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Introduction to Macroeconomics
Definitions:
In the words of Boulding, " Macroeconomics is that part of economics which studies the overall averages and aggregates of the system."
According to Shapiro, "Macroeconomics deals with the functioning of the economy as a whole."
High level of output (GDP) Full employment Price stability Sustainable balance of Payments Rapid Economic Growth
Objectives
High output level Low unemployment rate Stable price level
Instruments/Tools
Monetary Policy Fiscal Policy Exchange rate Policy
Maintenance of Balance of International Trade Policy Payments Steady economic growth Price and Income Policy
Economic Environment
Economic stages that exists at a given time in a country Economic system that is adopted by a country for example. Capitalistic, Socialistic or Mixed Economy Economic planning, such as five year plans, budgets, etc. Economic Indices such as National Income, Per Capital Income, Disposable Income, Rate of growth of GNP, Distribution of Income, Rate of savings, Balance of Payments etc. Economic policies for example, monetary, industrial and fiscal policies Phases of business cycle Structure of economy
Economic System
What is Capitalism?
"Capitalism is a system of economic organization featured by private ownership and its use for private profit of man-made and nature-made capital."
Features of Capitalism
Right to Private Property Freedom of Enterprise Freedom of Choice by Consumer Profit Motive Competition Importance of Price System
Socialism
"the important essentials of socialism are that all the great industries and the land should be public or collectively owned, and that they should be conducted (in conformity with a national economic plan) for the common good instead of private profit."
Features of Socialism
Social Ownership of Means of Production No Private Enterprise Economic Planning Classless Society Consumer is not sovereign
Mixed Economy
Co- Existence of Public and Private Property Price System and Government Directives Government Regulates and Controls the Private Sector Consumers' sovereignty is protected Government Protects Labor Interest
Contd..
8th Plan (1992-97)-Post Economic Reforms
The eighth plan was initiated just after a severe balance of payment crisis, which was intensified by the Gulf war in 1990.several structural modification policies were brought in to put the country in a path of high growth rate. They were devaluation of rupees, dismantling of license prerequisite and decrease trade barriers. The plan targeted an annual growth rate of 5.6% in GDP and at the same time keeping inflation under control.
Contd..
9th Plan (1997-2002)
It was observed in the eighth plan that, even though the economy performed well, the gains did not percolate to the weaker sections of the society. The ninth plans therefore laid greater impetus on increasing agricultural and rural incomes and alleviate the conditions of the marginal farmer and landless laborers. The main objectives of the ninth five year plan were agriculture and rural development, food and nutritional security, empowerment of women, accelerating growth rates, providing the basic requirements such as health, drinking water, sanitation etc.
Contd..
10th Plan (2002-2007)
The aim of the tenth plan was to make the Indian economy the fastest growing economy in the world, with a growth target of 10%.It wanted to bring in investor friendly market reforms and create a friendly environment for growth. It sought active participation by the private sector and increased FDI's in the financial sector. Emphasis was also on improving the infrastructure.
Economic Indicators
Contd
Lagged: trail behind the general economic activity. Example: Unemployment rate GDP (sometimes) Coincident: A coincident economic indicator is one that simply moves at the same time the economy does. The Gross Domestic Product is a coincident indicator.
Calculating Aggregates
At Market Price At Factor Cost Factor costs are really the costs of all the factors of production such as labor , capital, energy, raw materials like steel etc that are used to produce a given quantity of output in an economy. Factor costs are also called factor gate costs since all the costs that are incurred to produce a given quantity of goods and services take place behind the factory gate ie within the walls of the firms, plants etc in an economy.
Nominal GDP
Nominal GDP is the value of the total flow of goods and services produced in an economy over a specified period of time (usually a year] at current market price At current prices, GDP growth is partly due to increase in output and partly due to increase in prices so that GDP at current prices can give misleading conclusions on growth
Real GDP
GDP data is also calculated at constant prices taking the year in the past as base year to filter our the impact of current prices.
