macroeconomics currenci review

7/27/2019 Macroeconomics Currenci Review

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MacroEconomics

Preparatory Material

Currenc-I


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Important StatsParameter ValueGDP $1.85 TrillionGDP growth rate 5.2% (2nd Quarter, 2012)Contribution to GDP by sector Agriculture 17.2%

Industry 26.4%

Services 56.4%Inflation rate WPI 7.24% (Nov, 2012)Exports $300 billion (Dec 2011)Forex reserves 295.29 billion (Oct, 2012)Fiscal deficit 5.7% of GDP (FY 12)Bank rate 9%CRR 4.25%SLR 23%Repo rate 8%Reverse repo 7%MSF 9%


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Trending Topics

Direct Cash Transfer: Union Governments flagship subsidy transfer

schemehttp://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-

transfer-scheme-rolls-out_1784497

Foreign Investment Promotion Board (FIPB) clears IKEAs 1.5 billion Euro

investment in to set up its furniture retail chain

http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/

2G spectrum auctions: No takers for 57% of airwaves

http://articles.economictimes.indiatimes.com/2012-12-

12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctions

UPA-II big bang reforms 2012: FDI in retail upto 49%, FDI in insuranceraised to 49%, FDI in aviation

http://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-

friday-reforms-456864.html
http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://www.firstpost.com/business/the-murky-truth-behind-upas-big-bang-friday-reforms-456864.htmlhttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://articles.economictimes.indiatimes.com/2012-12-12/news/35774073_1_airwaves-mhz-band-upcoming-spectrum-auctionshttp://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.business-standard.com/india/news/ikea-may-enter-indiacut-down-product-rangenot-without-cafes/496491/http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497http://www.dnaindia.com/india/report_fingers-crossed-as-direct-cash-transfer-scheme-rolls-out_1784497


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Sahara Vs SEBI: OFCD legal tangle

http://thefirm.moneycontrol.com/story_page.php?autono=792521

Kingfisher airlines rowhttp://articles.economictimes.indiatimes.com/2013-01-

06/news/36162199_1_lessors-rival-carriers-goair-and-indigo

US fiscal cliff resolution

http://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-

Cliff.htm

Labor dispute pits France against ArcelorMittal

http://www.nytimes.com/2012/11/28/business/global/labor-dispute-pits-

france-against-arcelormittal.html?pagewanted=all&_r=0

Libor fixing scandal Barclayshttp://www.economist.com/news/finance-and-economics/21569053-banks-

face-another-punishing-year-fines-and-lawsuits-year-lawyer
http://thefirm.moneycontrol.com/story_page.php?autono=792521http://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://www.nytimes.com/2012/11/28/business/global/labor-dispute-pits-france-against-arcelormittal.html?pagewanted=all&_r=0http://www.nytimes.com/2012/11/28/business/global/labor-dispute-pits-france-against-arcelormittal.html?pagewanted=all&_r=0http://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.economist.com/news/finance-and-economics/21569053-banks-face-another-punishing-year-fines-and-lawsuits-year-lawyerhttp://www.nytimes.com/2012/11/28/business/global/labor-dispute-pits-france-against-arcelormittal.html?pagewanted=all&_r=0http://www.nytimes.com/2012/11/28/business/global/labor-dispute-pits-france-against-arcelormittal.html?pagewanted=all&_r=0http://www.nytimes.com/2012/11/28/business/global/labor-dispute-pits-france-against-arcelormittal.html?pagewanted=all&_r=0http://www.nytimes.com/2012/11/28/business/global/labor-dispute-pits-france-against-arcelormittal.html?pagewanted=all&_r=0http://www.nytimes.com/2012/11/28/business/global/labor-dispute-pits-france-against-arcelormittal.html?pagewanted=all&_r=0http://www.nytimes.com/2012/11/28/business/global/labor-dispute-pits-france-against-arcelormittal.html?pagewanted=all&_r=0http://www.nytimes.com/2012/11/28/business/global/labor-dispute-pits-france-against-arcelormittal.html?pagewanted=all&_r=0http://www.nytimes.com/2012/11/28/business/global/labor-dispute-pits-france-against-arcelormittal.html?pagewanted=all&_r=0http://www.nytimes.com/2012/11/28/business/global/labor-dispute-pits-france-against-arcelormittal.html?pagewanted=all&_r=0http://www.nytimes.com/2012/11/28/business/global/labor-dispute-pits-france-against-arcelormittal.html?pagewanted=all&_r=0http://www.nytimes.com/2012/11/28/business/global/labor-dispute-pits-france-against-arcelormittal.html?pagewanted=all&_r=0http://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htmhttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://articles.economictimes.indiatimes.com/2013-01-06/news/36162199_1_lessors-rival-carriers-goair-and-indigohttp://thefirm.moneycontrol.com/story_page.php?autono=792521


