The Road Ahead

A SNAPSHOT OF MACROECONOMICS
SAI KUMAR SWAMY
PGPM IIM-B

Micro vs. Macro

2

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

Schools of Economic Thought

3

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

Schools of Thought - 1
4

Classical/ New Classical

Started with Adam Smiths 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 1970s- New Classical School
Says Law

Schools of Thought - 2
5

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

Key Concepts - 1
7

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

Key Concepts - 2
8

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 - 3
9

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

Key Concepts - 4
10

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%

Key Concepts - 5
11

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%

Key Concepts - 6
12

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

Key Concepts - 7
13

Causes of Inflation

Monetary Theory

Monetary policies of Central Banks

Monetary and fiscal restraint

Neo-Keynesian Theory
Demand-Pull
Cost-Push

Key Concepts - 8
14

How to control Inflation?

Monetary Policies

Open Market Operations

Fiscal Policy
Taxation
Government Spending

Key Concepts - 9
15

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

Key Concepts - 10
16

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
SDRs
Foreign currency assets

Liberalization - 1
17

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

Liberalization - 2
18

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

Currency Convertibility - 1
19

Currency convertibility is defined as the freedom to

convert one currency into other internationally

accepted currencies
Two forms of convertibility
Current account convertibility
Capital account convertibility

Currency Convertibility - 2
20

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

Financial Markets
21

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
22

Fiscal Policy - 1
23

Government uses its revenue and expenditure programs to

produce desirable effects on

National income
Production
Economy

Used as a balancing device

Two elements of Fiscal Policy
Taxation
Public Expenditure

Fiscal Policy - 2
24

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

Says Law
25
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.

Great Depression
26
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

HDI
27

US- GDP & Unemployment

28

Worldwide Impact
29

Great Depression in Pics

30

Great Depression in Pics

31

Great Depression in Pics

32

Great Depression in Pics

33

Dorothea Lange
Migrant Mother
Stamp

GDP Growth - Worldwide

34

GDP - Nominal
35

GDP - PPP
36

Gini Coefficient
37

HDI
38

Key Terms - 1
39

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

Key Terms - 2
40

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

Key Terms - 3
41

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