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Macroeconomics: Introduction, Factors, Policies, Impact on Trading – Part V

Macroeconomics: Introduction, Factors, Policies, Impact on Trading – Part V

Posted May 14, 2021 at 10:10 am
Rekhit Pachanekar
QuantInsti

Get started with Part IPart IIPart III and Part IV of this series.

Inflation rate

The inflation rate tells us how much the price of a good has increased. For example, if one loaf of bread was priced $1 in 2019 but increased to $1.05, then we would say the price inflated by 5%.

In a similar manner, the inflation rate for an economy is calculated by identifying the price level for a certain basket of goods. These will include food items, apparel, housing, electronic items, education expenses, etc. Once these items are identified, you calculate the price levels every year to get an estimate of how much the inflation has reached.

The inflation rate of the world is given below:

Visit QuantInsti for additional insight on this chart.

Does high inflation mean bad news for the economy?

The answer to this question is complicated because at first glance you would like to say yes. But if you get down to the basics first, let’s answer why inflation occurs?

It is a simple case of demand and supply. If there is a demand for a product with less supply, the prices are bound to rise. In normal scenarios, inflation can be an indicator that the economy is actually booming.

Taking the example of mobile phones used earlier, if the price is increased and people still buy it, it will be a sign that the existing environment is not able to meet the demand. Thus, new entrants would enter the market leading to more jobs, goods produced and in turn more spending, which increases the GDP.

In fact, during the 2000s, India and China had a high inflation rate along with high GDP figures. Of course, there are cases when the economy could crash heavily due to unchecked inflation, called hyperinflation. Thus, governments and central banks always keep an eye on the inflation rate to make sure it does not go haywire.

This brings us to the next macroeconomic variable.

Interest rate

The interest rate is another macroeconomic variable which tells us the state of the economy. The interest rate is decided based on the inflation rate as well as the liquidity requirements of the economy.

The Federal Reserve in the U.S. keeps revising the interest rate to keep a check on inflation. We will talk about the Federal Reserve’s role later on in the blog.

A low interest rate usually encourages companies to borrow money which is then used for expansion and in turn helps the economy grow. However, if the inflation rate keeps on increasing, the interest rate is increased, which discourages individuals and companies from borrowing and in turn, reduces the liquidity in the market. Thus, the demand is usually lowered and inflation decreases.

These were a few macroeconomic variables which help us understand the state of the economy. But can we control these factors?

In a manner of speaking, yes. Let’s find out how in the next section.

Stay tuned for the next installment in which the author will review Macroeconomic policies.

Visit QuantInsti for additional insight on this tutorial:
https://blog.quantinsti.com/macroeconomics/

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