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National Income Accounting GDP = C+I+G+NX

Value of all final goods and services produced in the country within a given

periodC Consumption spending ( ~60%)

I Investment spending by businesses and households (~20%)

G Govt purchase of goods and services (~10%)

NX Foreign demand for Net Exports (~10%)

Current India GDP: $1.85 Trillion US dollars

GNP = GDP + Receipts from abroad made as factor payments todomestically owned factors of production

or GDP + Inflows of factor earnings from abroad (Salaries, Dividends,

Interests on loans) Outflows of factor payments abroad (Salaries, dividends ,Interest from foreign operations in India)

GNP is monetory value of final goods and services produced by domesticallyowned factors of production

Current India GNP: $4.49 Trillion PPP dollars


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NDP = GDP Depreciation

Net amount of goods produced in the country in a given period OR

It is the total value ofproduction minus the value of the amount of capital

used up in producing that output

NDP factor cost = NDP IBT + Subsidies

It is the factor income generated in the process of production from economicactivities within the country

IBT = Indirect business taxes like excise duty, VAT etc

Subsidies = They generate factor income as they are used to offset payments

to wages, rents etc

National Income (NI) = NDP factor cost + Net factor earnings from abroad

It is the income earned by domestically owned factors of production


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Important points In India GDP is used for measuring growth rate and in India it is calculated

quarterly

Since GDP captures investments made in the country this is a preferred

measure of growth rate as compared to GNP

IMP LINKS:

Link for important stats:

http://www.indiastat.com/economy/8/nationalincome/175/grossdomesti

cproductgdpnetdomesticproductndp/449275/stats.aspx

World bank stats link :

https://www.google.co.in/publicdata/explore?ds=d5bncppjof8f9_&met_y

=ny_gnp_mktp_pp_cd&idim=country:IND&dl=en&hl=en&q=current%20in

dia%20gnp
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8/80

Various Economy Models Simple Economy

Y = C + I (Y Output)Y = S + C (S Savings)

C + I = S + C

With Govt and Foreign trade

Y = C+I+G+NX

YD= Y+TR-TA (YD- Disposable income, TR Transfer payments, TA Taxes)

YD = C +S

S I = (G+TR-TA) + NX

(S-I) -> Private sector spending(G+TR-TA) -> Govt budget deficit

NX Net exports

Excess of savings over investment in private sector is equal to sum of budget

deficit and trade surplus


9/80

Measuring GDP Final goods

GDP is taken as the value of final goods and services produced to avoid

double count Value added

At each stage of the manufacture of a good, only the value added to the good

at that stage is considered for GDP

Eg: Value of bread = value of wheat produced by farmer + (Value of flour sold

by miller value of wheat )

+ (Value of bread sold Value of flour used)

Current Output

GDP consists of value of output currently produced

Imp Points: Construction of new houses is a part of GDP

Trading of existing houses is not a part of GDP

Value of realtors fees in the sale of existing houses is included in GDP


10/80

Inflation and Price Indices Nominal GDP is GDP evaluated at current market prices. Therefore,

nominal GDP will include all of the changes in market prices that have

occurred during the current year due to inflation or deflation.

