Macroeconomics

Macro economics
1876 to 1929 (Classical theory)
Then great depression happened.

US AND UK changes

US - Tax increase by Herbet Hoover
UK- No change,state wouldn’t intervene

Then Keynes came into picture
1.Get govt to spend on public works program which is relatively cheaper
2.Put money into the hands of the people,increase in the consumption
The problem is that of lack of aggregate demand.He gave a fiscal policy kind of solution..Why?

Aggregate demand was tackled.. Either through fiscal or monetary policy.
Rate of interest – change in investment – change in demand

It is not just rate of interest, marginal efficiency of capital.(Keynes said that)

AD- CONSUMPTION,INVESTMENT,GOVERNMENT DEMAND
At height of prosperity,while consumption and investment (30 to 35%)
Invest ment percentages came down...consumption didn’t (check empirical data)
Check psychological factor of consumption.....
Unemployment vs output rationality
Based on the definition of unemployment

Keynes theory
Fiscal theories based on Keynes theory
Upto 1970s everything was good. Then oil shock came up. “Philips curve relationship”

Then came up Monetarism.
They said Inflation is primarily a monetary effect. Monetary policies should be in place
They said,they need a stable growth of money supply. Volatility gets changed.. In the short run
Do not have fluctuations in money supply.
In long run,the nominal variable.
Fiscal policy doesn’t play a role.

The most recent thought is the Rational expectation thoughts. Anything which is systematic wont work. Unsystematic changes work.
Supply side economics – LAFFERS CURVE
If you have very high tax rates,it will affect incentive to produce,supply etc.Low tax rates gives more incentives.India has seen some version of the supply side economics implemented on it.
Like tax base widening etc.

Growth rate
Investment and Incremental Capital Output Ratio (ICOR) in Indian context is 4:1
Savings rate =Investment rate = 36%
ICOR = 4%
ICOR = I/Q
Q= I/ICOR = 36/4 = 12%
Difference between savings and investments = external savings

36.8+1.3 = 38.1

Domestics plus international savings
Circular flow model which has 5 different actors/players. Interaction between them..savings = leakages eco on track.

Output – (Land,Labour,capital) = residual (profit)
Output=Income=Expenditure
If i don’t do a lot of expenditure, we use it for leakages, savings,taxes and imports
Leakages = Injections

When leakages > injections – contractions
When leakages < injections – expansions

Economy performance
-currently
-over time
-comparison with rest of the word
3 methods of national income
Product method/value added method
Income method – add wages,add rent,add interest,add profit
Expenditure method –
C(house)+i(firms)+g(govt)+x-m (rest of world)
Financial assets investment not added to gdp

FII – BALANCE OF PAYMENTS accounts
NATIONAL INCOME ACCOUNTS – IN GDP

Income method (gdp at factor cost)
Expenditure method (gdp at market prices)
Durables,non durables,services – consumptions

Pensions,subsidies,scholarships are transfer payments but not in Lieu of current production...

Government expenses = government purchase plus transfer payments
Govt purchases is taken in this mthod..but not transfer payments

Remittances are transfer payments (Saudi guy sending money to India)

Analysis
Crowding out concept,consumption proportion etc are very important concepts.
If consumption is stable, we need to look at the sectors
Gdp analysis – from macro to micro analysis can be done... (consumption goes down,which sector,which segment is driving it etc)

Used goods are not counted in gdp,financial transactions is not recorded in gdp.
Concepts of national income
Receipts and payments( be careful)
Factor income is wages plus rent plus interest plus profit
We are not allowed to invest in property abroad as well as capital, net factor income tends to be negative.
Depreciation is used because that part is used up.

FC is received by factors of productions. MP is what buyer pays to sell.

Why just indirect taxes?
Here it is just taking into account what the seller gets.
Difficult to calculate depreciation,so not NNI but GDP is used

Disposable income is greater than GDP ( Transfer Payments are high)
Fiscal deficit will be high

When we look at economic growth of a country – GDP at factor cost (at constant prices)
When we look at debt to gdp ratio ,deficit to gdp ratio ,current account deficit,savings rate,investment rates all these are at current prices (gdp at market prices)
So relevant concept is gdp at market prices at current prices.
Why market prices? Because we are looking at expenditure
How was per capita income increased post liberalization etc?

GDP Calculation

Find out gdp deflator value

Points from analysis * Output lesser * Manufacturing industry less * Derived demand (services sector) * Agricultural sector output has actually come down

GDP at current exchange – convert into dollars at current exchange rate
Prices might be different in different countries – we use PPP Conversion rates.
In india it is 0.41. we are ranked 3rd.

National Income identities

S – i = g +tr –ta +nx
S - ( g+tr –ta) – nx = I
S + (ta –(g +tr)) + (m-x) = I
Domestic pvt savings + public savings + external savings = investment

Current account deficit is a measure of external savings
External savings is quite bad in the long run – exchange rate,growth etc will get affected

Business cycles are fluctuations,trend rate,short term fluctuations around the trend rate
Trend growth rate

Recession
2 succesive quarter where output declines- recession- if it persists its a depression
When output fluctuates other indicators also fluctuate
Investment goes down,employment goes down,consumption goes down,prices have to come down

Output changes and price levels
Why?
* Model of aggregate demand and aggregate supply * How to overcome it? Policy measures – fiscal and monetary
AD downwards
AS can be upward,vertical,horizontal
We take AS as upward/
Why does AD curve slope downwards?What causes shifts in the aggregate demand curve?

