MACRO ECONOMICS

DR. P. RAVILOCHANAN
 STOCKS AND FLOWS
STOCK Measured at a specified point of time – Long run
concept
[Example : Total number of persons employed, balance sheet of a
company, money supply, price level, consumer price
index, unemployment level, foreign exchange reserves ]

FLOW Measured for a specified period of time – Short run concept

[Example : Number of persons who got new jobs, profit and loss
account of a company, Gross domestic product,
inflation, exports, imports, wages, taxes, consumption,
investment]

Flows have a direct counterpart stock variables.

However, some flow variables may not have direct stock variables.

Stock and flow are interdependent, that one affects the other
[Example : Capital stock and investment]
 REAL GNP AND NOMINAL GNP
‘Real’ implies that the data have been adjusted for changes in
the level of prices

Over time, nominal values reflect changes both in

A] real size of an economic variable and
B] the general level of prices

Over time, real values eliminate the impact of changes in price

level

REAL GNP [Current year] =

Price index of Base year
Nominal GNP current year X -----------------------------------------
Price index of Current year
 RATE OF GROWTH

Growth rate is the indicator of the performance of a country

Two types of growth rate :
a] Growth rate of Gross Domestic Product [in real terms]

b] Growth rate of Percapita Gross Domestic Product –

indicates improvement in standard of living. Calculated
after determining the growth rate of population [p]

So, Percapita GDP = [GDP growth rate [g%] / Population

growth rate] - 1
[ 1 + g% / 1 + p%] - 1
 CIRCULAR FLOW OF INCOME - TWO SECTOR
MODEL

SUPPLY OF GOODS & SERVICES

FACTOR INCOME

HOUSEHOLD BUSINESS
SECTOR SECTOR
FACTOR SERVICES

DEMAND FOR GOODS & SERVICES

MIC 1
 CIRCULAR FLOW OF INCOME – 3 SECTOR MODEL
GOVERNMENT SECTOR

TAXES
GOVT. EXPENDITURE

SAVING CAPITAL MARKET INVESTMENT

HOUSEHOLD SECTOR BUSINESS SECTOR

MIC 2
 CIRCULAR FLOW OF INCOME – 4 SECTOR MODEL

EXPORTS
IMPORTS

GOVERNMENT SECTOR
TAXES
GOVT. EXPENDITURE

SAVING CAPITAL MARKET INVESTMENT

HOUSEHOLD SECTOR BUSINESS SECTOR

 PRODUCTION POSSIBILITY CURVE

B
U
T
T
E
R

GUNS
ME
PERSONAL
 METHODS OF MEASURING NATIONAL INCOME
1. OUTPUT METHOD [VALUE ADDED METHOD]

OUTPUT OF AGRICULTURE & EXTRACTIVE INDUSTRIES

+
OUTPUT OF MANUFACTURING INDUTRIES
+
OUTPUT OF SERVICES & CONSTRUCTION
=
GROSS DOMESTIC PRODUCT AT FACTOR COST
+
NET FACTOR INCOME FROM ABROAD
[INCOME RECEIVED – INCOME PAID ABROAD]
=
GROSS NATIONAL PRODUCT AT FACTOR COST
-
CAPITAL CONSUMPTION OR DEPRECIATION
=
NET NATIONAL PRODUCT AT FACTOR COST OR
NATIONAL INCOME
 EXPENDITURE METHOD
CONSUMER’S EXPENDITURE [C]
+
GOVERNMENT CURRENT EXPENDITURE ON GOODS & SERVICES [G]
+
GROSS DOMESTIC FIXED CAPITAL FORMATION [I]
+
VALUE OF PHYSICAL INCREASE IN STOCKS AND WORK IN PROGRESS [I]
=
GROSS DOMESTIC EXPENDITURE AT MARKET PRICES
+
EXPORTS AND FACTOR INCOME FROM ABROAD [E]
-
IMPORTS AND FACTOR INCOME PAID ABROAD [I]
=
GROSS NATIONAL PRODUCT AT MARKET PRICES
-
INDIRECT TAXES
+
SUBSIDIES
=
GROSS NATIONAL PRODUCT AT FACTOR COST
 EXPENDITURE METHOD

