- What is the difference between economies and markets?
- Who predicts future markets and economies?
- How are future economies predicted?
- How accurate are economic predictions?
- How do financial markets influence economies?
- What is an advanced economy?
- What is the difference between emerging and developing markets?
What is the difference between economies and markets?
An economy is basically a collection of markets. An economy is the production and consumption of all goods and services within a country or region. The economy includes all individuals, companies, and governmental bodies within that country or region. The World Economy, therefore, encompasses all countries and their markets in the World. A local economy could focus on a smaller region, such as a town, city, or county within a country.
On their most basic level, a market is a place that goods or services are bought and sold. There are many types of markets, but let us focus on financial markets. The most typical examples of these financial markets include stock markets, money markets, foreign exchange markets (Forex), and bond markets. Markets constitute economies within a specific region or wider economic area.
The biggest difference between markets and economies is that markets are forward-looking and it is the unexpected events that drive prices, therefore, it isn’t whether the news is good or bad, but rather, whether it is better or worse than was already expected. If for instance, the markets expect the economy to be worse than it actually turns out to be, markets would respond positively to such news about a stronger economy than predicted and vice-versa if they expected the economy to be better than it turns out to be.
Who Predicts future markets and economies?
The short answer to who predicts markets and economies is anyone with an interest in the future. There are many people who predict markets and economies, such as individual investors, business managers, economists, universities, institutional investors, banks and central banks, rating agencies, governments, and supranational institutions to name just some.
Who do we rely on to find out these predictions though? These predictions are usually a collaboration between many parties who provide the data to make the calculations possible, some of whom were mentioned in the previous paragraph. Whilst there are many who try to predict the future, there are less to whom we trust to present these predictive outcomes. We rely on more authoritative sources that have a wider overview of all the moving parts involved. One such authority is the International Monetary Fund (IMF), another one of these authorities is the World Bank. Governments also try to forecast the future so they can set out budgets etc.
How are future economies predicted?
Forecasting the future when it comes to economies involves inputting several key variables into a statistical model and is sometimes combined with analytical reasoning. These key variables are a combination of widely accepted indicators and also examine fiscal and monetary policies to determine the future gross domestic product(GDP). So, let us take a look at some of these widely accepted indicators:
- Industrial production
- Interest rates
- Consumer confidence
- Employee productivity
- Retail sales
- Unemployment rates
Longer-term prediction models consider data from these primary indicators on shorter cycles and then abstract them forward to find the long-term estimated growth trend using key factors such as growth in the labour force of working age, human capital proxied by average educational levels across the adult population, growth in the physical capital stock driven by capital investment net of depreciation, and total factor productivity growth, which is driven by technological progress and lessening the gap of lower-income countries with richer ones by making use of their technologies and processes.
There are many types of market and economic forecasting models and it is important to be aware of the limitations of these models and their modelers. The outcomes can still be quite subjective and are prone to political and personal influence based on which model and beliefs or intended narratives are employed when making these predictions.
How accurate are market and economy prediction models?
As mentioned above the models can be rather subjective in their nature and require a soupçon of skepticism. Many factors influence these models including politics, types of models employed, modelers beliefs about the nature of what influences markets and economies, and many other factors.
Let’s look at how well these models have performed in recent times to test just how accurate or inaccurate they can be. We’ll look at models for forecasting a recession and see how the accuracy changes as the months in the year pass. In the images below the blue dots are individual forecasts, the red lines are the consensus forecasts, and the green lines are actual reality.
If short cycle models (1 year ahead) don’t fare very well, then long cycle models would probably fare even worse. Add to this that nobody knows the future and that unthought-of or unlikely events, such as natural disasters, wars, etc. could take place, which would not be considered in the models at the time they were created, means that we have a good chance that the models could end up incorrect by a large margin. That is not to say that these models are totally useless but they should be considered along with analytical reasoning and adapted when these unlikely events do occur.
Without getting too technical and explaining models in too much detail, consider that in long-term forecasts the data from individual forecasts are plotted on a graph and a margin of error is calculated to derive a consensus forecast to reduce these errors, as shown in the image above. The actual of that which is forecast still has a wide margin of error, but as the year passes this error is reduced significantly. So, our model for forecasting a recession year will get closer to the actual reality as that year passes, which is known as the evolution of forecasts. Even with the evolution of forecast getting closer to the actual reality there still can remain substantial errors.