When price goes up (here its cpi,wpi or any price level) – c changes i changes nx changes
All will move downwards
Y will go downwards

c- wealth of households reduces.consumption comes down investment effect – rate of interest changes sell stocks assets,price of assets goes down, rate of interest goes up,investment goes down (pb and r are inversely related)

nax, exports bcomes expensive, imports becomes cheaper,net exports goes down

one component which is fixed – purchasing manager index pmi is the index of business confidence

yn is difined as the natural rate of output = natural rate of employment it is the potential output.
Booms means ad curve shifts to right (stock market boom,tax incentive etc or some kind of prosperity in your exporting partner nation or increased govt spending)
Sustaining this in the long run is hard
Any kind of change in c i g or nx will cause shift in ad curve
Explanation :
Policy changes leads to shift in AD Curve. If autonomous measures are there,policy changes brings it back. Economy should be made back to ad0. If there was no policy intervention, production of more can be done using overutilization of capacity, in the long run as will shift upwards till it interests ad which has shifted already. Economy is at y0, but higher price

In 2008.2009
We had monetary expansion and fiscal stimulus tried to expand the economy, to avoid contractions.As result of AD going up and up (08-13), growth rate has come down from 9 to 5% and coming back at higher level of inflation.
Economy cant be growing forever just by stimulus packages.

What happens when there is supply shock?
AS will go down. Prices go up and output comes down (stagflation)
Supply shock which affects AS curve. This can be countered through policy measures. AD can be shifted outwards and can be back to Yo.

Balance of payments,open economy
Growth,inflation,exchange rate stability – focus maybe different of RBI during different times
08-09 –grwoth objective
12-13 – inflation controlling
Since may – exchange rate stabilization

Our system is called managed float – rupee can fluctuate, but rbi can step in and intervened to bring from 61 to 59.

Cad went from 4.2 to 4.8 cos of gold, services also went down,remittances came down and these 2 were the reasons ,why we didn’t have earlier cushioning effect.

Balance of payments
Current account (flow of goods and services) (how do I finance my CAD? – either by capital flow and monetary aspects)
Credits – payments being received
Refer to one article : -
Capital account (flows of capital) – Equity flow and debt flow
What type of capital flow can I use to finance my CAD?
What is hierarchy of preferences with respect to capital account?
Equity preferable to debt
Capital flow can be exactly equal to CAD ( theoretical)
Usually less or more. If it is less. The balance is managed from monetary policies ( RBI gives money)
100 , 80 gets funded. 20 from rbi

Depletion of foreign exchange reserves . by 20.
Capital account plus current account -100 + 80 = -20 which gets balanced by RBIs +20.

Equity – fdi and fii (equity)
Debt -
Merchandise
invisible * Services * Income * Transfers

How vulnerable are we when it comes to shocks? (2012)
Exports growth rate have come down (rbi report) . why? -1.8% Rest of the world has been experiencing a contraction Gdp growth of rwo is coming (gdp at fc at constant prices) Trade in goods alone

Services Go through ppt, different components in services Software services have come down
Imports
Non gold non oil
Gold
Oil
Imports have been growing. Gold import has been up,oil as well. Crude oil price has been coming down. Despite that imports are up. Financial savings have come down,fiscal savings are going up. So we are moving into gold.
Not using oil efficiently. Non gold non oil imports have gone down. Growth has actually deaccelarated. All these are actually manifestations of economic fundamentals.

Invisibles component sufficiently large to take care of trade deficit. Earlier we had a trade deficit but within current account,balance on invisibles was sufficiently large to take care of part of trade deficit.Such that overall current account deficit was not high as it as today.
Not only trade deficit has grown,surplus has come down.

Profits,interest income etc being payed out (short term) – it is part of current account
Fdi etc – capital account

CAD has worsened. (exports not growing or declining) (imports growing)
Invisibles (not supporting trade deficits)
Within invisible software,trade deficits are all very high.
If there is 8% growth rate,that should support a 3% CAD.
2.5% is a good CAD value.

We have to look at FDI numbers. Other component is the FII flows.
If there is an investment of 10% or more,it is FDI (international FDI) 1/3 of capital flows are equity flows, 2/3 is debt flows… Not really a good pattern of financing.
FII debt - external commercial borrowings (NRI deposits)
Short term debt
External assistance

Short term debt has increased, greater burden of repayment.

Total debt to gdp ratio (19.7 to 21.)
I would need to service my debt. Short term debt to gdp has also gone up. Short term debt is problematic as you have to finance it eveyr 3 months etc, 3rd vulnerability indicator – reserves to total debt. Reserves down means, ability to service debt comes down
Short term debt to reserves is actually going up…last and most important – import cover has actually come down. How many months of import can my foreign exchange service. ? 15 month come down to 7 months of import cover.

Exports plus imports to gdp – 43.8%, services and transfers it becomes 61.5, all these gdps are gdp at current market prices ..current account and capital account – 108% of gdp

Fiscal policy
Tax buoyancy refers to the responsiveness of tax receipts with respect to national income or gdp.if your tax receipts increase by more than 1 percent ,for every 1 percent increase in gdp then your taxes are said to be buoyant.
Bouyancy of direct and indirect taxes

fd figure of 4.8% is based on assumption that gdp is growing by 6.1 to 6.7%.

corporate taxes – buoyancy is less than 1 – investment climate is not as good as earlier. IIP is going down.

DIRECT TAXES – TAX Buoyancy will be less than 1 .
How does govt want to increase overall tax collections?
Indirect taxes – excise and customs duty have been imposed on additional kind of goods
Service tax – negative list declared by govt
Direct taxes ( govt has actually rationalized tax structures)

Fiscal marksmanship – actual vs budgetary estimates as a ratio of the gdp. How good were you at targeting.