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OPINION

Uses of macroeconomics

Uses of macroeconomics
September 29, 2016
Uses of macroeconomics

It's not just academic macroeconomics that's in question, though. Professional forecasters have consistently failed to foresee recessions. And macro hedge funds, which try to make money by predicting macroeconomic trends, have done poorly, returning only 0.5 per cent per year in the past five years.

What's more, even where macroeconomics is true and useful for policymaking, it is not necessarily helpful for investors. The claim "GDP growth will be lower than it otherwise would be because of tight fiscal policy" might have been true in 2010-11. But I'm not sure it was much help to investors; we make money because of how asset prices change in future, not because of how they perform relative to some never-observed counterfactual.

Nevertheless, I'd suggest macroeconomics is useful for investors. Here are three examples:

One is talk of secular stagnation. This tells us that growth and real interest rates might stay depressed for a long time. The man who'd invested in bonds on this basis when Larry Summers recoined the phrase "secular stagnation" in 2013 would have done better than the one who invested on the basis of talk of a bond bubble back then.

Secondly, a rejigging of basic national accounts identities can help equity investors. GDP is the sum of consumer spending, investment, government spending and net exports: Y = C + I + G + NX. It's also the sum of wages, profits and taxes (I'm ignoring other incomes such as rent and self-employed incomes for simplicity): Y = W + P + T. Rearranging these gives us an expression for profits:

P = (C – W) + I + (G – T) + NX.

This tells us that aggregate profits will grow if, and only if, consumer spending rises faster than wages; if investment or net exports grow; or if government borrowing increases. It also tells us that they cannot grow because of corporate cost-cutting or "focus on shareholder value". This might not help us forecast aggregate profits. But it organises our thoughts and dispels some common nonsense.

Thirdly, although professional macroeconomists aren't good forecasters, we know that consumers are. High ratios of consumer spending to wealth predict good returns on equities, and low ratios predict bad returns. This useful fact arises from macroeconomic research - the discovery of a co-integrating relationship between spending and wealth. This means that when one is far from the other the gap between them will close, and it does so by asset prices moving.

In these ways, macroeconomics is useful for investors.

But remember that macroeconomics is only a small part of economics. The discipline (I'd call it science) also comprises behavioural economics, which has taught us many ways of avoiding mistakes, and financial economics, which tells us not only how to manage risk but also how we might make money - by buying defensives rather than actively managed funds.

Yes, the economics you see on TV and read in newspapers is mostly useless. But there's much more to the subject than that.