Macroeconomic Analysis for Management

Lecture 5

IME, IIT Kanpur

Aside: Amazon’s investment in India

Jeff Bezos has announced an investment of $1 Billion in India.

Aside: Amazon’s investment in India

Jeff Bezos has announced an investment of $1 Billion in India.

Amazon’s total investment in India presently stands at around $6
Billion.

Amazon has been observed to practice predatory pricing.

Is Amazaon a Monopolist? Is it a monopsonist?
https://www.nytimes.com/2014/10/20/opinion/paul-krugman-amazons-monopsony-is-not-ok.html

There are allegations of paying either very low, or no taxes as

well.
https://www.wsj.com/articles/
does-amazon-really-pay-no-taxes-heres-the-complicated-answer-11560504602
Negative Nominal Interest Rate

https://www.weforum.org/agenda/2016/11/
negative-interest-rates-absolutely-everything-you-need-to-know/
Negative Nominal Interest Rate - II
This scenario was unheard of even a decade ago. In fact, existing
theories of macroeconomics did not even consider this as a
possibility, since implicitly, the floor for nominal interest cannot be
below zero.
After all, why would people keep their money in banks by paying
them?
Negative Nominal Interest Rate - II
This scenario was unheard of even a decade ago. In fact, existing
theories of macroeconomics did not even consider this as a
possibility, since implicitly, the floor for nominal interest cannot be
below zero.
After all, why would people keep their money in banks by paying
them?

It is a standard practice by central banks to reduce interest rates in

order to revive the economy.
However, what to do if there is a deflation at the same time?
(Example: if i = 0.05, and π = -0.55, then what is r?)
Negative Nominal Interest Rate - II
This scenario was unheard of even a decade ago. In fact, existing
theories of macroeconomics did not even consider this as a
possibility, since implicitly, the floor for nominal interest cannot be
below zero.
After all, why would people keep their money in banks by paying
them?

It is a standard practice by central banks to reduce interest rates in

order to revive the economy.
However, what to do if there is a deflation at the same time?
(Example: if i = 0.05, and π = -0.55, then what is r?) To avoid this trap,
central banks started lowering nominal interest rates to below zero.
The policy basically induces people to hold more cash and spend, so
start an economic recovery.
Negative Nominal Interest Rate - II
This scenario was unheard of even a decade ago. In fact, existing
theories of macroeconomics did not even consider this as a
possibility, since implicitly, the floor for nominal interest cannot be
below zero.
After all, why would people keep their money in banks by paying
them?

It is a standard practice by central banks to reduce interest rates in

order to revive the economy.
However, what to do if there is a deflation at the same time?
(Example: if i = 0.05, and π = -0.55, then what is r?) To avoid this trap,
central banks started lowering nominal interest rates to below zero.
The policy basically induces people to hold more cash and spend, so
start an economic recovery.
Secondly, it will create incentive to search for better returns abroad.
There will be a demand for foreign currency. Domestic currency will
depreciate. Imports will becomee costlier. That might create an
inflationary pressure.
Negative Nominal Interest Rate - III

But, why would people keep their money in banks even when (nominal)
interest rate is negative?
Negative Nominal Interest Rate - III

But, why would people keep their money in banks even when (nominal)
interest rate is negative?
1. For large amounts, there is cost of holding money.
2. There can be expectation that interest rate may fall further. So it is better
to invest now, especially in the bond market.
3. IF money with people is their wealth (like a piece of land, a mutual fund
etc.) then it may be fine to charge some fee for keeping your money safe.
However, such an environment may not be conducive for investments. If
prices of goods are expected to decline in future, business becomes wary.
Negative Nominal Interest Rate - III

But, why would people keep their money in banks even when (nominal)
interest rate is negative?
1. For large amounts, there is cost of holding money.
2. There can be expectation that interest rate may fall further. So it is better
to invest now, especially in the bond market.
3. IF money with people is their wealth (like a piece of land, a mutual fund
etc.) then it may be fine to charge some fee for keeping your money safe.
However, such an environment may not be conducive for investments. If
prices of goods are expected to decline in future, business becomes wary.
There is also a limit to go negative!
Negative Nominal Interest Rate - IV

