 Macroeconomics looks at the economy as a

whole unlike microeconomics which looks at

a firm or industry.
 Variables that are of interest in
macroeconomics are GDP and GDP growth,
inflation and employment.
 These variables often tend to move together
in the form of business cycles
• GDP growth
• Inflation
• Unemployment rate (relatively less important
in India)
• Exchange rate
• Interest rates
• Fiscal deficit
• Balance of payments (especially current
account deficit)
• Market value of final goods and services
produced within a country in a given period
of time (typically quarter or year).
• GDP= C+I+G+NX
C= Consumption: purchase of goods and
services by consumers
I= Investment: business expenditure on
factories, equipment etc. as well as
expenditure on new homes.
G= government purchases
NX= net exports = exports – imports
• Inflation is an increase in general level of
prices of goods and services in an economy
• Measured with the help of a price index
• The Wholesale Price Index (WPI) covers 697
items including agricultural commodities, fuel
and power and manufactured products
• A Consumer Price Index (CPI) is also
calculated which covers a typical basket of
consumer goods for rural and urban
consumers. Recently it has become more
important
 Unemployed workers are those who are
actively seeking work but unable to find it
 Unemployment rate= (Unemployed workers/
Labour Force)*100
 In rich countries this is often the single most
important statistic but in India it is relatively
unimportant compared to GDP growth and
inflation
 4.0
10.0
12.0

0.0
2.0
6.0
8.0
1990-91

1991-92

1992-93

1993-94

1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05
GDP growth

2005-06

2006-07

2007-08

2008-09

2009-10

2010-11

2011-12

2012-13

2013-14
GDP growth
 Macroeconomic policy tries to influence variables
like inflation, unemployment and economic growth.
 Main focus of macroeconomic stabilization is on
short-term stability.
 Long-term macroeconomic policy is more focused
on growth and is determined by broader variables
like infrastructure, education, labour market etc.
 Fiscal policy and Monetary policy are two main
tools of short-run macro policy
 In recent decades monetary policy has become
more important because of its much greater
flexibility
 However in the recent crisis has demonstrated the
limits of monetary policy and fiscal policy has been
heavily used.
 Fiscal Policy Monetary Policy

Expansionary Lower taxes, Lower interest

higher rates, expand
government money supply
spending
Contractionary Higher taxes, Higher interest
lower rates, restrain
government money supply
spending
 Aggregate Demand = C+I+G+NX
C= Consumption: purchase of goods and services by consumers
I= Investment: business expenditure on factories, equipment etc. as well as
expenditure on new homes.
G= government purchases
NX= net exports = exports – imports
 Potential GDP= total output of all the factors of production in the economy
(land,labour, capital etc) are fully utilized.
 In the short run aggregate demand determines the actual GDP
 The basic goal of macroeconomic policy is to keep actual and potential GDP
in balance. Market forces alone can’t do this always; sometimes the
government has to step in.
 If Actual GDP<Potential GDP, demand is too low, there is unused productive
capacity which isn’t being used. Expansionary fiscal, monetary policy is
appropriate
 If Actual GDP>Potential GDP, the economy is overheating, inflation is a
threat. Contractionary monetary/fiscal policy is appropriate
 In practical terms, the appropriate macro policy is determined
by examining growth, unemployment and inflation.
 A) Growth: Potential growth is the sustainable, non-
inflationary rate of growth for each economy.
E.g. If potential growth for US is 3%, expansionary policy is
appropriate if actual growth is 1% and contractionary policy if
actual growth is 5%.
B) Unemployment: Similarly NRU (natural rate of
unemployment) is the lowest unemployment rate consistent
with stable inflation.
If NRU for a country is 6% and the actual unemployment rate is
8% there is scope for expansionary policy to reduce
unemployment. In India unemployment is not measured
frequently and growth is the more important benchmark
C) Inflation: Actual inflation is compared with the inflation
target which is around 2% in most advanced economies and
4% in India.
Source:Trading economics
 Demand Shocks Supply Shocks