Real GDP is the physical quantity of goods and services produced in a given period changes in real GDP measure changes in living standard
Example
Assume economy only produces apples and pears. The price for an apple is $2 in 2000, whereas the price for a pear is $3. Same year we produce 100 apples and 50 pears. In 2005, because of the inflation the price for an apple goes up to $3, whereas the price for a pear is $4 at the same production levels. The nominal GDP in 2000 is $350 and the nominal GDP in 2005 is $500. However real GDP did not change, because real GDP only changes with the changing production level and therefore is a better size measure for economy.
GNP at factor cost =GDP at factor cost + Net Income from abroad
Examples - GNP
The income of an Indian working in Bahrain is part of Bahrain's GDP as well as India's GNP Suppose Toyota owns a plant in Bahrain to produce Camry's using Bahraini workers. How to count the product of this plant in the GDP and GNP of Bahrain and Japan? With GDP, Bahrain gets all of it, because the plant and the workers are all located in Bahrain. With GNP, the capital share goes to Japan
Contd.
In addition, a growing gap between GNP and NNP indicates increasing obsolescence of capital goods, while a narrowing gap would mean that the condition of capital stock in the country is improving.
NNP at factor cost = GNP at factor costDepreciation which is accurate measure of National Income
Expenditure Approach
Considers total spending on all final goods & services during the year It is a demand based concept Includes:
Personal Consumption Durable Goods & Non-Durable Goods and Services Gross Private Investment Government Consumption and Gross Investment Net Exports of Goods and Services
Income Approach
Measures by summing the following components
Employee Compensation Proprietors Income Corporate Profits Rent Interest Income Indirect Business Taxes Net Income from foreigners
Money Supply
Money supply is another important indicator of macroeconomic environment This refers to the total volume of money circulating in the economy, and conventionally comprises currency with the public and demand deposits (current account + savings account) with the public. Money supply in an economy determines liquidity conditions in the market, which in turn impacts interest rate structure and hence the cost of capital to the firms.
Contd..
Money supply is basically determined by the central bank of a country (e.g. Reserve Bank of India) and the commercial banking network. RBI has adopted four measures of money supply viz.-Ml, M2, M3 and M4 . M3 (broad money) is most popular from operational point of view. M3 includes time deposits (fixed deposits), savings deposits with post office saving banks and all the components of M1.
Inflation
A sustained increase in the general level of prices so that a given amount of money buys less and less. Reasons of inflation 1. inflation caused by monetary expansion (monetary inflation) 2. inflation caused by real demand expansion 3. inflation caused by aggregate supply contraction
Types of Inflation
Demand pull inflation: Arises when aggregate demand outpaces aggregate supply in an economy. It involves inflation rising as the real gross domestic product rises and unemployment falls Cost Push inflation: This is because of large increases in the cost of important goods or services where no suitable alternative is available. A situation of this kind has been cited during oil crisis in 1970s
Hyperinflation: Hyperinflation is also known as runaway inflation or galloping inflation. This type of inflation occurs during or soon after a war
Measurement of Inflation
Inflation is measured by the Wholesale Price Index (WPI) Consumer Price Index (CPI) A Wholesale Price Index (WPI) is the price of a representative basket of wholesale goods. Some countries use the changes in this index to measure inflation in their economies, in particular India The Indian WPI figure is released weekly
Headline inflation
Headline inflation is a measure of the total inflation within an economy and is affected by certain components which may experience sudden inflationary spikes such as food or energy. As a result, headline inflation may not present an accurate picture of the current state of the economy. WPI is the measure of headline inflation in India
Core inflation
Core inflation has emerged as an alternative for measuring inflation. In this, volatile items like food prices and fuel items are excluded. The first two categories include food articles and fuel items which can be excluded. The third category Manufacturing also includes food products which tends to be volatile as well and moves in line with prices of primary articles. So after excluding food products from manufacturing sector, we get non-food manufactured products inflation. This can also be called as core inflation for India
Effects of inflation
Wealth costs inflation affects those on fixed incomes and redirects wealth to other (physical) assets Planning costs businesses uncertain about future price changes may be reluctant to invest hits economic growth Competitiveness inflation at a higher rate in the UK than elsewhere hits domestic competitiveness and affects the balance of payments Social stability - At very high rates, confidence in the currency is eroded and production and exchange can be stifled can lead to food riots, looting and violence
Economic Policies
Economic Policies
Monetary Policy Fiscal Policy Industrial Policy Foreign Trade Policy
Monetary policy
Monetary policy is one of the tools used to influence its economy. Using its monetary authority to control the supply and availability of money, a government attempts to influence the overall level of economic activity in line with its political objectives. Usually this goal is "macroeconomic stability" - low unemployment, low inflation, economic growth, and a balance of external payments. Monetary policy is usually administered by a Government appointed "Central Bank.
instead and suck in liquidity, the effect would exactly be the opposite!!
