a competitive salary as well. On the demand side, it might see a slump due to less consumer spending. When consumers lose their jobs, they have less disposable income for discretionary spending. So while businesses may enjoy lower recruitment costs, they might also see a drop in revenue.

Inflation

Inflation refers to the rising prices of goods because of the economy’s high cash supply and consumers’ willingness to pay higher prices for the same amount of goods and services. Whichever industry the business functions in, inflation is sure to impact it. When prices of goods increase, a country’s ability to buy those items declines. At the same time, a business has to charge more from its customers. In contrast, when the prices of goods and services decline, it is called deflation. In this phase, the customer’s purchasing power is higher, and they can buy an increased number of goods and services. Hence, businesses must follow the trends leading to changes in inflation rates and deflation.

Exchange Rate

For the companies which export their final goods and services or import raw materials, exchange rate fluctuations play a significant role. Depreciation in the currency value results in cheaper exports, leading to higher demand for export goods overseas. On the other hand, firms that import raw materials are likely to witness high production costs—some of the different areas where exchange rate impacts are investment returns, interest rate, and inflation.

National Debt

Domestic debt is a critical subject of analysis for businesses. While a small amount of debt is acceptable to push economic growth, a higher debt burden is counterproductive. It might drive economic growth beyond the standard level, leading to a boom and a bust. Higher national debt results in a higher rate of interest and raises the cost of borrowing for businesses.

As the economy is in a slowdown phase, firms produce less, hire fewer workers, and experience lower demand. If a country cannot pay its debts, it snowballs into a sovereign debt crisis, a highly unfavorable business environment. It is best to study the debt-to-GDP ratio to understand a nation’s ability to repay its borrowings. According to the World Bank, if the debt-to-GDP ratio exceeds 77%, it signals a default. The threshold for emerging nations is 64%.

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Leo Smigel

Based in Pittsburgh, Analyzing Alpha is a blog by Leo Smigel exploring what works in the markets.