Real GDP is GDP evaluated at the market prices of some base year. For

example, if 1990 were chosen as the base year, then real GDP for 1995 is

calculated by taking the quantities of all goods and services purchased in

1995 and multiplying them by their 1990 prices.

Inflation is defined as a rise in the overall price level, and deflation is

defined as a fall in the overall price level.

GDP deflator. Using the statistics on real GDP and nominal GDP, one can

calculate an implicit index of the price level for the year. This index is

called the GDP deflator and is given by the formula


11/80

CPI: differs from the GDP deflator in two important ways. First, the CPImeasures only the change in the prices of a basket of goods consumed by atypical household. Second, the CPI uses base year quantities rather thancurrent year quantities in calculating the price level index value

Producer Price Index (PPI):It measures the average change over time in the

selling prices received by domestic producers for their output. The pricesincluded in the PPI are from the first commercial transaction for manyproducts and some services.

Core inflation represents the long run trend in the price level. In measuringlong run inflation, transitory price changes should be excluded. One way of

accomplishing this is by excluding items frequently subject to volatile prices,like food and energy

Useful Link: http://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.html
http://en.wikipedia.org/wiki/Inflationhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://www.cliffsnotes.com/study_guide/Nominal-GDP-Real-GDP-and-Price-Level.topicArticleId-9789,articleId-9734.htmlhttp://en.wikipedia.org/wiki/Inflation


12/80

Goods Market Equilibrium, the IS curve

IS curve gives combination of income and interest

at which goods market is in equilibrium ie.,

income or output of the economy equals the

aggregate demand for a given interest rate. The IS curve is downward sloping because at

lower interest rates investment I is higher. Hence,

output is more at lower income levels.

Increase in income/ spending/ investments

moves IS curve to the right. Decrease moves it to

the left.


13/80

A

A

AD

Y

Y

AD1

Y=AD

IS

A0-bi1

i

i1

Y1

AD2

A0-bi2

Graphical Derivation of IS curve

Y1

B

Bi2

Y2

Y2

IS curve gives

combinationof income and

interest at

which goods

market is in

equilibrium

AD= (A0-bi) + c(1-t)Y


14/80

IS Curve

Y = (A0 - bi) is the IS curve equation. Rewriting,

Interest, i = [A0/b] [Y/ (b) ]

Slope of the curve is -1/ (b).

is income multiplier given by 1/ (1 c(1-t) )

b is sensitivity of interest to income changes

Larger the value of, b flatter the IS curve.

Increase in tax rate reduces the multiplier. So

higher the tax rate, steeper the IS curve.


15/80

A BC

A B

Y1 Y0 Y2

AD

Y

i

Y

AD

Y=AD

IS

Ao-bi

(EDG)

ADY

(ESG)

ADY

C

Points to the left of

the IS curve : excess

demand for goods

(EDG)

Points to the right :

excess supply of

goods (ESG).

Goods market equilibriumPositions of the IS curve


16/80

Money Market Equilibrium, the LM curve

Money supply is determined by the centralbank. M/P= M0/P0.

M/P = real balances.

Money market equilibrium-The LM curve

LM curve gives the combination of interest andincome at which money market is inequilibrium. For points along the LM curve,

demand for money = supply of money.


17/80

i

L,M/P

i

Y

L1(Y1)

M/P LM

i1

i2

Y1 Y2

L2(Y2)

Graphical derivation of LM curve

L1, L2 represent demand for money for given income levels


18/80

M0/P0 is constant real balances in theeconomy (M/P = Real balance)

k,h sensitivity of demand for real balances wrt

income and interest rate respectively.

Slope of the curve is K/h.

This is LM equation

0

01

P

MkYh

i


19/80

LM Curve position is determined by level of

M/P.

Increase in M (money supply), increases M/P,

so LM curve moves right.

Increase in P (prices), decreases M/P, so LM

curve moves to the left.


