Macro Economic Policy

– Concerned with macro economic problems like

unemployment, inflation , BOP, economic instability and
problems concerning growth.
– It also deals with ways in which the problems may be
solved.
Primary Objectives
Full Employment
Price stability – (absence
of sharp short run
movements in the general
price level)
Economic growth - % increase in GNP.
 Macro Economic Policy
Secondary Objectives
• Full production (reduction of GNP gap)
• Higher standard of living
• Reduction of inequalities and distributive justice
• Social justice
• Control of Monopoly
• Avoidance of cyclical fluctuation
• Economic freedom
• Balance of payment
 Macro Economic Policy
These objectives aims at process of regulated development.
The process of regulated development in India took the shape
of demographic planning of the economy which is enforced
though the monetary and fiscal policy of the government.
Monetary policy
Monetary
policy
Monetary policy is the
process by which
the monetary authority of a
country controls the supply of
money, often targeting a rate
of interest for the purpose of
promoting economic growth
and stability.
The official goals usually
include relatively stable
prices and low
unemployment.
• In India, the central monetary authority is the 
Reserve Bank of India (RBI). is so designed as
to maintain the price stability in the economy.
 Monetary Policy
As monetary policy can be implemented only through a monetary
system, it involves the central bank, commercial banks and other
financial institutions in monetary policy.

1. it consists of deliberate management of money supply.

2. it covers wide range of policies and measures.

 Objectives in monetary policy

Since the planned economic process started in India, the

money and credit policy followed by the RBI is based mainly
on two considerations
a) to accelerate growth rate
b) to control and reduce inflationary trends in the
economy.
 Functions of RBI
1. Monopoly of note
issue
2. Banker to the
government
3. Banker’s Bank
4. Clearing Function
5. Control of credit
6. Custodian of Foreign
Exchange
7. Additional function
 objectives of the monetary policy of India,
as stated by RBI, are:
• Price Stability
• Controlled Expansion Of Bank Credit
• Promotion of Fixed Investment
• Restriction of Inventories
• Promotion of Exports and Food Procurement Operations
• Desired Distribution of Credit
• Equitable Distribution of Credit
• To Promote Efficiency
• Reducing the Rigidity
 Monetary operations
• Monetary operations involve monetary techniques which
operate on monetary magnitudes such as money supply,
interest rates and availability of credit aimed to maintain Price
 Stability, Stable exchange rate, Healthy Balance of Payment,
Financial stability, Economic growth. 
• RBI, the apex institute of India which monitors and regulates
the monetary policy of the country stabilizes the price by
controlling Inflation.
• RBI takes into account the following monetary policies:
 Major Operations
• Open Market Operations
• Cash Reserve Ratio
• Statutory Liquidity Ratio
• Bank Rate Policy
• Credit Ceiling
• Credit Authorization Scheme
• Moral Suasion
• Repo Rate and Reverse Repo Rate
• CRR - RBI is empowered to vary CRR between
15 percent and 3 percent. But as per the
suggestion by the Narsimham committee Report
the CRR was reduced from 15% in the 1990 to 5
percent in 2002. 
• As of Sep 2014, the CRR is 4.00 percent.
• Statutory liquidity ratio- There was a reduction of
SLR from 38.5% to 25% because of the
suggestion by Narshimam Committee. The
current SLR is 22.0%(w.e.f.05/08/14)
• Bank rate :- As of 1 January 2013, the bank
rate was 8.75% and as on 21 June 2014 bank
rate is 9%.
• As of October 2013, the repo rate was 7.75 %
and reverse repo rate was 6.75%.
• On January 28, 2014, RBI raised repo rate by
25 basis points to 8.00 % and reverse repo rate
by 25 basis points to 7.00%.
 Key Indicators
As of 5 August 2014, the key indicators are

Indicator Current rate

Inflation 8.0%

Bank rate 9%

CRR 4.00%

SLR 22.00%

Repo rate 8.00%

Reverse repo rate 7.00%

Marginal Standing 9.00%

facility rate
 Fiscal Policy

• A policy under which the government uses its

expenditure and revenue programme to
produce desirable effect and avoid undesirable
effect on the national income, production and
employment.
• Fiscal policy is used by the government revenue collection
(mainly taxes) and expenditure (spending) to influence the
economy.

• According to Keynesian economics, when the government

changes the levels of taxation and government spending, it
influences aggregate demand and the level of economic
activity.

• Fiscal policy can be used to stabilize the economy over the

course of the business cycle
 Fiscal Instrument
• Public Expenditure

• Taxation Policy

• Government Borrowing and Debt

Management
 Public Expenditure
– Increase in public expenditure --- increase in
aggregate demand
– Decrease in public expenditure --- decrease in
aggregate demand
– During inflation public expenditure should be
decreased to control demand pull inflation
Public Expenditure
– During depression PE
gains much
importance.
– Keynes established
that the Great
Depression of 1930’s
caused by deficiency
in aggregate
demand.
 Public Expenditure
• Private investment will be
sluggish in depression .
• So expenditure on public work
programmes must be increased to
raise aggregate demand.
Govt expenditure results in
changes in income via ordinary
multiplier.
 Taxation Policy
• Rise in taxation – reduces disposable income
reduces consumption and savings.
Inflation – taxation is increased to reduce the disposable
income
During depression – taxation should be decreased to leave
more disposable income
Inflation – surplus budget
Depression – deficit budget
 Government Borrowing and Debt Management

