Economics

MFM
Session Day 3
 ECONOMIC POLICY

It covers Govt actions intended to influence economy of the nation

Objectives
• High level of output (GDP)
• Rapid Economic Growth
• Full employment
• Price stability
• Financial Stability
Fiscal Monetary
Policy Policy
Taxation & Measures Interest Rate
Government
Money Sup
Spending
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 ECONOMIC POLICY : FUNCTIONS

Allocative Distributive Stabilization

How much of the Levels of taxation Control interest
budget to be and distribution of rates, inflation, &
allocated to certain economic burden push employment
projects rate

INFLUENCING OVERALL ECONOMY

 Monetary Policy

Control of supply Objective Formulated by

of money in
Achieve price Monetary Policy
economy by
stability, financial Committee
controlling interest
stability & growth (wef 2016)
rates

Announced in April
Implemented by each year
the Reserve Bank Reviewed bi-
of India (RBI) monthly (6 times a
year)
HOW RBI IMPLEMENTS MONETARY POLICY

Credit Quantitative Qualitative

Control Instruments Instruments
Instruments Bank Rate Margin
Requirement

Repo & Reverse

Quantitative Repo Rates Credit
Rationing

CRR
Direct Action
Qualitative
SLR

Open Market Moral Suasion

Ops
5
 As of
today, the
bank rate
is about money
6.75% It controls the supply of
(Highest was
12% in Oct
1991) (Long Term)
Bank Rate Also known
as the
discount rate
commercial banks It is the rate
the cost of borrowing by of interest
Increase in Bank Rate increases charged by
RBI for
providing
loans to the
banking
BANK RATE
system
 REPO & REVERSE REPO RATE

REPO Rate Reverse REPO Rate

Rate at which RBI lends Rate at which
to commercial banks commercial banks
against Govt securities deposit funds with RBI

Increase in Repo Rate As of today, the Repo

and Reverse Repo Rate rate is 6.5 % and
is a symbol of tightening Reverse Repo rate is
of the monetary policy 3.35%
 Cash Reserve Ratio is a perc
Higher the CRR – more would be
RR is presently 4.5% of bank deposits - banks
reserves and lower will be
(Highest was 15%) required to keep with RBI in t
the liquidity
of reserves or balances
CASH RESERVE RATIO (CRR)
 STATUTORY LIQUIDITY RATIO (SLR)

Every financial institute has to maintain a certain amount of

liquid assets from their time and demand liabilities

These liquid assets can be cash, precious metals, approved

securities like bonds etc.

The ratio of the liquid assets to time and demand liabilities is

termed as Statutory Liquidity Ratio.

The current SLR is about 18%

(Highest was 40% in 1980s)
Lower SLR supports growth. Higher SLR controls inflation
 OPEN MARKET OPERATIONS

It involves buying / selling of government securities by

RBI from / to the public & banks

During inflation, RBI sells

bonds at increased interest During deflationary period,
rate, resulting in decrease in RBI reverts to repurchasing
deposits of commercial Govt securities, to increase
banks to reduce their money supply
power of credit
 Taxation

• Paid by individual directly

to the government from
own pocket
Direct
Taxes

• Individual collects from

costumer and pays to the
goverment
Indirect
Taxes
 Taxation

• Income tax
• Wealth tax
• Property tax
Direct • Gift tax
Taxes • Capital gain tax
• Corporate tax

• GST (except petrol& wine)

Indirect • Custom duty

Taxes
 Current account deficit & Trade deficit
• A current account deficit occurs when a
country spends more on its imports than what
it receives for its exports.
• A trade deficit means there is more being
bought than there is being sold by a country.
• If a current account deficit remains on the
books for a long time, it can mean future
generations will be burdened with high debt
levels and large interest payments.
 Balance of Payments
• The balance of payments (BOP) is a statement
of all transactions made between entities in
one country and the rest of the world over a
defined period of time, such as a quarter or a
year.
• The balance of payments of a country is the
difference between all money flowing into the
country in a particular period of time and the
outflow of money to the rest of the world
 INFLATION

Inflation is a general and sustained increase in overall

price level of goods and services.