20/80

i

L,M/P

i

Y

L(Y1)

M/P

LM

i1

Y1

i2

LM

M/PM/P

i3

LM

Impact of changes in money supply

Position of the LM curve


21/80

i

L,M/P

i

Y

L

M/P LM

i0

i2

Y1

A

B

Ci1

A

B

C

(ESM)

(EDM)

Positions off the LM curve

Md

Ms

Md

Money market equilibrium

Positions off the LM curve


22/80

Joint Goods and Money Market Equilibrium

Income, Y

Interest, i

IS0

LM0

Y0

i0

The intersection of the IS and LM graphs gives a uniquecombination of interest and income at which both

money market and goods markets are in equilibrium.


23/80

IS CURVE

LM CURVE


24/80

Liquidity Trap

At very low interest rates, money demand is infinitely

elastic. The LM curve is flat here. People prefer tohold only cash at this interest rate and no other

asset.

Here monetary policy is ineffective, fiscal policy ismost effective.


25/80

Which target for the central bank?

Ultimate tgt. (Goal)

Growth

Inflation

Unemployment

Instruments of

monetary policy

CRR

Repo (disc.) rate

OMO

Intermediate tgt.

Money

Interest

Credit

Exchange rate

Some countries have adopted inflation targets: ECB, New Zealand


26/80

Policy Equil. Income Equil. interest rate

Monetry expansion + -

Fiscal expansion + +

IS0

LM0

Y0

r0

LM1

IS1


27/80

Crowding Out

Crowding out occurs when an expansionary fiscalpolicy leads to rise in interest and results inreduction in private spending (investment).

Extent of crowding out depends on the slope ofLM curve

Fiscal expansion by tax cut also leads to crowdingout.

Crowding out is minimized when tax cut isprovided for investment I, Investment subsidy, asthis promotes investments.


28/80

Classical Case

Classical case is the one with vertical LM

curve.

In classical case, money supply alone

determines level of income and interest rates

are immaterial. ie., Sensitivity of demand in

real balances for decreases in interest rate,

h = 0.


29/80

In the classical

case LM curve is

vertical Fiscal policy is of

no use as there is

completecrowding out.

Monetary

expansion alonehelps to increase

income.


30/80

INTERNATIONAL LINKAGES


31/80

Open economy means the economy is open toexports and imports.

Perfect capital mobility means there is no restrictionon capital flows into and out of the country.

Balance of payments (BOP)

BOP is the record of the transactions of the residentsof a country with the rest of the world.

There are two main accounts in the BoP: the current account and

the capital account


32/80

Balance of payments (BOP)

Current account records trade in goods and services

as well as transfer payments. Capital account records purchases and sales of assets

such as stocks, bonds and land.

Under fixed exchange rate,

BoP surplus = Current account surplus + netprivate capital inflow = increase in officialreserves

Under flexible exchange rate,current account surplus + net private capitalinflow =0


33/80

Terminology

Fixed exchange rate : devaluation, revaluation

Flexible exchange rate : depreciation,appreciation

Clean float, Dirty (Managed) Float

The real exchange rate is the ratio of foreign todomestic prices, measured in the same

currency. R = ePf/P. It measures competitiveness in international trade

In the long run R moves towards PPP of the 2countries


34/80

Imports are a function of our income and R

Exports are a function of our income, foreign

income and R So, NX = f (Y, Yf, R)

- + +

In fixed exchange rate, money supply is tightlycontrolled by BoP. Surpluses imply automatic

monetary expansion, deficits imply monetary

contraction. This is required to maintain theexchange rate.

In Flexible, the money supply can be set at will

by the central bank.


35/80

If Prices are Fixed


36/80

International linkages Internal balance is achieved when Y = Y*

External balance when BoP = 0

BP curve under perfect capital mobility (PCM)

i

Y

BP = 0

BP curve will be flat and is equalto 0 when i = if

Otherwise, there will be huge

capital inflows (if i>if) or huge

capital outflows (if i


37/80

i

BP = 0

Y

i0 = if

LM0

IS0

Y0


38/80

Fixed exchange rate

Commitment to fixed exchange rate requires

intervention from central bank in the forex

market

If BoP is in surplus (deficit), central bank has to

buy(sell) forex. This leads to increase

(decrease) in money supply


39/80

i

BP = 0

Y

i0 = if

LM0

IS0

Y0

LM1

Monetary policy under fixed exchange rate

International linkages

PCM

E0

E1i1

No in Y. Monetary policy is ineffective


40/80

Increase in money supply increases real balancesand this moves LM curve to the right.