Positive E.g. Financial E.g. New technology

bubbles Higher growth,
Higher growth and lower inflation
inflation Readjust potential
Contractionary growth rate
policy
Negative Financial crisis Eg. Oil shocks, bad
Lower growth and monsoon
inflation Lower growth,
Expansionary policy higher inflation
Unclear policy
implications
Livemint
 Policy shocks like demonetisation, GST and RERA.
 GST in particular will bring long-term structural
benefits but in the short run these shocks reduce
aggregate demand and create uncertainty.
 Preexisting “twin balance sheet problem” which
has depressed investment
 Global slowdown and increased protectionism
has clouded export outlook along with structural
shift towards automation in IT industry.
 AD= Consumption + Investment+
Government Purchases+ Net Exports
 Exports: dramatic slowdown in export growth
in last few years (3%) versus 18% growth in
2003-2008.
 Investment: Twin balance sheet problem.
Companies in sectors like infrastructure and
metals and banks which lent to them.
 AD is mainly being driven by consumption
and government purchases
 Huge economic and investment boom in mid-2000’s
 Highly profitable companies rapidly expanded their
investment plans especially in infrastructure
 Investment/GDP reached 38% by 2007-8
 This huge surge of investment was financed by both
bank credit as well as foreign investment
 Then 2008 global financial crisis hit the world
economy
 Infrastructure companies also faced problems in land
acquisition and environmental clearances
 RBI raised interest rates to fight inflation, Rupee also
fell in value making it harder to pay back dollar debt
 Companies developed severe cash flow and debt
servicing problems
 In 2015 steel companies were particularly hit by
falling prices because slowing Chinese economy
 Reaction of banks was to wait and restructure
loans lending fresh funds hoping that growth and
time would eventually solve the problem
 However in 2016 and 2017 the NPA problem has
gotten worse spreading to more industries
including the telecom industry
 Feedback loop on growth: NPA problem slows
down GDP growth which in turn worsens NPA
problem
 Asset reconstruction companies (ARC’s): specialized FI’s
that purchase NPA’s from banks
 Strategic Debt Structuring (SDR): Banks who have given
loans to companies who can’t pay back can restructure
loans including converting them into equity.
 Neither of these steps have solved the problem
 Possible comprehensive solution is a single public asset
rehabilitation agency that can would purchase NPA’s from
banks and work to maximise the value extracted from
them in a limited time period
 In Oct 2017, GOI announced a Rs.2.11 trillion bank re-
capitalization plan of which
 1.35 trillion : bank recapitalization bonds,
 0.58 trillion: raised by PSB’s through financial markets
 0.18 trillion: budgetary support from the government
 Inflation target 4% +/- 2
 Potential growth rate of around 7%

 Macropolicy tries to find a balance between these

two numbers. Currently growth is below 7% and
inflation below 4%.
 So why not reduce rates? Monetary policy forward
looking and concerns about rising inflation.
 RBI is behaving cautiously and wants to establish
credibility
 Worried about other central banks raising rates.
 Concerns about rising oil prices and adverse
macro impact on India
 Central government has some room for fiscal
loosening especially if tax collections improve
 However money should be spent on public
investment instead of subsidies/loan waivers
etc.
 Government spending is also needed to
infuse capital in public sector banks
 While central fiscal deficit is moderate, state
fiscal deficits have been rising
 Overall probably less space for stimulus than
monetary policy
 Macro policy alone only goes so far. In particular boosting
exports requires major structural reforms:
 Human capital: need to improve education, skills, health
indicators, sanitation, to take advantage of demographic
dividend
 Labour reforms to help labour-intensive manufacturing
 Property rights and land markets to speed urbanization
and infrastructure creation
 Reduce cost of business: electricity, transportation, land
acquisition
 Financial inclusion to grow informal sector including
agriculture
 Tremendous scope to use digital tools to achieve all the
above much more efficiently than before