• Influences aggregate demand through the volume of liquid

assets

floats a loan - transfer of liquid fund from public to the

government .

at the time of interest payment and repayment of debt-

transfer of funds from govt to public.
 Objectives of Fiscal Policy
• Full Employment
• Price Stability
• To accelerate the rate of economic growth
• Optimum allocation of resources
• Equitable distribution of wealth and income
• External stability
• To promote capital formation and investment
• To remove regional imbalance
 Compensatory fiscal policy
The way the government plans a budget surplus or deficit to compensate
expenditure by the public in the economy.
• Unemployment during depression – fiscal policy should be geared to
increased AD
• Inflation – AD should be reduced
• Full employment – fiscal policy should be maintain the level of AD, so
that there is neither inflation nor unemployment.
1. Anti deflationary fiscal policy
2. Anti inflationary fiscal policy
Related concepts
Fiscal Stabilizers and flexibilities
Discretionary Fiscal Policy
varying tax rates, varying public expenditure, varying
welfare payment and public works.
Balance of Trade
Trade
• Trade is the
commercial
exchange
(buying and
selling on
domestic or
international
markets) of
goods and
services;
 Internal Trade &
International Trade
• Internal Trade
• Trade within a country
• It is also known as “inter-regional trade”

• International Trade

• Trade between countries or across national

boundaries
 Differences Between Internal Trade &
International Trade
• Factor Mobility • Commercial Policy

• Differences in • Separate market

Currencies
• Transport cost
• Problem of Balance
of Payments • Difference in natural
resources
 Theory of Absolute Advantage
(Adam Smith)
Per unit of Labor Cost
Country
Rice Jute

India 30 60

Bangladesh 50 20
 Theory of Absolute Advantage

• Every county should specialize in the

production of commodities which they can
produce at a lower cost of production (in
which they have absolute advantage in cost
of production)
 Comparative Advantage Theory
(David Ricardo)
Per unit of Labor Cost
Country
Rice Jute

India 30 60

Bangladesh 50 80
 Comparative Advantage Theory
(David Ricardo)

• A county specializes not necessarily in those

commodities which it can produce at a
lower absolute cost buy certainly specializes
on commodities which it an produce at a
lower comparative advantage.
 Balance of Trade

• The balance of trade (or net exports,

sometimes symbolized as NX) is the difference
between the monetary value of exports and
imports in an economy over a certain period of
time.
 Balance of Trade
• A positive balance of trade is known as a trade
surplus and consists of exporting more than is
imported

• A negative balance of trade is known as a trade

deficit or, informally, a trade gap.

• The balance of trade is sometimes divided into a

goods and a services balance; especially in the United
Kingdom the terms visible and invisible balance are
used.
 Terms of Trade
• The quantity of domestic goods that must be given in
exchange for one unit of imported goods.

• The rate at which the goods of one country exchange

for the goods of another country.

• Value of Imports
Terms of Trade = ______________
Value of Exports
The Balance Of Payments ( BOP)
 The Balance Of Payments ( BOP)

• A systematic record of all economic transactions

(trade transactions) between the countries during a
certain period of time.

• The Balance of Payments for a country is the sum of

the current account, the capital account, the
financial account

• It generally adopts double entry book-keeping system

 Uses of ‘BOP’
• Helps to frame monetary and foreign policy

• Helps to analyze a country’s strength and

weakness in international trade.

• Helps to understand the changes of national

consumption
 BOP Accounts
BOP Accounts

Current Account Capital Account

Visible Items Invisible Items Short-term Capital Long-term Capital

 Current Account

• It deals with payments for currently produce

goods and services like exports and imports,
expenses on travel, transportation, insurance
etc

• The current account of the BOP affect the

level of national income directly
 Capital Account

• It deals with payments of debts and claims.

• The capital account influences the volume of

assets which a country holds.
 BOP Disequilibrium
• If the total receipts and payments are unequal,
the BOP is in Disequilibrium

• If the total payments exceed the total receipts,

the BOP shows Deficit (Unfavorable
disequilibrium)

• If receipts exceed the payments the BOP is in

surplus (Favorable Disequilibrium)
 Causes for Unfavourable Disequilibrium in
the BOP
• All the factors which are • Economic Factors
reducing the exports and
• Business Cycles
increase Imports are the
causes • Inflationary Spiral
• Capital Movements
• Changes in habits and
• Natural Factors customs
• Rains
• Floods
• Natural calamities
• Political Factors
• Political Changes
• Wars
 Methods of correcting unfavorable BOP
• Devaluation • Deflation
• Official decrease in • Automatic decrease in
the external value of the external value of a
a country currency. country currency due
to the market forces

• Import Restriction • Exchange control

and Export • Submission of foreign
Promotion exchange to RBI
• Steps to boost export • Licensing importers
and reduce imports • Capital movement
(heavy import tax,
import quotas etc.) • Adjusting rate of
interest