This lowers the interest rate, followed by hugecapital outflows.

This results in a pressure for devaluation whichthe central bank negates by selling foreign

currency and buying local currency from foreignmarket.

This means a decreases in money supply asreserves are depleted. Hence the LM curve

moves back to original position. Thus, monetary expansion is ineffective.

Vice versa for monetary contraction.



41/80

i

BP = 0

Y

i0 = if

LM0

IS0

Y0

IS1

LM1

Y2

International linkagesFiscal policy under fixed exchange rate

E0 E2

E1

i1

Y rises. Fiscal policy is effective


42/80

Expansionary fiscal policy moves the IS curveto the right, accompanied by increase in

interest rates. This causes huge capital inflows and a

pressure for currency revaluation.

To avoid this, central bank buys foreigncurrency and sells local currency.

This increases reserves and so moves LMcurve to the right.

Now output is increased as much as possible.

Fiscal policy is most effective.


43/80

i

BP = 0

Y

i0 = if

LM0

IS0

Y0

IS1

Y2

Monetary policy under flexible exchange rate


E0E2

E1i1

LM1

Monetary policy is effective Y rises


44/80

As money supply is increased LM curve moves

to the right which lowers interest rates

capital outflows depreciation of currency. Depreciation increases competitiveness and

export demand increases. This increases

aggregate demand and so IS curve moves tothe right.

However, currency is now depreciated.

Foreign countries becomes less competitivenow, hence called Beggar thy neighbor Policy



45/80

i

BP = 0

Y

i0 = if

LM0

IS0

Y0

IS1


Fiscal policy under flexible exchange rate

E0

E1

ri

No in Y. Fiscal policy is ineffective


46/80

Fiscal expansion IS curve moves right

Interest rates increase Capital Inflowsexchange rate appreciates.

This decreases competitiveness and export

demand decreases; and so IS curve moves tothe left to its original position.

Now currency has appreciated and income

mix has changed (as NX has reduced andY = 0 )


47/80

POLICY FIXED EXCHANGE RATE FLOATING

EXCHANGE RATE

Monetary

Expansion

No output change;

reserve losses equal to

money increase

Output expansion,

trade balance

improves, exchange

depreciation

Fiscal Expansion Output expansion, trade

balance worsens

No output change;

reduced net exports;

exchange

appreciation


48/80

If Prices are Flexible


49/80

Aggregate Demand

Aggregate demand curve gives combinations of

price and output at which the goods market andmoney market are in equilibrium.

AD is downward sloping because demand forgoods is higher if price is lower.

Any changes in exogenous variables thatdetermine shift in the IS (changes in A0)or LMcurve (changes in M0) lead to shift in the ADcurve.

Expansionary fiscal policy and expansionarymonetary policy shift AD to the right.

Restrictive monetary policy and restrictive fiscalpolicy shift AD to the left.


50/80

Aggregate Supply

AS gives the amount of output firms are willing tosupply at different prices.

AS is upward sloping because firms are willing tosupply more at higher price levels.

SR AS curve is horizontal as prices are sticky(Keynesian AS curve)

LR AS is vertical as full employment level of

output has been reached (classical AS curve) How long does it take for AS to change from

horizontal to vertical is a matter of debate.


51/80

Growth of Output Over Time, Translated into

Shifts in Aggregate Supply


52/80

AD Curve and Medium Run AS Curve

P

ADY

P

Y0

AS


53/80

Phillips Curve Phillips curve gives the inverse relation between

inflation and unemployment. If inflation increases,(u-u*) decreases

Inflation in prices is synonymous with increase in

wages here

U* is the natural rate of unemployment.

In the final form, Philips curve states that difference

between actual and expected inflation is inversely

related to unemployment level in economy. - e = - (u-u*)

Stagflation is the scenario of high inflation (yet below

expected level of inflation) and high unemployment.