As far as India is concerned, we are far from going to a negative

interest rate regime. Should we worry then?
Negative Nominal Interest Rate - IV

As far as India is concerned, we are far from going to a negative

interest rate regime. Should we worry then?
However, the interest rate differential attracts foreign capital. As and
when the central banks in those countries decide to increase interest
rates, dollars will start flowing outward.
Negative Nominal Interest Rate - IV

As far as India is concerned, we are far from going to a negative

interest rate regime. Should we worry then?
However, the interest rate differential attracts foreign capital. As and
when the central banks in those countries decide to increase interest
rates, dollars will start flowing outward.

It is tough time for the people living on interest rates only. The old
people!
Note that it is difficult to get out of this scenario once you get in.
Germany has banned negative interest rate.
One Interest Rate

– There are many interest rates in an economy. They vary depending

upon the term of the loan, credit risk of borrower etc. Which interest
rate are we talking about?
One Interest Rate

– There are many interest rates in an economy. They vary depending

upon the term of the loan, credit risk of borrower etc. Which interest
rate are we talking about?

However, since interest rates generally go up or down together, in

Macroeconomic analysis, we can ignore the differences, and
consider as if there is only one existing interest rate.
Government Expenditure
– Governments purchases services of the government employees.
They also build schools and roads.
Government also makes transfer payments. Since this expenditure is
not made in exchange of something, it is not counted as part of the
G. Should the government then make this expenditure?
Government Expenditure
– Governments purchases services of the government employees.
They also build schools and roads.
Government also makes transfer payments. Since this expenditure is
not made in exchange of something, it is not counted as part of the
G. Should the government then make this expenditure?
Transfer payments affect consumption indirectly by increasing
disposable income
Government Expenditure
– Governments purchases services of the government employees.
They also build schools and roads.
Government also makes transfer payments. Since this expenditure is
not made in exchange of something, it is not counted as part of the
G. Should the government then make this expenditure?
Transfer payments affect consumption indirectly by increasing
disposable income
However, note that transfer payments financed by raising taxes has
no effect on national disposable income. Should the government still
go for transfer payment?
Government Expenditure
– Governments purchases services of the government employees.
They also build schools and roads.
Government also makes transfer payments. Since this expenditure is
not made in exchange of something, it is not counted as part of the
G. Should the government then make this expenditure?
Transfer payments affect consumption indirectly by increasing
disposable income
However, note that transfer payments financed by raising taxes has
no effect on national disposable income. Should the government still
go for transfer payment?
If G = T , the government has a balanced budget. G > T implies a
budget deficit. Government funds this by borrowing from the market.
G < T implies budget surplus.
Government Expenditure
– Governments purchases services of the government employees.
They also build schools and roads.
Government also makes transfer payments. Since this expenditure is
not made in exchange of something, it is not counted as part of the
G. Should the government then make this expenditure?
Transfer payments affect consumption indirectly by increasing
disposable income
However, note that transfer payments financed by raising taxes has
no effect on national disposable income. Should the government still
go for transfer payment?
If G = T , the government has a balanced budget. G > T implies a
budget deficit. Government funds this by borrowing from the market.
G < T implies budget surplus.
In some of our models in this course, we do not deal with how
government decides tax rates or expenditure. Therefore, these
variables will remain exogenous to our model (G and T ).
Basics of Government budget

The budget consists of two parts: revenue budget, and capital budget.
The revenue budget is concerned with revenue receipts and revenue
expenditure.