C + I + G = GROSS DOMESTIC EXPENDTIURE

+
[E – I]
=
GROSS NATIONAL PRODUCT AT MARKET PRICES
-
INDIRECT TAXES
+ SUBSIDIES
=
GROSS NATIONAL PRODUCT AT FACTOR COST
METHODS OF MEASURING NATIONAL INCOME
3. INCOME METHOD

INCOME FROM EMPLOYMENT

+
INCOME FROM SELF-EMPLOYMENT
+
GROSS TRADING PROFITS OF COMPAIES
+
GROSS TRADING SURPLUS OF PUBLIC CORPORATIONS
+
RENT
=
GROSS DOMESTIC PRODUCT AT FACTOR COST
+
NET FACTOR INCOME FROM ABROAD
=
GROSS NATIONAL PRODUCT AT FACTOR COST
DIFFICULTIE
INCOME
 SYSTEM OF SOCIAL ACCOUNTING

• PRODUCTION ACCOUNT [BUSINESS SECTOR]

EXPENDITURE REVENUE
Factor incomes
A) Paid to Domestic Sales to Households
residents
B) Paid to Foreign residents Sales to Government

Retained profits Domestic Investment

Corporate profit tax a) Fixed investment
Indirect tax b) Inventory investment
Imports Exports
Depreciation Subsidies from
Government
 SYSTEM OF SOCIAL ACCOUNTING

HOUSE HOLD SECTOR

EXPENDITURE INCOME

CONSUMPTION INCOMES FROM

DOMESTIC PRODUCTION
PERSONAL INCOME TAX INCOME FROM ABROAD

TRANSFERS TO TRANSFERS FROM

FOREIGNERS GOVERNMENT
PERSONAL SAVINGS TRANSFERS FROM
FOREIGNERS
 SYSTEM OF SOCIAL ACCOUNTING
• GOVERNMENT ACCOUNT
EXPENDITURE REVENUE

WAGES & SALARIES CORPORATE PROFIT TAX

PURCHASES OF GOODS & INDIRECT TAXES

SERVICES
TRANSFERS TO PERSONAL INCOME TAX
FOREIGNERS
TRANSFERS TO
HOUSEHOLDS
SUBSIDIES TO
PRODUCERS
SURPLUS DEFICIT
 SYSTEM OF SOCIAL ACCOUNTING

EXTERNAL ACCOUNT
RECEIPTS PAYMENTS

EXPORTS IMPORTS

TRANSFERS FROM TRANSFER TO

FOREIGNERS FOREIGNERS

INCOMES FROM ABROAD INCOMES PAID TO

FOREIGNERS

DEFICIT ON CURRENT SURPLUS ON CURRENT

ACCOUNT ACCOUNT
 SYSTEM OF SOCIAL ACCOUNTING
SAVINGS – INVESTMENT ACCOUNT
SAVINGS INVESTMENT

PERSONAL SAVINGS FIXED INVESTMENT

BUSINESS SAVINGS NET CHANGE IN

STOCK

GOVERNMENT SAVINGS

DEFICIT ON CURRENT SURPLUS ON CURRENT

ACCOUNT ACCOUNT
 -KEYNISIAN ECONOMICS
EFFECTIVE DEMAND = OUTPUT = INCOME = EMPLOYMENT

AGGREGATE SUPPLY FUNCTION AGGREGATE DEMAND FUNCTION

CONSUMPTION INVESTMENT GOVERNMENT EXPENDITURE

SIZE OF INCOME PROPENSITY TO CONSUME

MARGINAL EFFICIENCY OF CAPITAL RATE OF INTEREST

SUPPLY PRICE OF CAPITAL PROSPECTIVE YIELD

TRANSACTION PRECAUTIONARY SPECULATIVE

MOTIVE MOTIVE MOTIVE
 MACRO ECONOMICS –
CONSUMPTION FUNCTION
 CONSUMPTION FUNCTION (1)

Consumption function explains the relationship between Income

[Y] and Consumption [C]
So, C = f ( Y)
Keynes’ Psychological law of Consumption :
When Y increases C also increases at a lesser rate
When Y decreases C also decreases at a lesser rate

INCOME [Y] : 100 150 200 250 300 350

CHANGE IN Y (50) (50) (50) (50) (50)

CONSUMPTION [C] : 100 145 190 230 250 260

CHANGE IN C (45) (45) (40) (20) (10)
CONSUMPTION FUNCTION (2)

