Economic Analysis

What is Economic Analysis?

All the common stocks are susceptible to the change in the economic conditions. The deterioration or improvement of economic conditions can lead to fluctuations in the stock price. Hence, it is very important to perform economic analysis to understand the prevailing economic factors affecting stock prices.

What are the factors to analyse the Economy?

Fiscal Policy

Fiscal policy is a tool employed by governments that affects the demand & supply dynamics of the economy to maintain the economic growth, specifically by adjusting the levels and allocation of taxes, subsidies & government expenditures. 

If the tax rate increases, the demand in the economy decreases and if the tax rate decreases, the demand increases. Likewise, changes in the level of Government spending affects overall demand for goods & services.

The Fiscal policy can be contrasted with the other main type of macroeconomic policy i.e. monetary policy, which attempts to stabilize the economy by controlling interest rates and the supply of money. 

The two main instruments of fiscal policy are government expenditure and taxation. Any changes in the level of taxation and government spending can have an impact on the following variables in the economy:

• Aggregate demand and the level of economic activity
• The pattern of resource allocation
• The distribution of income

Monetary Policy

In the same manner, Monetary Policy is used by the Central Bank to control the economic growth rate. If the Reserve Bank increases the repo rate, the demand for money decreases (since cost of borrowing funds has increased). This reduces the money supply in the economy, cools down prices and puts a downward pressure on demand. If interest rates fall, money supply increases which puts an upward pressure on prices, i.e. stokes inflation & increases the general demand for goods & services.

Monetary policy can either be expansionary (dovish) or contractionary (hawkish) in nature.

An expansionary monetary policy is in favour of lower interest rates with a view to increase money supply in the economy and vice-versa. An Expansionary policy is traditionally used to combat recession. 

Similarly, contractionary policy reduces the supply of money in the economy using higher interest rates as a means. A contractionary policy is used to tame inflation.