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Macroeconomics 1: What is Macroeconomics?

Macroeconomics, as its name suggests, is the study of economics on a large scale, such as on a national level. It was developed as a separate theory from Microeconomics, mainly as a result of the work of legendary economist John Maynard Keynes who postulated among other things, that short-run fluctuations in economic activity can be mitigated by appropriate use of monetary policy. This was in stark contrast to classical economic theory, which stated through its principle of monetary neutrality, that nominal variables such as the money supply cannot affect real variables, such as output or unemployment.

In this series of articles, we will explain how and why Keynes, as well as other economic theorists who followed him, came to some of these conclusions, and examine what evidence there is to support the theory. More importantly, we will discuss what changes to fiscal and monetary policies governments and central banks should adopt, if any, in order to minimize the negative effects of what is thought to be the natural business cycle.

If you are wondering what any of this has to do with forex trading, you may be surprised: even in today's speculation-driven market, real-money flows, based on fundamental economic reasons, are still the single most important factor in determining the relative values of currencies. Furthermore, once macroeconomics is understood, it is easier for a trader to follow economic data and central bank jargon.The main point is, therefore, that a working knowledge of economics is an important tool if a trader has any hope of engaging in fundamental analysis.

There is a on-going debate between "technical" and "fundamental" analysts among retail forex traders. The bottom line is that very few traders at this level understand what either of those types of analysis really means. There is a notion out there that fundamental analysis consits of simply reading Bloomberg news (or similar). In fact, listening to the analysts is simply consumption of someone else's fundamental analysis, and often with very little evidence being given to support the conclusions. There is no analysis being done by the trader him/herself. In the murky world of financial and economic analysis, there is a bull for every bear, and details are hard to come by. Opinions of the "experts" are contradictory to one another, and they have to be - otherwise there would be no market, no one to sell if everyone is buying, and no one to buy when everyone is selling.

This is why fundamental analysis can be a very useful tool, if you know what you are doing, and this is why at least a basic knowledge of economics can be an extremely valuable asset: find an inefficiency that is not in the public sphere, by doing your own analysis of the underlying economic numbers, and exploit it for profit. That is the name of the game.

Continue to Macroeconomics 2: Ten Principles of Economics.

<< Fundamental vs Technical Analysis in Forex Ten Principles of Economics >>

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