CONSUMPTION

[C] C

b δ
MPC = δ C/δ Y
C
δ
Y
a

INCOME [Y]
 CONSUMPTION FUNCTION (3)
Keynes’ equation :
Y = C + S
Y = C + I
So, S ≡ I
Marginal Propensity to Consume [MPC]
The extent of change in consumption[C] for a change in
income [Y] MPC = δ C / δ Y

Marginal Propensity to Save [MPS]

The extent of change in Saving [S] for a change in
income [Y] MPS = δ S / δ Y
 CONSUMPTION FUNCTION (4)
From Keynes’ basic equation :
Y = C+S
So C = Y - S
And S = Y - C

Therefore MPC + MPS = 1

MPC = 1 - MPS
MPS = 1 - MPC
Ex : Suppose income increases from Rs. 100 to Rs. 120 and
Consumption expenditure goes up from Rs. 75 to Rs. 90
Then MPC = 15 / 20 = 0.75
and MPS = 1 - 0.75 = 0.25
 CONSUMPTION FUNCTION (5)

Determinants of Consumption Function :

A] Subjective factors :
i ) Individual motives ii) Business motives
- Desire to hold reserves for - Desire to do big things
contingencies - Liquidity maintenance
- Reserves for future needs - Increase income and
- Desire to get large interest provide for reserves
return - To discharge debts
- Improve standard of living
- A sense of security
- To bequeath wealth
- Miserliness
 CONSUMPTION FUNCTION (6)

Determinants of Consumption Function :

B] Objective Factors
– Change in Wage level
– Windfall gains / losses
– Changes in Fiscal policy
– Change in expectations
– Change in rate of interest
– Financial policies of Corporations
– Holding liquid assets
– Distribution of income
– Change in attitude
– Demonstration effect
 CONSUMPTION FUNCTION (7)

Measures to increase Consumption :

• - Income re-distribution
• - Increase in wages / salaries
• - Introducing Social security measures
• - Extending credit facilities
• - Improving distribution of resources
• - Urbanization
 LONG RUN CONSUMPTION FUNCTION IN A STEADY
STATE

Ct = a + b Ytd + gCt – 1

Where : Ct = Consumption expenditure for the current period

a = Autonomous consumption

b = Short run MPC

Ytd = Disposable personal income for the current period

g = Coefficient indicating the relation between current period

consumption and previous period consumptions
C t – 1 = Previous period consumption expenditure
 INVESTMENT MULTIPLIER (8)

Multiplier [ki] explains the relationship between additional

investment and additional income. That is, when there is
additional investment, it will lead to increase in income. The
quantum of increase income for an increase in investment is
measured to determine the multiplier.

The value of multiplier depends on the value of Marginal

Propensity to Consume [MPC]

k = (1/ 1- MPC) or 1 / MPS

(as MPS = 1 - MPC)
INVESTMENT MULTIPLIER (9)

ROUND ∆ I ∆ Y ∆C ∆ S
MPC = 0.5
1 100 100 50 50

2 50 25 25

3 25 12.5 12.5

4 12.5 6.25 6.25

5 6.25 3.12 3.12

100 200 100 100

INVESTMENT MULTIPLIER (10)

Y=C
C C+I
+
I
∆ I C

Y1 ∆ Y Y2 (Y)
 INVESTMENT MULTIPLIER (13)

Example : Additional investment is Rs. 100 crores and

MPC = 0.8. Calculate multiplier and the increase in
income.
Using MPC : k = 1/ 1 – 0.8 = 1 / 0.2 = 5
Increase in income = k . Additional investment
= 0.5 . 100 = Rs. 500 crores
If MPC in the above example is 0.6, then k = 2.5 and income
generated would be only Rs. 250 crores

GREATER THE MPC, GREATER WOULD BE THE

INCOME GENERATED AND LESSER THE MPC,
LESSER WOULD BE THE INCOME GENERATED
 INVESTMENT MULTIPLIER (12)

Leakages in Multiplier
1. Savings
2. Tax imposed
3. Transfer of additional income to other countries
4. Hoarding of additional income
5. Investment in unproductive investment [like jewels]
6. Purchase of old shares and securities
7. Cancellation of debts
8. Undistributed profits
9. Maintaining excess of consumption goods
BALANCED BUDGET MULTIPLIER
Balanced budget means that revenue and expenditure of the
government would be equal. Hence, whenever a tax is imposed,
there would be reduction in consumption, but this is
neutralized by increasing public expenditure to the extent of
the tax amount. However, when tax is imposed, the level of
disposable income is reduced which is used for consumption
purpose. Hence, the economy’s consumption expenditure
would not fall by the full amount of tax.
•