54/80

Phillips Curve One question in P.Curve is why people dont expect the

correct rate of inflation, adjust wages accordingly andensure 0 unemployment.

The answer is that people make incorrect expectations(mostly based on past data) and wages are sticky.

Wages are sticky due to

Labor contracts

Lack of coordination among firms for changing wages

Motivation Theory of Wages : low wages may demotivate

Insider-outsider problem: wage negotiation is always withpeople working in your firm and not the unemployedoutsiders


55/80

AS Curve from Phillips Curve

AS : Pt+1= +1 [(*(Y-Y+1]

Prices tomorrow will equal expected price

only if economy is in full employment level of

output.

Prices/wages increase if there is surplus

output (due to overemployment)


56/80

Supply Shocks

Permanent supply shocks are those that movethe long run AS curve permanently to the rightor left. They could be due to technological

enhancements, newly discovered naturalresources or war, famine etc.,

Temporary supply shocks is a sudden increase(decrease) in supply of goods. This is

characterized by sudden increase in prices. ie.,As curve moves up (down).


57/80

Supply Shock


58/80

Supply Shocks

Due to a temporary supply shock, prices

increase and output Y < Y*. Prices decrease

slowly until AS returns to its original position.

This takes a long time and is recessionary innature.

Expansionary monetary policy or fiscal policy

can restore output to Y*, however pricesremain at the high level (P2).


59/80

International Linkages

External and Internal Equilibrium


60/80

Y*

P

External and Internal Equilibrium

AS

AD

Y

E

NX=0

If a country has BoP

current a/c deficit it ispossible to finance

through reserves,

borrowings/ capital

flows.

But this is notsustainable for long.

Eventually current a/c

also must balance.

NX is downward sloping because at lower prices export demand is

higher. We assume NX to be steeper than AD. Above NX I trade

deficit, below is trade surplus

Automatic adjustment mechanism


61/80

Y*

NX=0

AS

AD

P

Y

E

E

Automatic adjustment mechanism

Selling FX reduces, H

and M. AD shifts to

the left.

AS: Unemployment

reduces wages and

prices, AS shiftsdown

Equilibrium at E.

If economy is not at equilibrium, AD and AS shift slowly to point of

external and internal equilibrium.


62/80

Policies to create employment will typically

worsen trade balance, policies to create a

trade surplus will affect employment.

It is necessary to combine expenditure-switching policies, which shift the demand

between domestic and imported goods and

expenditure reducing (increasing) policies

Devaluation Shifts AD and NX schedule


63/80

Y*

ASP

Y

NX=0AD

E

Devaluation Shifts AD and NX schedule

to the right

ADNX=0

E

Exports increase

In this case one

policy instrument

(devaluation) solves

both the problem of

unemployment andBoP deficit.

Normal Rule:

As many policyinstruments as there

are policy targets


64/80

Devaluation

Devaluation is effective only when foreign priceof domestic goods decreases Real devaluation

If prices increases with devaluation its is of no

effect. In crawling peg exchange rate, the exchange rate

is depreciated at a rate roughly equal to theinterest rate differential between the country and

its trading partner. The idea is to maintain R constant by increasing e

at the same rate as P/Pf. R= eP/Pf

Exchange rate and prices: empirical


65/80

Exchange rate and prices: empirical

issues

In small open economies with wageindexation, it may be difficult to change realexchange rate through devaluation.

This is because changes in cost of living bydevaluation changes real wages which feedsinto wages. This is the Wage price spiral.

In general countries using devaluation willhave to use restrictive AD policies to ensurethat real exchange rate stays devalued.

Exchange rate and prices: empirical issues


66/80

Y*

AS

AD1

P

Y

E

Exchange rate and prices: empirical issues

Initial: Y= Y*, NX


67/80

J-Curve and Hysteresis Effect As NX = X (ePf/P)Q , devaluation initially worsens NX

as volume traded doesnt change immediately. This is

the Price effect. In the long run, exports start to increase and NX

improves. This is the Volume effect.