Bank rate
Rate at which Central Bank lends money to commercial Banks The bank rate signals the central bank's long-term outlook on interest rates. If the bank rate moves up, longterm interest rates also tend to move up, and vice-versa. Any increase in Bank rate results in an increase in interest rate charged by Commercial banks which in turn leads to low level of investment and low inflation
Meaning of Repo
The term Repo is used as an abbreviation for Repurchase Agreement or Ready Forward. A Repo involves a simultaneous "sale and repurchase" agreement. It enables collateralized short term borrowing and lending through sale/purchase operations in debt instruments
Repo Rate
In current monetary policy RBI raised repo rate by 25 basis points to 5.75% Repo rate is the interest rate charged by the Central bank when banks borrow money from it against pledging its securities If the RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.
Reverse Repo
The rate at which RBI borrows money from the banks (or banks lend money to the RBI) is termed the reverse repo rate. If the reverse repo rate is increased, it means the RBI will borrow money from the bank and offer them a lucrative rate of interest. As a result, banks would prefer to keep their money with the RBI (which is absolutely risk free) instead of lending it out (this option comes with a certain amount of risk) Consequently, banks would have lesser funds to lend to their customers. This helps stem the flow of excess money into the economy Reverse repo rate signifies the rate at which the central bank absorbs liquidity from the banks, while repo signifies the rate at which liquidity is injected.
Objective : The funds under LAF are used by the banks for their day-to-day mismatches in liquidity. Tenor :Under the scheme, Reverse Repo auctions (for absorption of liquidity) and Repo auctions (for injection of iquidity) are conducted on a daily basis (except Saturdays). Eligibility : All commercial banks (except RRBs) and PDs having current account and SGL account with RBI. Minimum bid Size : Rs. 5 cr and in multiple of Rs.5 cr Eligible securities: Repos and Reverse Repos in transferable Central Govt. dated securities and treasury bills.
Discretion to RBI : Under the revised Scheme, RBI will continue to have the discretion to conduct overnight reverse repo or longer term reverse repo auctions at fixed rate or at variable rates depending on market conditions and other relevant actors. RBI will also have the discretion to change the spread between the repo rate and the reverse repo rate as and when appropriate. (As per an IMF 1997 publication, the sale and repurchase transactions (reverse repo), are sales of assets by he central bank under a contract providing for their repurchase at a specified price on a given future date; they are used to absorb liquidity. On the contrary, prior to above change, in the Indian context, repo denotes liquidity absorption by the Reserve Bank and reverse repo denotes liquidity injection).
Highlights of RBI Monetary Policy Review for first quarter of the financial year FY2010-11
The Bank Rate has been retained at 6.0% Repo rate increased by 25 bps from 5.5% to 5.75% with immediate effect Reverse repo rate increased by 50 bps from 4.0% to 4.50% with immediate effect Cash Reserve Ratio (CRR) of scheduled banks has been retained at 6.0% of their net demand and time liabilities (NDTL) The projection for WPI inflation for March 2011 has been raised to 6.0% from 5.5% Baseline projection of real GDP growth for FY2010-11 is revised to 8.5%, up from 8.0% with an upside bias
Contd..
The move was aimed to moderate inflation by reining in demand pressures and reduce the volatility of short-term rates, RBI governor Subbarao was quoted as saying. "Inflation is now being significantly driven by demand-side factors," Subbarao said. "It is imperative that we continue in the direction of normalizing our policy instruments to a level consistent with the evolving growth and inflation scenarios." The RBI said that the Monetary Policy actions are expected to:
Moderate inflation by reining in demand pressures and inflationary expectations. Maintain financial conditions conducive to sustaining growth. Generate liquidity conditions consistent with more effective transmission of policy actions.