Govt. expenditure multiplier = ∆ Y = [1 / 1 – c ] x ∆ G

[∆ Y / ∆ G] = 1 / 1 - c

This shows that change in income will equal the multiplier times the
changes in autonomous government expenditure

Tax multiplier is = ∆ Y= [-c∆ T]/1–c

=∆ Y/∆ T=-c/1-c

This shows that the change in income will equal multiplier times the
product of the MPC and change in taxes.

Suppose there is a simultaneous change in tax and public expenditure

[i.e., to ensure that the budget in balance]
Suppose there is a simultaneous change in tax and public expenditure
[i.e., to ensure that the budget in balance]

[∆ Y / ∆ G ] + [ ∆ Y / ∆ T] = [ 1/ 1-c ] – [c / 1 – c] = [1 – c] / [1 – c] =
1

Example : Suppose MPC = 0.67, ∆ G = ∆ T = 10

Government expenditure multiplier =

[1 / 1- c] = [1 / 1 – 0.67] = 1/ 0.33 = 3

Tax multiplier = [- c / 1 – c ] = - 0.67 / 1 – 0.67

= - 0.67 / 0.33 = 2

Therefore the increase in income due to the combined effect of tax

and public expenditure =

∆ Y = [3 x ∆ G - 2 ∆ T ] = 3 x 10 – 2 x 10 = 10
INVESTMENT, TAX AND FOREIGN TRADE MULTIPLIER

MULTIPLIER = 1 / [1- β (1 – t) + µ ]

β - MPC
t - Tax rate
µ - MPI
FOREIGN TRAD MULTIPLIER

Also called export multiplier, operates like the

investment multiplier. When exports go up, the income
of all persons associated with export industries also go
up. This creates demand for goods. But this depends on
MPS and Marginal Propensity to Import. [MPI] The
Foreign trade multiplier can be explained as below :

Y = C + I + X - M
[Y – Income, C – Consumption, I – Investment, X –
Exports and M – Imports
The above relationship could be stated as :
Y - C = I + X–M
S = I+ X - M
S + M = I + X
 In an open economy, Investment is divided as :
Domestic investment Id and Foreign
investment If
I = S

Id + If = S

Foreign investment = If = X - M
So Id + X - M = S [or]
Id + X = S + M
Foreign trade multiplier co-efficient
[ kf] = ∆ Y / ∆ X and
∆ X = ∆ S +∆ M
Dividing both sides by ∆ Y
∆ X / ∆ Y = (∆ S + ∆ M ) / ∆ Y
1 / kf = (∆ S + ∆ M ) / ∆ Y
or kf = ∆ Y / (∆ S + ∆ M ) Dividing by
∆ Y
Therefore kf = 1 / (∆ S / ∆ Y ) + (∆
M / ∆ Y]
= 1 / MPS + MPI
 PRINCIPLOE OF ACCELERATOR

A PROCESS BY WHICH AN INCREASE [OR] DECREASE IN

THE DEMAND FOR CONSUMPTION GOODS LEADS TO
AN INCREASE [OR]DECREASE IN INVESTMENT ON
CAPITAL GOODS

ACCELERATION COEFFICIENT
β =ΔI / ΔC
ΔI =βΔC
β - is accelerator coefficient
Δ C is the net change in consumption expenditure
Δ I is the net change in investment

Ex: If the C increases by Rs. 10 crores and investment increases

by Rs. 30 crores, then β is 30/10 = 3
 ACCELERATION PRINCIPLE
PERIOD TOTAL REQUIRED REPLACEMENT NET GROSS
OUTPUT CAPITAL INVESTMENT INVESTMENT INVESTMENT
Y v=4 R In [Ig= In+ R]
(Req. cap = vY)

t 100 400 40 0 40

t+1 100 400 40 0 40

t+2 105 420 40 20 60

t+3 115 460 40 40 80

t+4 130 520 40 60 100

t+5 144 560 40 40 80

t+6 145 580 40 20 60

t+7 140 560 40 - 20 20

t+8 130 520 40 - 40 0

t+9 125 600 40 - 20 20

Therefore Accelerator is ratio of induced investment to
changes in output it calls forth.
v=ΔI / ΔY
Gross investment [Igt = v(Yt – Yt-1 ) + R
= v Δ Yt + R
Where Igt is gross investment in period t
Yt is the national output in period t
Yt-1 is the national output in the previous
period [t-1]
R is the replacement investment
To get net investment In R must be deducted from
both sides of the equation so that the net
investment in period t is
Int = v(Yt – Yt-1 )
= v ΔYt
In other words, this is the same as v = Δ I / Δ Y
Since Δ Y = Yt – Yt-1

