Stock Market and Interest Rates and measuring the Macroeconomy

Stock Market and Interest Rates:

The Stock Market:

We don't have to compute the value of an index for stock market since news agencies perform that task for the public already. The best, the most representative index of U.S. stock marketplace is most likely Standard and Poor's Composite Index, typically known as S&P 500. The index you will listen to about most, though, is the ‘Dow-Jones Industrial Average’. But if DJIA tells a different story from S&P, disregard it; it is less representative of market than S&P.

Although we don't have to assemble and computer a stock market index, we do have to split the numbers reported in news by some measure of the cost level, normally either the Consumer Price Index [CPI] or the GDP deflator.

The stock bazaar is a sensitive sign of the relative hopefulness or pessimism of investors, and consequently a good forecaster of future investment spending. The real value of stock bazaar sums up in one number which is reported everyday:

A) Whether investors are optimistic (expecting long-run earnings to be above today's level) or pessimistic (expecting long-run earnings to be below today's level), and how optimistic or pessimistic they are.

B) The current level of profits, or earnings.

C) Attitudes toward risk: whether people are strongly averse to the risks involved in entrepreneurship (in which case σs is high) or willing to gamble on new industries and new businesses (in which case σs is low).

D) The current cost of assets whether money is cheap and easy to borrow (in which case r is low) or expensive (in which case r is high).

These are factors which determine whether corporate managers' are eager to undertake investments to increase their companies' capital stocks. So the stock marketplace summarizes all the details relevant to the economy wide level of investment spending. Its usefulness as a synopsis of all the information related to determining investment spending is reason it’s one of the ‘six key variables of Macroeconomics’.

Interest Rates

The interest rate is the cost at which purchasing power can be shifted from future into the present, borrowed at the moment with a guarantee to pay it back with interest in future. Instead of single lump sum, Interest is an ongoing stream of payments made over time.

Economists akin to to talk about "the" interest rate in the similar way in which they like to talk on the subject of "the" exchange rate. Since there are a wide range of different exchange rates, there are a wide range of interest rates. Loans of higher risk carry higher interest rates: whoever you lent your funds to might not pay it back which is a risk you accepted when you lent in first place. Loans of different period carry different interest rates as well.

Furthermore, the interest rates published in newspaper are nominal rates: they tell how much money you will earn in interest per annum if you lend out a total of dollars now and collect the principal at loan's maturity. You won’t be astonished to learn that economists are interested instead in real interest rate: how much purchasing authority over merchandise and services you obtain in the future in exchange for trading away your purchasing authority over goods and services today.

When we computer real exchange rates, or real GDP, or real stock values, we divide nominal exchange rate or nominal GDP level or stock index value by price level, but that’s not what we do to computer real interest rates. Instead of dividing nominal interest rate by price level, we minus the inflation rate, the percentage rate of change in price level from the nominal interest rate to acquire the real interest rate.

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