Public Finance
Study of State Finance is called Public Finance Deals with the income and expenditure of central, state and local governments. Raising of necessary funds for incurring expenditure for public goods constitutes the subject matter of Public Finance Components of Public Finance Public Revenue Public Expenditure Public Debt Fiscal Policy
Fiscal policy refers to government policy that attempts to influence the direction of the economy through changes in taxation, public borrowing and public expenditure with specific objectives in view.
Contd..
Changes in the level and composition of taxation and government spending can 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.
Importance Depression
of
Fiscal
Policy
Post
Great
The ineffectiveness of monetary policy as a means of overcoming the severe unemployment of the Great Depression The development of the new economics by Keynes with its emphasis on aggregate demand. Fiscal policy is based on the theories of British economist John Maynard Keynes. Also known as Keynesian Economics, this theory basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. This influence, in turn, curbs inflation (generally considered to be healthy when at a level between 2-3%), increases employment and maintains a healthy value of money.
Budget
The main instrument of fiscal policy is the budget, presented annually by the Minister of finance to Parliament. Budget means plans of government finances submitted for the approval of the Legislature It is a time bound financial program systematically worked out and ready for execution in the ensuing fiscal year. It is a comprehensive plan action which brings together in one consolidated statement all financial requirements of the government.
Non tax Revenue Interest receipts Dividend Profits of PSUs Revenue from social services like education and hospitals External Grants
Capital Receipts
Interest receipts Dividend from state enterprises Share in Central taxes Grants in aid from Centre And other contributions from Centre Like those given for central schemes
Public Expenditure
Revenue Expenditure Plan Expenditure Central Plan such as agriculture, rural development, social service and others Central Assistance for plans to States and UTs Capital Expenditure Plan Expenditure Developmental Projects
Non Plan Expenditure Interest Payments Subsidies Debt relief to farmers Grant to states and UTs Others
Non Plan Expenditure Loans to PSUs Loans to states and UTs Defense
Revenue Deficit
Current revenue expenditure of the central government is composed of plan and non-plan expenditure of the government. Revenue expenditure is met out of current revenue receipts Revenue Deficit = Revenue expenditure Revenue receipts
Fiscal Deficit
It is the difference between the government's total receipts (excluding borrowing) and total expenditure. Fiscal deficit gives the signal to the government about the total borrowing requirements from all sources. Components of fiscal deficit revenue deficit and capital expenditure.
Fiscal Deficit
In India, the fiscal deficit is financed by obtaining funds from Reserve Bank of India, called deficit financing. The fiscal deficit is also financed by obtaining funds from the money market (primarily from banks)
Monetized Deficit
It is net increase in net Reserve Bank credit to Central government which is sum of increase in RBIs holdings of govt of India dated securities, treasury bills, rupee coins and loans and advances from Reserve Bank to Centre since April 1, 1997
Scheme of Ways and Means Advances (WMA) to State Governments for the fiscal year 2007-08 On a review of the State-wise limits of Normal Ways and Means Advances for the year 2006-07, the Reserve Bank of India has decided to keep these limits unchanged for the year 2007-08. Accordingly, the aggregate Normal WMA limit would be retained at Rs.9,875 crore in 2007-08. Other terms and conditions of the Scheme would also continue to remain unchanged for 2007-08.
The cycle involves shifts over time between periods of relatively rapid growth of output (recovery and prosperity), and periods of relative stagnation or decline (contraction or recession). Phases of Business Cycle Prosperity Recession Depression Recovery
Prosperity Phase
Unemployment rate declines Income tends to rise Investment increases Investors become more optimistic Consumption tends to rise Share price index tends to rise Money Supply increases
Recessionary Phase
Recession is turning point ie when prosperity ends recession begins Liquidation in stock market, fall in prices are symptoms Banks & People try to gain greater liquidity so credit sharply contracts Business expansion stops
Depression Phase
Shrinkage in volume output Rise in level of unemployment Fall in aggregate demand Contraction of Bank credit Fall in prices
Recovery Phase
Rise in demand for consumption goods which in turn lead to demand for capital goods and new investment is induced This will give rise to increase in income and employment
Peak
Trough
Trough
2005
2010 Year
2015
10-4
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