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Macro-Economic Variables

The description and forecasting of macroeconomics require statistics on macroeconomic variables. The most prominent of these variables is the GDP, inflation, interest rates, and unemployment, but there are many others. The Gross Domestic Product (GDP) is the total value of all goods and services produced in one year within the country. GDP also measures total income, since the payments for the total production must go to someone, usually to the producers of those goods and services.

Because the measure of GDP depends on payment for the product or service, only those products and services are measured. Activities where legal payments were not made or were not reported are not part of the GDP. This includes the domestic services by a stay-at-home spouse and illegal activities by criminals. It also does not include payments under the table for labor.

In major economies, most of these unreported items are only a small fraction of the total GDP, but in many poor countries, unreported payments can constitute a major share of the economy.

Another key macroeconomic variable related to GDP is GDP per capita, which is the amount of GDP per person, found by dividing total GDP by the number of people in the country. This provides a rough estimation of the average income per person, which is useful for comparing living standards.

Employment and Unemployment Rates

Employment and unemployment rates are also significant macroeconomic variables, especially since they can have a major impact on political elections. Unemployment rises when businesses reduce their production, usually when the economy enters a recession. The unemployment rate falls when the economy is growing. If the economy grows too fast, shortages may increase, leading to higher prices.

Inflation

Another key macroeconomic variable is inflation, which can result when the supply of money exceeds the demand for money, which occurs when the supply of money increases faster than the economy. People and businesses are negatively impacted by short-run inflation, but over the long term, the economy adapts to the greater supply of money, causing higher wages and prices.

The main beneficiary of inflation is the government, since the government can create more money before it has an impact on prices. Often, crooked governments will print massive amounts of money to enrich government employees and policymakers and to pay government bills. For instance, the annual inflation rate in Zimbabwe exceeded 231,000,000% in 2008, when it was reported that some people were using Zimbabwean dollars as toilet paper. In fact, Zimbabwe issued a $100 trillion bill, which is the highest denomination ever issued for any currency.

This type of hyperinflation causes people to trade the hyperinflated currency for more stable currency of other countries, such as the American dollar. (In fact, the American dollar is used so often in hyperinflated economies that the process is called dollarization!) The currency exchanges are made as quickly as possible, before the currency falls even further in value, which can happen in hours. If the currency cannot be exchanged, then purchases are made as soon as possible, since the maximum real value can be received by immediately exchanging the hyperinflated currency for something else, whether it be other currencies or for goods and services.

Interest Rates

Another important variable is interest rates, which is the cost of credit, the cost of borrowing money. Although there are many types of interest rates, the prime rate, which is the interest rate that a sound business qualifies for, is often published in the newspapers. Central banks have significant control over the interest rate, since they can set interest rates for other banks and they can also control the money supply. A greater supply of money leads to lower interest rates, while a contraction of the money supply raises rates. When the interest rate set by the central bank is already near 0 or even 0, then the central bank may turn to what is called quantitative easing, where money is created and placed within the economy by buying longer-term government debt from primary dealers of the central bank.

Interest rates affect not only how much consumers will borrow, but it will also affect how much businesses will borrow, especially since businesses will only borrow if they can invest the money for a higher expected return than the interest rate on the borrowed funds.

So, if a business project is expected to return 10%, a business will borrow if the interest rate on the loan is 6% but not if it is 12%, since the business can earn a net 4% in the 1st case, but lose 2% in the 2nd.

Businesses will keep borrowing if they have projects where they can earn a greater expected return than the interest rate on the loan, but at some point, additional projects will yield a diminishing marginal return, where the expected value of additional invested capital will fall to equal the interest rate, reaching what macroeconomists call a capital stock equilibrium.

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