Table of performance during recessions.
|Number of Recessions|
Total of 153
| Consensus Forecasts|
Apr [t-1] Oct [t-1] Apr [t] Oct [t]
| IMF Forecasts|
Apr [t-1] Oct [t-1] Apr [t] Oct [t]
|Recessions missed (#)|
Downward revisions (#)
As you can see from the table above out of 153 recessions only 5 were correctly forecast on the consensus forecasts, with IMF Forecasts faring slightly better early in the year at 6 correct forecasts. As the year passed into the later months fewer recessions were missed by both consensus and IMF. This indicates that even though forecasters failed to predict recessions in most of the cases, they started to realize the potential trouble ahead. Despite the downward revisions in forecasts, however, the forecast errors remain quite large. This is of course just one of many forecast models and recessions could be one of the harder ones to predict, given the nature of possible outlier onsets to a recession, such as political crisis, etc. You can find a full explanation about these forecasts by downloading the PDF at https://www.imf.org/en/Publications/WP/Issues/2018/03/05/How-Well-Do-Economists-Forecast-Recessions-45672
How do financial markets influence economies?
Capital flows, financial instruments, and operating systems are very complex, the quality of intermediation, financial oversight, and players of this complex game are all put into practice to support the development of the real economy and the benefit of financial market participants. Financial markets have become the arbiters of national and global economies in recent decades. The financial markets don’t miss a trick! Domestic macroeconomic performance reflects on the money market; governmental economic policies (fiscal, financial, monetary, and social) are assessed on stock and bond exchange markets, and the performances of state and private companies are often judged on financial markets by trading stocks and bonds.
Proper functioning of financial markets facilitates social and economic evolution and leads to a higher level of confidence for investors. This is not a zero-sum game though and for these markets to develop they rely on stability in political, social, and economic arenas. Markets and economies are in a symbiotic relationship, whereby one helps the other to develop and maintain the status quo. Developed economies use financial markets to keep in equilibrium with the balance of payments, and to maintain economic and social stability.
Financial markets help to expedite the development of countries, by assembling investors, individuals, and governments which have money or which are in need of money. Financial markets participate actively in constructing and developing a sustainable economy.
What is an advanced economy?
An advanced economy is a term developed by the IMF and whilst there are no rigid criteria for this definition, there are certain prerequisites for a country to be considered an advanced economy. The main metric is that of Gross Domestic Product (GDP) per capita, so if we divide the GDP by the number of people living in a country we obtain a figure. That figure is not set in stone but starts around $12,000 per person, though others suggest it should start at $25,000 per person. An advanced economy tends to concentrate on raising the standard of living through consumer investments. Another metric used to define an advanced economy is the Human Development Index (HDI), this metric measures a country’s levels of education, literacy, and health into a single figure. Export diversification and integration into the global financial system are also important factors in deciding what constitutes an advanced economy. There were 39 nations classified as advanced economies in 2016, which was an increase from 34 nations in 2010, I couldn’t find any more recent data than this, but it does show that these figures do move over time.
What is the difference between a developed and emerging market?
Emerging markets are usually nations that have less developed infrastructure and lower standards of living. These emerging markets have less advanced capital markets and regulatory bodies when compared to advanced economies. Their GDP to capita metric also falls short of the minimum requirements to be classified as an advanced economy. Emerging markets might have had political strife in recent years and are trying to remedy such ills by becoming more standardized with global norms and practices. An emerging market can experience more rapid growth than a stabilized advanced market by funding new infrastructure and fixed asset projects to fund this growth, rather than investments more weighted towards standards of living and consumption. They tend to export many of their goods to consumers in advanced economies.
Emerging markets in countries such as Egypt, for instance, are predicted to have staggering growth over the coming decades. Standard Chartered predicts that Egypt will see growth from its 2017 IMF figures of a mind-boggling 583% by 2030. With Egypt’s high-value Human Development Index (HDI) score, oil and gas exports, tourism industry, and infrastructure investments, plus concerted effort on its agricultural development, is it any wonder why these emerging markets are capturing the attention of investors?
Whilst forecasts can sometimes be dubious they offer some insights into future profitable markets and it is plain for all to see the economic reasoning for growth in these markets. Countries in the Middle East are primed for economic growth through their emerging markets, technological innovations, political stability, and global regulatory adoptions. Whether they are able to sustain these key factors or not will determine their projected future growth. If you are looking to diversify your portfolio outside of advanced economies then the Middle East should certainly be on your radar.
What do you think about emerging economies, investing in the Middle East, and the usefulness of economic forecasting models? Let me know your thoughts in the comments section.