Revenue receipts are of two types: tax revenue and non-tax revenue.
Tax ravenue again can be broken into two parts: direct tax revenue
(personal tax, corporate tax, wealth tax etc.)
Indirect tax revenue comes from sales tax, excise, customs duties.
Governments earn its non-tax revenues from public property, such as
earning from PSUs, government owned lands etc. Governments
receipts of interests on loans it advanced is also non-tax revenue.
Revenue expenditures are the regular operational expenditures, such
as defence expenses, grants to states, running the administration etc.
It does not create any asset for the government nor reduces its
liability.
Basics of Government budget II

Capital receipts are borrowing by the government in order to create

some assets. Example: Domestic and foreign borrowings etc.
Capital expenditures are the spendings on creating infrastructure.
Benefits from capital expenditure extend over a period of time.

Fiscal Deficit = Revenue Expenditure + Capital Expenditure -

Revenue receipts - non-debt creating capital receipts.
What can be an example of non-debt creating capital receipt?
The Fiscal Responsibility and Budget Management Act (FRBM),
enacted in 2003 requires the goverment to reduce its fiscal deficit
over a period. Presently the target is to reach 3% of GDP by 31st
March 2021.
Subsidies in India
Which category should subsidies fall into?
Merit subsidies and non-merit subsidies. Expenditure on education
and health is merit subsidies, whereas power subsidies may be
called non-merit subsidies.
What could be the scale of non-merit subsidies in India?

Non-merit subsidies in India. Source: Economic Survey 2016-17, chapter 9.

Misallocation of subsidies

HIgher the proportion of the poor living in a district, higher is the

difference between the proportion of the poor and proportion of
subsidies allocated in that district.
Misallocation of subsidies

HIgher the proportion of the poor living in a district, higher is the

difference between the proportion of the poor and proportion of
subsidies allocated in that district.

Source: Economic Survey 2016-17, chapter 9

Net Export

I It is difference between Exports (X) and Imports (M)

I Exports are a function of income of the foreign country/Rest of
the world/Home country’s export markets
I Exports are also a function of relative prices/exchange rates
I Imports are a function of domestic income
I Imports are also a function of relative prices/exchange rates
Exchange Rate and its depreciation

I Depreciation is a decrease in the value of a currency relative to

another currency.
I A depreciated currency is less valuable (less expensive) and
therefore can be exchanged for (can buy) a smaller amount of
foreign currency.
I If the exchange rate moves from Rs 60/$ to Rs 70/$ it means
that the INR has depreciated relative to the Dollar. It now takes
Rs. 70 to buy one US$, so that the INR is less valuable.
I The dollar has appreciated relative to the INR: it is now more
valuable.
Exchange Rate and its depreciation

Cost Export Export

Exchange Volume Import Import Volume Trade
of pro- Price Rev- Rev- Import
Rate of ex- Price price in of im- Bal-
duction in $ enue enue cost
Rs/$ ports in $ Rs ports ance
(in Rs) (in $) (in Rs)

40 200 5 100 500 20,000 10 400 50 20,000 0

50 200 4 150 600 30,000 10 500 30 15,000 15,000

Exchange Rate and its depreciation

Cost Export Export

Exchange Volume Import Import Volume Trade
of pro- Price Rev- Rev- Import
Rate of ex- Price price in of im- Bal-
duction in $ enue enue cost
Rs/$ ports in $ Rs ports ance
(in Rs) (in $) (in Rs)

40 200 5 100 500 20,000 10 400 50 20,000 0

50 200 4 150 600 30,000 10 500 30 15,000 15,000

Cost Export Export

Exchange Volume Import Import Volume Trade
of pro- Price Rev- Rev- Import
Rate of ex- Price price in of im- Bal-
duction in $ enue enue cost
Rs/$ ports in $ Rs ports ance
(in Rs) (in $) (in Rs)

40 200 5 100 500 20,000 10 400 50 20,000 0

50 200 4 110 440 22,000 10 500 48 24,000 -2,000

Summing up so far...

– In a simple Macroeconomic model, we use four components of

aggregate demand

1. Consumption/saving: depends on disposable income

2. Investment: depends upon interest rate
3. Government expenditure
4. Net export: depends upon exchange rate (in an open economy)