Given that no market moves in isolation, acquiring basic macro-economic knowledge is essential for financial market participants whether, investors, traders, or analysts investing on different time horizons. Macroeconomics studies aggregate economic behavior including, Gross Domestic Product (GDP), rate of growth, employment rate, and inflation. Statistical data reflecting on each of the above mentioned are crucial indications on economic status and future projections for the country subject to investment and to which market instruments such as bonds, stocks, commodities, and currencies react; thus, developing what is called the Economic cycles.
Gross domestic product – GDP is simply everything produced by all the people in the country while the GDP growth rate measures how fast the economy is growing. It is the percentage increase or decrease in the GDP for a year versus the previous one. Accordingly, we would label the GDP growth rate as a measure for the overall health of the economy. If it is growing, then businesses will be in demand of labor and raw materials so there will be an increase in personal income and consumer spending, and the opposite occurs when the GDP growth rate decreases.
Inflation is the persistent increase in the prices of goods and services over a period of time; in other words, a decrease in the value of the means of exchange. The primary measure of inflation is the annualized percentage change in a general price index, generally the consumer price index - CPI.
Unemployment is one of the most misperceived terms. There are different types of unemployment rates which include different categories of the populations; however, the most common declared one is the "U3", which is not the percentage of the population who are unemployed. However, it is the percentage of the labor force who are unemployed in which the discouraged workers are not included.
An economic cycle is the natural fluctuations of the economy between periods of expansion and contraction. Below are the basic characteristics of economic cycles:
Economic expansion is identified when national output is rising strongly above the normal rate. In other words, growth rate momentum is on a rise. At this stage, businesses record higher net income, employment rate increases, inflation rate rises on a demand-pull basis. When the economy’s GDP reaches the highest point in the expansion phase, this is called the Economic Peak.
Economic slowdown evolves when GDP growth rate decelerates, the economy still records higher GDP; however, the percentage of acceleration decreases for a year compared to the previous one. At this stage, businesses avoid further expansion or investing in new projects. The same applies to employment rate and per capita income, momentum flattens. Inflation, on the other hand, increases shifting to a cost-push since businesses decrease unit production, and accordingly raw material prices rise.
A recession happens when the national GDP is in the negative zone, and the economy starts a contraction phase. It’s the phase when the GDP growth rates would also accelerate; however, in the negative territory. The unemployment rate is on the rise as well due to a sharp fall in business confidence leading to destocking and heavy price discounts. Accordingly, living standards start to fall. When the GDP reaches its lowest point at the time of a recession this is called “depression” or the trough.
Recovery depends on the business’s vulnerability to the previous depression. The faster the business reacts to economic confidence indicators, the faster the pace of recovery at which supply revives and the GDP growth rate re-accelerates heading to the equilibrium point.
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