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INTRODUCTION

Macroeconomic Policy
22-Jul-14
Prepared by Dr. S.K. Shanthi, Great Lakes Institute of Management
Chapter
1: Page 1


Macroeconomic Policies
22-Jul-14
Prepared by Dr. S.K. Shanthi, Great Lakes Institute of
Management
Chapter
1: Page 2



Macroeconomic policies of government are
broadly classified in to two categories:
Fiscal Policies, and,
Monetary Policies
Fiscal Policies
22-Jul-14
Prepared by Dr. S.K. Shanthi, Great Lakes Institute of
Management
Chapter
1: Page 3



Relate to the government's policies on
expenditure and taxation.
When the expenditure exceeds the revenues, the
govt. is said to run a deficit budget.
When the two are equal, it is a balanced
budget, and
When the revenues exceed the expenditures,
it is called a surplus budget.
Fiscal Policy
22-Jul-14
Prepared by Dr. S.K. Shanthi, Great Lakes Institute of
Management
Chapter
1: Page 4
Whether a country follows an expansionary policy or
a contractionary policy may depend on the phase of
the business cycle prevailing then.
Fiscal policy is considered to be expansionary if the
govt. runs a deficit budget either by increasing
expenditures or by reducing taxes or both.
In general countries may do this during recessions
and depressions
Fiscal policy is said to be contractionary, when the
opposite is true.
Usually countries may adopt this policy during a
recovery phase or a boom phase.
Caveats
22-Jul-14
Prepared by Dr. S.K. Shanthi, Great Lakes Institute of
Management
Chapter
1: Page 5
Fiscal prudence is however to be observed
due to the following consequences arising
out of expansionary fiscal policies.
Keeping in mind that deficits need to be
funded, either through borrowing or creation
of new money, we can see that
Repeated deficits will lead to debt build up to
unsustainable levels, if funded through
extensive govt borrowings, either domestically
or from abroad
Monetizing deficits can lead to an inflationary
spiral.
India's Fiscal Policy
22-Jul-14
Prepared by Dr. S.K. Shanthi, Great Lakes Institute of
Management
Chapter
1: Page 6
Is entirely summarized by the annual budget
presented by the central government in the
parliament. (let us also remember that state
governments and local bodies also have
budgets which announce their policies, but their
impact is quite minor).
Indian govt has only run deficit budgets since
independence.
Central govt's debt currently stands at around
82% of the GDP. Though it is very high, it is
sustainable due to the economy's high growth
rate.
Measures of deficits
22-Jul-14
Prepared by Dr. S.K. Shanthi, Great Lakes Institute of
Management
Chapter
1: Page 7
Fiscal Deficit = Revenue
expenditure+Capital expenditure Revenue
Receits exernal Grants.
To the extent that this gap is filled by borrowing
from the RBI, it is called monetized deficit. (BE:
4.1% of GDP in 14-15)
Revenue Deficit = Revenue expenditure
Revenue receipts. (2.9% of GDP in 14-15)
Revenue Receipts comprise of total Tax
revenues and non-tax revenues such as
interest receipts, dividends and profits from
PSUs etc.,
The biggest item on the RE side is interest
payments (45%) followed by defence (25%).
Recent Years
22-Jul-14
Prepared by Dr. S.K. Shanthi, Great Lakes Institute of
Management
Chapter
1: Page 8
During 2009-10, the Government of India ran a
very big fiscal deficit, of about 6.8% of Indias
GDP
This had a big expansionary impact on the
Indian economy and as a result India was able
to achieve a growth rate of 7.2% during a
world recession.
The budgeted fiscal deficit for 2014-15 is
4.1%, a smaller percent but it is expected that
since India is on a recovery path, we can still
achieve a growth rate of about 5.7-5.9% for
this year.
Impact of Expansionary Fiscal
Policy on the economy
22-Jul-14
Prepared by Dr. S.K. Shanthi, Great Lakes Institute of
Management
Chapter
1: Page 9
Since the govt will borrow extensively from the
markets to fund the Fiscal deficit, the immediate
impact will be an upward pressure on interest
rates.
Fiscal deficits lead to an increase in Aggregate
demand, and therefore, can result in an
increase in the GDP.
High fiscal deficits can lead to inflation as well,
if the supply side is slow to catch up with the
sudden bost given to demand.
Public debt will increase, with an increase in the
net interest payments in the subsequent years.
Monetary Policy
22-Jul-14
Prepared by Dr. S.K. Shanthi, Great Lakes Institute of
Management
Chapter 1:
Page 10
The policy of the central bank, RBI in case
of India, relating to money supply and
interest rates come under the umbrella of
monetary policy. RBI has the following tools
to control credit growth in the economy.
Bank Rate (9% since 2003)
Repo rate (8%) and reverese repo rate (7%)
The Cash Reserve Ratio (CRR) (4%), and,
The Statutory Liquidity Ratio (SLR) (22.5%)
Expansionary Monetary Policy
22-Jul-14
Prepared by Dr. S.K. Shanthi, Great Lakes Institute of
Management
Chapter 1:
Page 11
Monetary policy is considered expansionary
if it results in an increase in credit supply.
Reduction in Banks rate and repo rates make
borrowing from the RBI cheaper, and therefore
considered expansionary. (an increase in the
rates will be considered contractionary)
Reduction in CRR rates in principle make more
money available for lending with the
commercial banks and are also expansionary
in nature (while an increase in the rates will be
contractionary in impact)
Rate of Inflation needs to be considered.
Some data
22-Jul-14
Prepared by Dr. S.K. Shanthi, Great Lakes Institute of
Management
Chapter 1:
Page 12
Aggregate bank deposits end of Dec. 13
stood at 57,386, 135 Crs. Approx.($900 bn)
A 0.25% increase in CRR can result in
reducing loanable funds of Rs. 10250 crs.
The actual contraction in the credit growth
can be as hign as Rs. 41,000 crs since
according to RBI, the credit multiplier is
approx. 4.
potentially a powerful tool if credit availability is
a problem.
Unlikely to have any credit squeezing impact
at the moment because credit off take has
not picked up.
Policy Making A Balancing Act
22-Jul-14
Prepared by Dr. S.K. Shanthi, Great Lakes Institute of
Management
Chapter 1:
Page 13
Macroeconomic policy making is a balancing
act between the Finance Minister, responsible
for fiscal policy and the RBI Governor
responsible for setting monetary policy.
Bad outcomes can land economies in to hyper
inflations and/or debt traps.
Bad outcomes can take the form of a recession
set off by excessive contraction leading on to a
depression.
Many economists feel that policy interventions
should be minimal since economies have the
resilience to self-correct.