This change in NX is characterized by the J-Curve (NX

dips first, rises later) Hysteresis : If currency was over valued for long time,

people may move to imports, ie. Foreign brands. In thiscase, devaluation might take a really long time to bringany improvement.

For eg. The US $ was over-valued for a really long timeand people in the US had by then accustomed tocheaper Japanese goods. When $ was devalued,demand took a long time to move from Japanese to USgoods.


68/80

Monetary Approach to BoP

It is suggested (IMF) that BoP imbalance is

monetary phenomenon, can be corrected

through monetary policy changes.

Tight money policy reduces demand, incomeand hence BoP deficit can be corrected.

But with sterilization persistent deficits are

possible money stock remains high.



69/80


& the IMF

ASSETS LIABILITIES

NET FOREIGN ASSESTS (NFA) HIGH POWERED MONEY (H)

DOMESTIC CREDIT (DC)

CCENTRAL BANK BALANCE SHEET

NFA= HDC

IMF approach involves fixing target : NFA* -based on how

much deficit the country can afford, ability to take external

loans, forex reserves. Next decide on target for increase in H: H* - this should

be such that it meets the increase in money demand.

The two targets set the limit on domestic credit expansion

DC*



70/80


& the IMF

Curtailment of domestic credit reduces demand,induces recession and corrects the BoP

Proponents of monetary approach argue that

devaluation can not improve BoP except in theshort run

Criticisms of IMF approach:

Countries which are having unemployment willfind it difficult to implement credit contraction.


71/80

Adjustment of Exchange Rates and Prices

Y>Y* results in inflation. Yif appreciation, i


72/80

Monetary Expansion

In the short run LM moves to the right Interest


73/80

In the short run, LM moves to the right. Interest

rate is below world level.

Exchange rate depreciates, competitivenessincreases. NX improves and so IS curve moves

right. Short run equilibrium is achieved at E.

In the long run, however, since output is above Y*

prices increaseM/P falls LM moves inward.

This increases interest rates currency

appreciates competitiveness is lost restored

to Y*. Nominal exchange rate appreciates in this

process. Real exchange rate remains the same

Short run and long run effects of


74/80

Short run and long run effects of

monetary expansion

M/P e Pe

PfP

Y

Short run + + 0 + +

Long run 0 + + 0 0

Return on foreign bonds (in terms of domestic


75/80

Return on foreign bonds (in terms of domestic

currency) = if+ e/e

e is Rs/$ (Rs is home currency here). So ifexchange rate depreciates, e increases and return

on foreign bond is higher.

When capital is completely mobile we expect

interest rates to be equalized, after adjusting for

expected depreciation

Hence, high-inflation countries tend to have high

interest rates and depreciating currencies. Inflation differential Interest differential

Depreciation rate

Response to an Expected Appreciation of


76/80

i

BP = 0

Y

LM0

IS0

Y*

Response to an Expected Appreciation of

Domestic Currency

BP = 0

IS1

Self-fulfilling expectation

if


77/80

Explanation If home currency is expected to appreciate, domestic

assets are attractive even at lower interest rate.

Hence, economy achieves BoP = 0 for a lower interestrate i.

But at the current level, economy is operating in asurplus and cash flows force the currency toappreciate.

This reduces competitiveness and forces the IS curve tomove down.

Hence an expectation for appreciation came true, withappreciation of currency, lowered output andemployment. The expectation is Self fulfilling in nature.

Why governments intervene in FX


78/80

Why governments intervene in FX

markets?

Speculative capital flows may cause unstableexchange rates and unnecessary changes inoutput.

Influence Real exchange rate to affect tradeflows

Effects of exchange rate on domestic inflation

To even out fluctuations in currencymovement not justified by fundamentalsdifficult to judge this.

Monetary and fiscal expansion with


79/80

Monetary and fiscal expansion with

interdependence

US Monetary

contraction

US fiscal expansion

US ROW US ROW

Exch. Rate $ Appn. $ Appn.

Output - + + +

Inflation - + - +


80/80

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