Accelerator v and β are one and the same

 ASSUMPTIONS OF ACCELERATION PRINCIPLE

1. A CONSTANT CAPITAL – OUTPUT RATIO

2. RESOURCES ARE EASILY AVAILABLE
3. THERE IS NO EXCESS OR IDLE CAPACITY IN PLANTS
4. THERE IS ELASTIC SUPPLY OF CREDIT / CAPITAL
5. INCREASED DEMAND IS PERMANENT
6. INCREASE IN OUTPUT IMMEDIATELY LEADS TO
INCREASE IN INVESTMENT
 MULTIPLIER - ACCELERATION INTERACTION
TIME INITIAL INDUCED INDUCED INCREASE IN
INVESTMENT CONSUMPTION INVESTMENT INCOME
t [c= 0.5] [v = 2] [COL. 2+3+4]

t+1 100 - - 100

t+2 100 50 100 250

t+3 100 125 150 375

t+4 100 187.50 125 412.50

t+5 100 206.25 37.50 343.75

t+6 100 171.88 - 68.74 203.14

t+7 100 101.57 - 140.62 60.95

t+8 100 30.48 - 142.18 -- 11.70

t+9 100 - 5.48 - 72.66 -21.49

t+10 100 10.75 - 33.20 43.95

 INFLATION

TYPES OF INFLATION
1. DEMAND PULL INFLATION
WHEN DEMAND FOR GOODS & SERVICES CONTINUE TO INCREASE
AND EXCEED THE SUPPLY OF GOODS AND SERVICES, THE PRICE
LEVEL WILL GO UP. BEYOND FULL EMPLOYMENT, INCREASE IN
DEMAND WILL BE FOLLOWED ONLY BY INCREASE IN PRICE AND
TILL FULL EMPLOYMENT, INCREASE IN DEMAND IS FOLLOWED BY
INCREASE IN OUTPUT AND PRICE.

2. COST PUSH INFLATION

WITH INCREASE IN PRICE, THE DEMAND FOR MORE WAGES AND
SALARIES GOES UP. WHEN THIS IS MET, THE COST OF
PRODUCTION WILL INCREASE. TO OFF-SET THIS, THE
MANUFACTURERS INCREASE THE PRICE [i.e., pass on the increase in
cost of production to the ultimate consumers]
 PHILIPS CURVE [UNEMPLOYMENT AND INFLATION]

PRICE WAGE

3 6

2 5
4
1
0 3

-1

-2 2
1

1 2 3 4 5 UNEMPLOYMENT RATE
 CONTROL OF BUSINESS CYCLES – FISCAL POLICY

INSTRUMENTS OF FISCAL POLICY

- TAX
- PUBLIC EXPENDITURE
- PUBLIC DEBT

TAX - PRINCIPLES OF TAXATION – A] BENEFIT PRINCIPLE

- B] ABILITY TO PAY PRINCIPLE
- TYPE OF TAX - a] Progressive b] Proportional c] Regressive

- DIRECT TAX & INDIRECT TAX – JUSTIFICATIONS

- EFFECTS OF TAXES
- TAX AS A FISCAL INSTRUMENT OF CONTROL
 INSTRUMENTS OF FISCAL POLICY [CONTD..]

