The Road Ahead

A Snapshot of Macroeconomics

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Micro vs. Macro

Macroeconomics deals with the Economy as a whole GDP Unemployment Prices Consumption Investment International Trade

Term coined by Ragnar Frisch in 1933 Microeconomics deals with

Actions of individuals Firms and Consumers

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Schools of Economic Thought

Mercantilism Physiocracy

Physiocrats – Agrarian philosophy Francois Quesnay Land Agriculture

Term coined by Ragnar Frisch in 1933 Microeconomics deals with

Actions of individuals Firms and Consumers

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Schools of Thought - 1

Classical/ New Classical Started with Adam Smith’s Wealth of Nations (1776)

Prices and wages are flexible Markets carry out their functions efficiently The supply side of the economy is very important Changes in the demand side of the  economy have only

temporary effects on the economy No role for the Government to play- Laissez-Faire

Alfred Marshall, Adam Smith, David Ricardo Failed to predict/correct the Great Depression of 1929 Early 1970’s- New Classical School Say’s Law

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Schools of Thought - 2

Keynesian/New Keynesian Prices and wages are not flexible Markets are not efficient The demand side of the economy is very important Government has a major role to play - Fiscal Policy

John Maynard Keynes – 1930s The General theory of Employment, Interest and Money Great Depression Advocated Government Intervention Multiplier Effect

Resurgence in 2008-2009 Global Financial Crisis – Sub-prime Crisis Paul Krugman, Joseph Stiglitz, Greg Mankiw, Akerlof

Schools of Thought - 3

Austrian School Von Mises, Murray Rothbard, Hayek

Unscientific Economist

Mathematical Modeling impossible Rejected Mathematical & Statistical methods No Government intervention Criticizes Central Bank actions

Central Bank actions responsible for Depressions and Recessions Inflation caused by Central Bank actions

Absolute Laissez Faire Praxeology – logical processes of human action Predicted the Great Depression – Hayek Advocate Gold standard Criticized by Krugman, Friedman and Jeffrey Sachs

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Key Concepts - 1

GDP - Gross Domestic Product Definition Broadest measure of Economic activity Who- ‘Where’ is important

Ex: MNC in India is incl. In GDP Ex: Indian in the Gulf is not included in GDP

GDP = C + I + G + X – M Personal consumption (C), Gross private domestic investment (I),

Government purchases (G), and Net Exports (X-M)

Product, Income and Expenditure Approach GDP Growth rates - Worldwide

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Issues with GDP Parallel economy/Shadow economy Barter Transactions Double Counting Quality of Data/ Estimates Household Production Ignores Externalities Distribution of wealth Sustainability of Growth

Alternatives HDI – Gini Coefficient

Key Concepts - 2

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Key Concepts - 3

GNP - Gross National Product

Gross National Product includes income earned by the factors of production (assets and labor) owned by a country's residents but excludes income produced within the country's borders by factors of production owned by nonresidents

“Where” - is immaterial

“Who” - is important

GNP = GDP + Receipts – Payments

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Key Concepts - 4

CPI – Consumer Price Index It is the annual percentage change in the cost of acquiring a

fixed basket of goods and services Measures

Inflation Purchasing power of consumers – Today vs. Yesterday

Basis for Dearness Allowance 4 types

Working class Agricultural labor Industrial workers Rural labor

Food-60% ;Clothing-8% ;Fuel-6% ;Housing-8% ;Misc-18%

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Key Concepts - 5

Wholesale price index - WPI It is the index used to measure the change

in the average price level of goods traded in wholesale market

600+ commodities data tracked Captures price movements in a comprehensive way Widely used in Business, Industry, Government Better approximate of inflation

Primary Articles - 22% Mfcg. Goods - 64% Fuel – 14%

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Key Concepts - 6

Inflation An increase in the general level of prices Measured by CPI and WPI Is it Bad and undesirable? Could it be an incentive to invest?

Deflation A fall in the general price level or a contraction of credit

and available money Deflation, not inflation, is now the greatest concern for the

world economy

Disinflation A period or process of slowing the rate of inflation

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Key Concepts - 7

Causes of Inflation

Monetary Theory Monetary policies of Central Banks

Monetary and fiscal restraint

Neo-Keynesian Theory Demand-Pull Cost-Push

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Key Concepts - 8

How to control Inflation?

