Inside the Macroeconomic Mindset
It’s time to look at the big picture. Macroeconomics focuses on the movements and trends in the national and global economies, and deals with the performance, structure and behavior of economies. Indicators that are used in interpreting trends in global economies include inflation, price levels, gross domestic product (GDP) and changes in unemployment.
As we enter National Economic Education Month in the U.S., we have been doing some economic eavesdropping. Wharton Global Youth’s collective ear has been pressed to the Wharton School walls, listening for valuable insights that might empower future business leaders with macroeconomic muscle. That analysis, combined with so much data, presents a snapshot of economic performance. Here’s what we heard.
Back on Target? Inflation, which is the general increase in prices over time, has been a headline-grabber in the U.S. in recent years, peaking at 9.1% in June 2022 and falling sharply since then to under 3.7%. Consumers feel inflation in their wallets, paying higher prices for food, housing, textbooks, and more. Will inflation continue to fall? Wharton MBA Neel Kashkari, president of the Minneapolis Federal Reserve, visited Wharton in September 2023 to discuss the economy and whether numbers will return to the Federal Reserve’s targeted 2% annual inflation rate. Kashkari is a voting member on the Federal Open Market Committee, setting interest rate policy for the U.S. “We can definitely get back to 2% inflation,” said Kashkari. “I’ve not seen anything that suggests that we should change the inflation target or that we can’t get back to 2% inflation. We can get back to 2% inflation because everybody on the Federal Open Market Committee is committed to getting back to the goal that we set.” The wild card to inflation? Recent oil and gas price increases. “These rising energy prices are impacting rates and cutting back purchasing power of consumers,” noted Jeremy Siegel, a Wharton professor emeritus of finance and an expert on the economy and financial markets, in a September 2023 WisdomTree blog post.
“If you want to better understand the role that sentiment has on economic activity, GDP growth, labor market decisions, and other fundamentals, it’s always better to have more granular and longer-time series data.” –Jules van Binsbergen, Wharton Finance Professor
Riding the Rates. Interest rates, or the price you pay to borrow money, are linked to the inflation story, as higher interest rates are typically a Federal Reserve policy response to rising inflation. All eyes have been on the Fed’s monetary policy in the past several months – but as Kashkari observed, the economic story has played out unexpectedly. “One of the big surprises for all of us over the last few years is we’ve raised interest rates by 5.25%,” Kashkari noted. “I would have thought – given how quickly we did it — that would have slammed the breaks on the economy. Consumers would be pulling back [on spending] and the labor market would be weakening with that aggressive a tightening cycle. What’s happened? The labor market has remained very strong…very low unemployment by any measure, and consumers have remained strong. We keep getting surprised by how much consumers are spending and GDP growth has remained strong…the economy has continued to exceed expectations in its underlying resilience. If the economy is fundamentally much stronger than we realized, on the margin that would tell me rates probably have to go a little bit higher and then be held higher for longer to cool things off. That’s why if you look at the updated forecasts, you see a longer high path, but much stronger economic fundamentals beneath it.”
Better Forecasts. The practice of economic forecasting is when economists and other financial professionals make predictions about the economy – like whether interest rates will rise or fall. It is heavily dependent on data and models to tell a story about future economic activity. A recent study by Jules H. van Binsbergen, a Wharton finance professor, and colleagues from other business schools around the world, advanced economic forecasting techniques. Van Binsbergen and his co-authors used a machine learning algorithm to produce more accurate and granular forecasts for GDP growth, employment and interest-rate decisions. In their paper, Almost 200 Years of News-Based Economic Sentiment, they customized a machine-learning technique to create an algorithm that analyzed more than a billion articles across 200 million pages of 13,000 U.S. local newspapers from 1850 to 2017 to study indicators reflecting the optimism or pessimism around economic conditions. Economic sentiment refers to people’s and companies’ attitudes, perceptions and confidence about the state of the economy. “If you want to better understand the role that sentiment has on economic activity, GDP growth, labor market decisions, and other fundamentals, it’s always better to have more granular and longer-time series data,” said Binsbergen in the Knowledge@Wharton business journal. “We show this sentiment has predictive power for economic activity over and above the standard predictors, such as the so-called yield spread, or the difference between long-term and short-term interest rates.”
Hungry for deeper economic data? The Penn Wharton Budget Model provides ongoing economic analysis of public policy’s fiscal impact. Most recently, you can check out Budgetary and Macroeconomic Effects of the Build It in America Act and the Budgetary Cost of Climate and Energy Provisions in the Inflation Reduction Act.