• PUBLIC EXPENDITURE

JUSTIFICATIONS
• EFFECTS OF PUBLIC EXPENDITURE
• CONTROL OF PUBLIC EXPENDITURE
• AS AN INSTRUMENT OF FISCAL CONTROL

PUBLIC DEBT
JUSTIFICATIONS
. EFFECTS OF PUBLIC DEBTS
. DEBT SERVICING
. DEBT REDEMPTION
 CONTROL OF BUSINESS CYCLES - MONETARY POLICY

MEANING OF MONETARY POLICY

INSTRUMENTS OF MONETARY POLICY
CREDIT CONTROL POLICY
A] QUANTITATIVE CREDIT CONTROLS
- BANK RATE POLICY
- OPEN MARKET OPERATIONS
- VARIABLE RESERVE RATIO

B] QUALITATIVE CREDIT CONTROLS

- CONSUMER CREDIT REGUALTIONS
- MARGIN REQUIREMENTS
- MORAL SUASION
- DIRECT ACTION
 BALANCE OF PAYMENT
Current account
1. MERCHANDISE
Exports of goods on FOB - credit items
Imports of goods on CIF - debit items
2. INVISIBLES
Credits
Receipts of :
Value of services rendered by residents to non-residents
Income earned by residents on ownership of financial assets
Use of non-financial assets [property income]
Cash or kind without transfer payments

Debits
Remittances under the above items Made by residents to
non - residents
• 1. Government not included elsewhere
•
• Credit : Funds received from foreign government for the
maintenance of their embassy, consulates, etc., in India.
• Debit : Payment to foreign technical consultant for professional
services rendered by him
• 2. Transfers
• A] Official transfers
• Debit :
• Revenue contributions by the government to international
institutions or any transfer in the form of gifts also, of
commodities by the government to non-residents
• B] Private transfers
• Debit :
• Cash remittances by non resident Indians for their family
maintenance in India and redemption in rupees of both principal
and interest under Non resident external [rupee] accounts and
non-resident non-repatriable rupee deposit schemes
• CAPITAL ACCOUNT
•
• Debits Credits
• Country’s foreign
• Financial Assets Increase Decrease
•
• Foreign financial liabilities Decrease Increase
•
• MONETARY MOVEMENTS
•
• Repayments made to IMF or
• Addition made to existing reserves Debit
•
• Drawings from the IMF or drawing down
• Of reserves Credit
•
 METHODS OF CORRECTING BALANCE OF PAYMENTS
DISEQUILIBRIUM

• MEANING : ANY ADVERSE BALANCE OF PAYMENTS IS CALLED

DISEQUILIBRIUM

• TYPE OF DISEQUILIBRIUM

– STRUCTURAL DISEQUILIBRIUM
– FUNDAMENTAL DISEQUILIBRIUM

• METHODS OF CORRECTING DISEQUILIBRIUM

– EXCHANGE DEPRECIATION
– DEVALUATION
– EXCHANGE CLEARING AGREEMENTS
– EXCHANGE CONTROLS
» TARIFFS
» QUOTAS
 MONEY STOCK MEASUREMENTS
A. MONETARY AGGREGATES
CONSTITUTENTS
M0 = Currency in circulation + Bankers’ deposits with RBI + Other
deposits with RBI
[Weekly]

M1 = Currency with public + Demand deposits with banks + Other

deposits with RBI
[Fortnightly]

M2 = M1 + Time liabilities portion of savings deposits with banks +

Certificates of deposit issued by banks + term deposits [maturity up
to 1 year]
[Fortnightly]

M3 = M2 +Term deposits with maturity above 1 year with banks + call

borrowings from Non depository financial corporations by the banks
 MONEY STOCK MEASUREMENTS
B. LIQUIDITY AGGREGATES

L1 = M3 + All deposits with Post office savings banks

[excluding NSCs]
[Monthly]

L2 = L1 + Term deposits with term lending institutions

and refinancing institutions + term borrowings by
refinancing institutions + Certificates of deposit
issued by Financing institutions

L3 = L2 + Public Deposits of NBFIs

 HIGH POWERED MONEY

High powered money = Monetary liabilities of RBI + Govt.

money
[i.e., currency issued by RBI + reserves held by
the commercial banks with RBI + other deposits
with RBI ]
RBI Assets = RBI LIABILITIES
FA + OA = ML + NML
Ms [with the influence of time deposits with commercial banks]

= [ 1 + c + t ] / c + r [1 +t]
Ms [ without the influence of time deposits with commercial
banks]
= [1 + c] / [ c + r]
With excess reserve m = [1 + c] / [r + c + e]
 MONETARY LIABILITIES

1. NOTES IN CIRCULATION
2. OTHER DEPOSITS
A. Deposits of quasi-government
b. Balances in the accounts of foreign central
banks and governments
c. Accounts of internal agencies such as the
IMF, etc.
3. Deposits of Banks [Reserves]
 NON MONETARY LIABILITIES

