This module's about the relationship between the 'real economy' - company results, economic indicators, the actions of government - and the financial sector - bond markets, FX markets, money markets and, in particular, equity markets.

At the heart of this relationship is a country's monetary authorities and specifically, how a country's monetary authorities react to changes in the level of activity in the economy.

In simple terms, governments want to achieve what's called 'sustainable growth'; basically, 'growth without inflation'. And they go about this by trying to control the level of activity in the economy.

They measure the level of activity in the economy in terms of the level of what's called nominal GNP(gross national product); and they - and the financial markets - pay very careful attention to its components. GNP's important because there's a well established relationship between the level of nominal GNP and what are called 'monetary aggregates'. Monetary aggregates - of which there are many - basically measure the amount of spending power in the economy (the amount of cash and credit floating around).

If nominal GNP grows too quickly monetary authorities will fear that there's too much money swilling around and that this will translate into inflation. Consequently, they'll react by tightening monetary policy; that is, by increasing interest rates, increasing the cost of credit and putting downward pressure on spending and on economic activity in general.

If the growth of nominal GNP slows, monetary authorities will fear economic slowdown and they'll react by loosening monetary policy; that is, by decreasing interest rates, decreasing the cost of credit and boosting spending and economic activity in general.

The question of how all this impacts on financial markets is the subject of this module, but before we look at the specific relationship between a range of economic indicators and the markets' valuation of different assets, we need to understand the general pattern of economic behaviour - the so-called business cycle - and how governments (and in particular, monetary authorities) fit into this pattern.

The business cycle

Economic growth tends to be cyclical, with a period of contraction, followed by a period of expansion, which is in turn followed by contraction, and so on. No business cycle is identical - they vary both in terms of the length of their different stages and the extremity of their peaks and troughs. But the one thing that's certain is that - historically at least - economies do seem to behave in a cyclical manner.

As we've already seen, governments want to achieve sustainable growth. Putting this in the context of the business cycle, governments try to even out the cycle's highs and lows. Why though is growth broadly cyclical? To understand why we need to follow the cycle through its stages.