Conversation Starters
How have current macroeconomic trends affected your life as a consumer? Share specific examples in the comment section of this article.
Investors often consider macroeconomic factors when assessing the market and building portfolios. Are you an investor? If so, which economic indicators have you been following and how are they informing your investment strategy and stock and ETF selections?
Do you enjoy learning about economics? If so, why?
My first contact with inflation was in a supermarket. My favorite is guacamole, I always prepare it by myself. One day, just a little after I watched on the news that the Brazilian federal bank (I’m Brazilian) had changed its monetary policy, I realized avocados had gone from the usual $2 per kilogram to $2.50 per kilogram.
This connection between monetary policy and real-life experiences is very present in recent economic discussions. For instance, Kashkari’s surprise at the economy’s resilience despite a 5.25% increase in interest rates is noteworthy. This resilience, marked by strong consumer spending and a robust labor market, is valuable for understanding why higher interest rates haven’t cooled the economy as expected and indicate that rates might need to stay elevated longer. In fact, a very recent – May 2024 – article by the Wall Street Journal titled “Fed Officials Saw Longer Wait for Rate Cuts After Inflation Setbacks” comments on this. It states that “Officials voted to hold their benchmark federal-funds rate steady in a range between 5.25% and 5.5%, the highest level in more than two decades.” However, rising energy prices pose a significant challenge, as highlighted by Jeremy Siegel.
The advancements in economic forecasting using machine learning are also really cool. Knowing that researchers are analyzing historical data from newspapers to predict economic trends shows the power of technology in economics. This will lead to more accurate predictions and better decision-making, not just for businesses but for us – future adults – too. Especially because most young people (myself included until very little time ago) believe economics is just about money. It is not; it is about understanding how people make decisions, how markets operate, and how policies can impact us all.
Thank you, Diana Drake, for an insightful article on the significance of macroeconomics in understanding our broader economic landscape. The comprehensive discussion on inflation, interest rates, and economic forecasting techniques highlights the importance of staying informed about macroeconomic trends.
As a high school student with a keen interest in economics, I find the dynamics of inflation particularly compelling. The recent fluctuations in inflation rates, as detailed in the article, demonstrate how critical it is for consumers and policymakers to remain vigilant. The comments from Neel Kashkari on achieving the Federal Reserve’s 2% inflation target, despite the challenges posed by rising energy prices, underscore the complexities involved in managing national economic health.
The discussion on interest rates was equally enlightening. Kashkari’s observations about the resilience of the labor market and consumer spending, despite significant interest rate hikes, illustrate the unpredictability of economic behavior. This resilience is a testament to the strength of the underlying economic fundamentals, which continue to exceed expectations. It’s a powerful reminder of how interconnected various economic indicators are and how they can collectively shape policy decisions.
The advancements in economic forecasting, particularly through the work of Jules van Binsbergen and his colleagues, are fascinating. The use of machine learning algorithms to analyze historical news data and predict economic sentiment is a brilliant example of how technology can enhance our understanding of economic trends. This innovative approach not only provides more accurate forecasts but also emphasizes the role of sentiment in economic activity.
On a personal level, these macroeconomic trends have a tangible impact on my life as a consumer. For instance, the recent volatility in energy prices has affected household budgets, prompting us to be more mindful of our spending on utilities and transportation. Additionally, understanding these trends has informed my interest in investing, where I closely monitor indicators like GDP growth and inflation rates to make informed decisions about stock and ETF selections.
Learning about economics is not only enjoyable but also empowering. It equips us with the knowledge to navigate the complexities of the global economy and make informed decisions that can enhance our financial well-being. I look forward to deepening my understanding of these concepts through programs like Wharton’s Essentials of Entrepreneurship and Future of the Business World.
Thank you again for this comprehensive and engaging article. It has certainly sparked a deeper interest in macroeconomic trends and their implications.
Inflation is always waiting for you at the edge of New Year’s Eve, when the 1st of January suddenly, all the prices of the products and services you used to buy go up, and this can happen abruptly and subtly. And in both ways, inflation always becomes a problem for consumers, increasing poverty, and killing the middle class. Budgets cannot stretch any other increase in inflation; however, we continue to survive despite it, and it is encouraging to observe how our economy maintains itself resilient.