Monetary PoliciesOpen Market Operations

Fiscal PolicyTaxationGovernment Spending

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Key Concepts - 9

Recession A recession is a prolonged period of time when a

nation's economy is slowing down, or contracting Prerequisite: Two consecutive Quarters Trends indicating Recession

Decrease in Consumer Spending Decrease in industrial production Growing unemployment Slump in personal income An unhealthy stock market

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Key Concepts - 10

Forex External assets that are readily available to and controlled by

monetary authorities for direct financing of external payments imbalances, for indirectly regulating the magnitudes of such imbalances through intervention in exchange markets to affect the currency exchange rate, and/or for other purposes

Foreign exchange reserves targets are fixed to accommodate imports of three months

Foreign exchange reserves include three items Gold SDR’s Foreign currency assets

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Liberalization - 1

The term is used for a more ‘outward-oriented’ economic policy Elimination of anti-export biases Lowering high import tariffs Reducing/phasing out Quantitative Restrictions (QRs) on inputs Switching to tariff-related measures

The goals of liberalization were to motivate Indian manufacturers to Prefer updated technology Deliver better products at lower costs Face global competition Deliver world class goods and services

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Liberalization - 2

Liberalization in Various Sectors Infrastructure Power Telecom Oil Insurance Automobiles Agriculture Software

Second Generation of Reforms Cutting down the fiscal deficit Reform the archaic labor laws Remove the QRs on consumer goods imports

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Currency Convertibility - 1

Currency convertibility is defined as the freedom to convert one currency into other internationally accepted currencies

Two forms of convertibilityCurrent account convertibilityCapital account convertibility

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Currency Convertibility - 2

Current account convertibility has been defined as the freedom to buy or sell foreign exchange for International transactions consisting of payments due in

connection with foreign trade, other current businesses including services and normal short-term banking and credit facilities

Payments due as interest on loans Moderate remittances for family living expenses

Capital account convertibility means that the home currency can be freely converted into foreign currencies for acquisition of capital assets abroad

The rupee is currently not freely convertible on the capital account

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Financial Markets

Provide facilities for the buying and selling of financial claims and services Classified as

Primary Secondary

Also classified as Money – Short Term – CP & CD Capital – Long term – Stocks & Bonds

Stock Markets SEBI

Forex Markets

Annexures

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Fiscal Policy - 1

Government uses its revenue and expenditure programs to produce desirable effects on

National incomeProductionEconomy

Used as a balancing device Two elements of Fiscal Policy

TaxationPublic Expenditure

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Fiscal Policy - 2

Objectives of Fiscal Policy Mobilization of resources Acceleration of economic growth Minimization of the inequalities of income and

wealth Increasing employment opportunities Price stability

Reflationary Fiscal Policy Deflationary Fiscal Policy

Say’s Law

Jean Baptiste Say - “Products are paid for with Products”

“It is worthwhile to remark that a product is no sooner created than it, from that instant, affords a market for other products to the full extent of its own value. When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should diminish in his hands. Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable. But the only way of getting rid of money is in the purchase of some product or other. Thus the mere circumstance of creation of one product immediately opens a vent for other products”

What does it mean – Supply equals Demands In order to obtain a desired commodity, one must first and necessarily

produce a commodity which is itself desirable. Those who produce undesirable commodities, or produce desirable commodities but at unprofitable costs, will fail.

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Great Depression

Coined by Lionel Robbins – “Great Depression” Started in 1929 and lasted till 1940 Global Scale Black Tuesday – 29th Oct, 1929 Large Scale Unemployment – 25% in US Frantic Attempts at Protectionism – Smoot Hawley Tariff Act Causes

Collapse of banks Smoot Hawley Act Monetary Contraction

Recovery in 1933 Public Works Government Spending WWII

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US- GDP & Unemployment

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Worldwide Impact

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Great Depression in Pics

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Great Depression in Pics

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Great Depression in Pics

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Great Depression in Pics

Dorothea Lange

“Migrant Mother”

Stamp

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GDP Growth - Worldwide

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GDP - Nominal

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GDP - PPP

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Gini Coefficient

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HDI

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Key Terms - 1

Cash Reserve Ratio – CRR is the portion of deposits (as cash) which banks have to keep/maintain with the RBI. This serves two purposes: Ensures that a portion of bank deposits is totally risk-free Enables that RBI control liquidity in the system, and thereby, inflation

Bank Rate - is the rate at which the central bank lends to the commercial banks

SLR is the portion of their deposits banks are required to invest in government securities

Repo rate - is the rate at which the RBI borrows short term money from the market. After economic reforms RBI started borrowing at market prevailing rates. So it makes more sense to banks to lend money to RBI at competitive rate with no risk at all

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Key Terms - 2

Balance of Payments ( BoP)A statement of economic transactions

showing the relative difference between the inflow and outflow of goods, services, and capital claims and liabilities between a country and its trading partners

BoP= (Exports + Inflows)- (Imports + Outflows)

1991 Crisis

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Key Terms - 3

Exchange Rate the price of a national currency in terms of the currency of

another nation. The exchange rate is a way of stating how many units of

currency (dollars, for example) it would take to buy a unit of a foreign currency

Changes in the exchange rate of a country's currency can make a difference in the price of its imports and exports

Fixed Rate held fixed in terms of a foreign currency

Floating Market forces allowed to determine the rate

Mixed