What is a Macro Model?

This is the first of two blog posts about understanding how to use a macroeconomic model to stay ahead of risks and opportunities for your organisation.

A macroeconomic model is an analytical tool designed to replicate the operation of the global or individual country’s economy. It examines the dynamics of important economic indicators like output, inflation and unemployment.

Macroeconomic forecasts allow policymakers and businesses to stay ahead of risks and opportunities as they emerge and to compare different policy or strategic options.

When looking to enter a new market, assessing current markets or considering different policy scenarios, organisations can use this type of information to plan ahead of major macroeconomic events.

How does a macro model work?

Macroeconomic models facilitate medium to longer term planning by serving three primary purposes: understanding the past and present, predicting different economic indicators and evaluating alternative “what if” scenarios.

As a key component of market research, Macroeconomic models can help determine the economic implications of various hypothetical economic events and changes. This brings us to two different types of forecasts: baseline and scenarios.

A baseline forecast presents the most likely outlook for a country or region. Even if baseline forecasts can be revised periodically to reflect the most recent economic developments, they are usually surrounded by a range of uncertainty.

While a baseline is the most likely of several possible scenarios, it still might turn out to be wrong. Therefore, a probability rate should be assigned to baseline forecasts, leaving room for other scenario outcomes.

Scenario forecasts capture a range of alternative futures to the baseline forecast, assigning them different probabilities. These hypothetical “what if” scenarios are particularly important when dealing with highly volatile economic environments. For instance, what will the economy look like if there is a major oil price shock or if a major global financial crisis hits? Scenario analysis can help minimise surprises by examining the impact of downside risks.

Scenario analysis can simulate potential economic shocks in one or more industries, in one or more economies. It can also predict the flow-on effects in each individual country. Let´s look at two types of scenarios: global and individual country.

Global scenarios focus on events which would have a notable economic effect on more than one economy. These scenarios usually represent significant global or regional economic events, such as global downturn, China hard landing, Eurozone recession or global trade war.

Individual country scenarios help to capture uncertainty around the impact of important economic developments that are taking place in that particular country. Individual country scenarios can include pessimistic scenarios such as a growth slowdown and optimistic scenarios such as growth acceleration as compared to the baseline.

Why does this matter to businesses?

The use of a macroeconomic model elevates economic forecasting to a scientific and systematic level. Pairing macroeconomic forecasts with market research leads to more robust strategy planning and a better response to negative shocks. Here are 4 key ways a macro model can help businesses stay ahead of risks and opportunities:

  1. A better understanding of past and future economic trends
  2. Systematic business planning is driven by risk analysis and economic outlook
  3. Assessment of how major events might impact business environments
  4. Tests to understand a range of alternative optimistic and pessimistic forecasts

Now that you know why macro model forecasts are so critical to business strategy, it’s time to learn how to utilise the insights from a macro model.