Macroeconomic studies have shown that inflation has been decreasing since June 2022. Neel Kashkari gives us hope when he says there should be nothing in the way of inflation to continue decreasing if that is what the Federal Open Market promised. But Jeremy Siegel gets us back down to earth, hitting us with the harsh but real truth, that if oil and gas prices continue to increase, mostly due to the lack of supply and increased demand in the market, then the consumers’ purchasing power will naturally decrease. Of course, every single company needs energy to offer its product or service to the public, and if that basic element’s price increases, then the price of almost all products will increase too. And just as the energy companies play a vital role in inflation, so do interest rates and federal spending. As interest rates increase, they can slow down inflation as they reduce how much people are spending on certain goods, and the same is true for its opposite. As well as irresponsible federal spending, which produces an unnecessary increase in taxes on certain services or commodities, and therefore increasing inflation in many markets. However, even though our society is facing these current issues, it is motivating to see how employment rates are still the same and consumers are generally spending as much as they used to. It is indeed motivating but most of all shocking to see our economy staying resilient in the face of inflation.
I have to say I am amazed a curious to investigate more about what Van Binsbergen said about how economic sentiment could be the main explanation for this resiliency. It is very similar to what we call in psychology a “self-fulfilling prophecy” and it happens when you believe in something so fervently, that you begin to adjust your actions to agree with your beliefs, unaware of it. According to Binsbergen, economic sentiment is people’s and companies’ attitudes toward our economy and macroeconomic factors such as inflation, interest rates, and employment rates. This sentiment is usually a greater predictor of economic activity than other methods, and it is amazing and encouraging to observe how if our economic sentiment is positive, then the economic activity will behave accordingly.
Long-time series of data are crucial for understanding macroeconomic factors such as economic sentiment, and many others concerning investors and companies. From such data recollected from years of studies, investors and shareholders of companies can understand which strategic moves to make whenever interest rates go up, inflations peak or decrease, there is economic growth or recession, and whenever fiscal or monetary policies are implemented. In the end, the existing inflation rate, its impact, and its potential future trajectory play a crucial role in shaping the prevailing interest rates and guiding investment tactics. It’s exciting to understand these factors, and essential to consider them when devising financial strategies.
Reading “Inside the Macroeconomic Mindset” by Diana Drake really got me thinking about how our economy works. As a high school student, I’ve definitely noticed the impact of inflation. For example, prices for things like my favorite school supplies, snacks, clothing, and shoes at the stores have gone up a lot. Even though inflation has dropped to under 3.7% (3.3% as I write this comment), I’m still seeing higher prices on everyday essentials.
Inflation, interest rates, and economic growth are all connected. Inflation has been a big deal lately. To tackle inflation, the Fed usually raises interest rates. Higher rates make borrowing more expensive, which should slow down spending and help control inflation. But it’s surprising to see that even with these rate hikes, the economy has stayed strong. Kashkari said, “The labor market has remained very strong…very low unemployment by any measure, and consumers have remained strong.”
So, why do we need to increase interest rates if the economy is showing strong GDP growth (as noted by Kashkari) and consumers are happily spending? It seems counterintuitive, right? Here’s what I’ve learned. If we don’t increase interest rates, we could run into several problems:
If people keep spending freely, prices could keep rising, making everything more expensive over time.
A strong economy with low rates can lead to too much borrowing and spending, creating bubbles in markets. When these bubbles burst, it can cause severe economic downturns.
Low interest rates mean lower returns on savings accounts, discouraging people from saving money and reducing financial security, and cheap borrowing costs can lead to more debt.
On the other hand, how do the Interest rate hikes also affect corporations? When rates go up, borrowing becomes more expensive for businesses. This means companies may reconsider taking out loans for expansions, new projects, or even day-to-day operations. Higher borrowing costs can eat into profits, which might lead to less investment in hiring new employees or buying new equipment. Overall, it can slow down corporate growth and expansion plans and in turn, impact the stock prices.
I guess that’s why setting the interest rate is a tough balancing act.
Understanding these economic principles is crucial, especially in my podcast, “Sustainable Cents,” where I talk about money, markets, and the environment. Economic stability and responsible financial practices tie directly into sustainability efforts. When businesses face higher borrowing costs due to interest rate hikes, it encourages them to be more mindful of their financial decisions, potentially leading to more sustainable practices. For instance, companies may prioritize investments in eco-friendly technologies or reduce wasteful spending, aligning their financial goals with environmental stewardship.
Even though I’m still in high school, I’m really interested in how these macroeconomic factors affect us all. The Fed’s interest rate hikes have made me think more about investing in sectors like technology and healthcare that aren’t as affected by higher rates.