The inflation rate is a key parameter on basis of which

central government formulates its policies from time to
time.
 INFLATION

 SLOW PRICE RISE ACCEPTED AS COROLLARY OF

GROWTH , e.g. 2%
TYPES /CAUSES OF INFALTION
 DEMAND PULL
 COST PUSH
 TECHNOLOGY PUSH
 HOARDING
 IMPORTED INFLATION
 CONTROL OF INFLATION

Demand side measures

 MONETARY POLICY
 RAISING OF TAX LIMITS
 INTRODUCE SAVINGS SCHEMES
 WAGE FREEZE
 REDUCING GOVT DEMAND
 REDUCE EXPORT OF ESSENTIALS
 ADDRESSING ALL COMPONENTS OF
AGGREGATE DEMAND
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 CONTROL OF INFLATION

Supply side measures

 INCREASE SUPPLY OF BASIC BUT SCARCE AND

COSTLY ESSENTIALS
 INCREASE IMPORTS AND REDUCE EXPORT OF
GOODS IN SHORT SUPPLY
 INCENTIVES TO INDUSTRY

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 STAGFLATION

• Inflation & unemployment

• Stagnation of economy
• Increased unproductive govt expenditure
• Govt expenditure on long gestation project
• High energy prices

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 Inflation & Unemployment

The Phillips Curve

The Phillips curve shows the inverse relationship

between inflation and unemployment: as
unemployment decreases, inflation increases.
Inflation & Unemployment
 Deflation

• Negative Inflation
• Opposite of Inflation
• Very low demand in economy
• Side effect of very high/increased
unemployment
• Can lead to depression in economy

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 PRICE INDEX

Price index is reflective of the total change in

price level paid by a producer or consumer

Whole-sale price index (WPI)

and Consumer price index (CPI)
are the two primary measures
of inflation in India
 Wholesale Price Index- (WPI)

 Three commodity groups

• Primary agriculture articles (22.62 %)
• Fuel, Power & Light (13.15 %)
• Manufactured products (64.23 %)
 Weight allocated proportional to share value of output in economy
 Min of Commerce & Industry
 Base yr 2011-12
 Monitored by RBI & Govt
 Useful for early intervention – Before price fluctuations hit the
consumer market
 CONSUMER PRICE INDEX (CPI)

 3 Types and 6 Commodity groups

• Types – 1.Urban 2. Rural 3. Combined

• Groups – 1.Food & Beverages, 2.Pan Tobacco Intoxicants,

3.Clothing & Footwear, 4.Housing, 5.Fuel & light ,6. Misc

• Different weightage to each group

 Statistics ministry (MoSPI)

 299 items, Services included

 Base year 2012

 RBI uses CPI for the purpose of Monetary Policy

 Business Cycle in Economy

• Cement Industry – Capacity 100 Stagnation

• Cost cutting
tons, Prod to full cap Slow Down
• De-hire lab
• Demand only 80 tons • Shut part of Fact Recession
– Short term – can't cut plant size • Pause invest Depression
– Sub optimum utilisation of
factors of prod • Muster addl
resources
• Demand 120 tons • Incr prices
• Invest in cap
– Short term – can't incr plant size
• Outsource
Recovery
– Optimum utilisation of factors of
prod Boom
• What causes fluctuations?
Both slowdowns and booms are caused by fluctuations in demand
 PHASES OF BUSINESS CYCLE

Boom is generally accompanied with rising prices: Inflation

Recession: slow down of eco activity is mildLINE
TREND andOF
short term
GDP GROWTH
LEVEL OF BUSINESS ACTIVITY

3 • Business Cycles
2 3 2 are irregular,
1
varying in
4
frequency,
4 1 1-RECOVERY magnitude and
1
2-BOOM duration
3-RECESSION • Most sectors
4-DEPRESSION affected

Depression: Fall in NI is steep and spread over long term

TIME

Recovery: pick up in economic activity is gradual

 BUSINESS CYCLE

DEMAND
PRODUCTION
WAGES
PROFIT BOOM
STK MARKET
BANK CREDIT
INVESTMENT
UNEMP
INFLATION
ECON RECESSION
RECOVERY STABLITY •

DEMAND
UNEMP PRODUCTION
WAGES
PROFIT
DEPRESSION STK MARKET
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BANK CREDIT
INVESTMENT
INFLATION
Recession