B. Capital account
C. Government deposits
D. IMF Accounts
E. Miscellaneous - Bills payable, Pension fund,
etc.
 FINANCIAL ASSETS

A. Credit to government
- To central govt.
- To state govt.
B Credit to commercial sector
C. RBI’s gross claims on banks
- Refinance of RBI to the banks
- Fixed investments in commercial banks’ shares, etc
D. Net foreign assets – gold, bullion, foreign securities,
Balances held abroad with IMF, etc
E. Other assets
 OPEN ECONOMY

STERILIZATION
- Contractionary & Expansionary monetary
policy to correct imbalance due to foreign
exchange reserve is called sterilization
 POLICY MIX FOR BALANCE

1. INTERNAL BALANCE : Full employment &

[S – I] Price stability

2. EXTERNAL BALANCE : Current account

[X – M ] balance [surplus / deficit]

To achieve both internal and external balance

Policy mix :
Reduce govt. spending [fall in S – I] and
Devaluation [rise in X – M]
POLICY MIX FOR EXTERNAL & INTERNAL
BALANCE
INT.BAL
S–I*

S–I

FE
EX.BAL

X – M*

X-M
 MONETARY POLICY

Expansionary monetary policy leads to Demand pull inflation

and then cost push inflation. To control this contractionary
monetary policy is adopted.

But the above step should be balanced as it should not lead to

choking credit expansion.

When expansionary monetary policy is not followed by increase

in Agg. Supply, this leads to overheating of the economy
 LAGS IN MONETARY POLICY

LAGS IN MONETARY POLICY

t1 – Equilibrium status

t2 - When C + I fluctuate – there is need for correction

t3 - Policy action is initiated

t4 - Time taken for policy to become effective

 LAGS IN MONETARY POLICY

INSIDE LAG OUTSIDE LAG

INTERMEDIATE LAG
ADMINISTRATION DECISION PRODUCTION
RECOGNITION
LAG LAG LAG
LAG

EFFECT
ACTION NEED ACTION EFFECT EFFECT
NEEDED RECOGNISED FELT ON RI & FELT ON FELT ON
TAKEN CREDIT
CONDITIONS
SPENDING OUTPUT
DECISIONS &N
 FISCAL POLICY
BUDGET DEFICIT AND THE GOVERNMENT DEBT
Definitions
Revenue receipts = Tax revenue + Non - tax revenue
[Direct taxes + Indirect taxes + internal
receipts + Total profit ]
Capital receipts = Recoveries of Loans + Other
capital receipts + Borrowings
and other liabilities
Revenue expenditure = Non plan expenditure on revenue

a/c + Plan expenditure on

revenue a/c
Capital expenditure = Non plan expenditure on capital
a/c + Plan expenditure on
capital a/c
 FISCAL POLICY
Revenue deficit = Revenue expenditure - Revenue receipts

Fiscal deficit = Total expenditure –

( Revenue receipts + Recoveries of
loans + Other capital receipts )

Primary deficit = Fiscal deficit - Interest payments

Non plan expenditure = Interest payments + Subsidies + Defense

expenditure
 FISCAL POLICY
Example : 1
The following estimates are extracted from the Budget for 19xx – 19xx
Rs. In Crores
Tax revenue 1,16,857
Non tax revenue 45,137
Recoveries of loans 9,908
Other capital receipts 5,000
Borrowing and other liabilities 91,025
Non plan expenditure
On revenue account 1,66,301
[of which interest payment is 75,000]
On Capital account 29,624
Plan expenditure
On Revenue account 43,761
On capital account 28,241
Calculate : Revenue receipts, Capital receipts, Revenue expenditure, Capital
expenditure, Revenue deficit, Fiscal deficit and Primary deficit
 FISCAL POLICY

Solution :
Revenue receipts = 1,16,857 + 45,137 =
1,61,994
Capital receipts = 9,908 + 5,000 + 91,025 =
1,05,933
Revenue expenditure = 1,66,301 + 43,761 =
2,10,062
Capital expenditure = 29,624 + 28,241 = 57,865
Revenue deficit = 2,10,062 - 1,161,994 =
48,068
Fiscal deficit = 2,67,927 - [1,61,994 + 9,908 + 5,000]
91,025
Primary deficit = 91,025 - 75,000 = 16,025