Macro economics by bhawani nandan prasad iim calcutta


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Macro economics by bhawani nandan prasad iim calcutta

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Macro economics by bhawani nandan prasad iim calcutta

  1. 1. Recession, Inflation and Monetary PolicyBHAWANI NANDAN PRASADSMP – IIM CalcuttaMBA – Stratford UniversityB.E. ( Computer Sc. IT )
  2. 2. Economic crises• Recession• Inflation• Foreign exchange crisis2
  3. 3. 3Demand-constrained economy(aggregate demand < potential output)(Recession/depression)Potential amount not producedAggregate demandPotentialoutputK
  4. 4. 4Recession/depression• Recession:– Decline in output, income and employmentlasting more than few months• Depression:– a recession that is large in both scale andduration
  5. 5. 5Supply-constrained economy(aggregate demand > potential output)(Demand-pull inflation)PotentialoutputAggregate demandK
  6. 6. 6Why is demand deficient and how can it be increasedAggregate demandPotentialoutputK
  7. 7. 7How demand can be managed to tackledemand-pull inflationPotentialoutputAggregate demandK
  8. 8. 8How K (and productivity etc) can be increasedto accelerate growthPotentialoutputK
  9. 9. Tools of Economic Policy• Fiscal Policy:– Government expenditure and taxes• Monetary Policy:– Money supply, credit, interest rates9
  10. 10. We focus onMonetary Policy10
  11. 11. Evolution of Money• Barter: exchange of goods for other goods• Commodity money: commodities such ascattle, copper, silver, gold, diamonds etcfunctioning as money• Modern money:– Paper currency:• India: minimum reserve system since 1956 (Rs400 crores of forex reserves and Rs 115 crores ofgold)– Bank money11
  12. 12. Different forms of MoneyIn India:M1 = Currency (notes & coins) with public +demand deposits with banks (narrow money)M3 = M1 + time deposits with banks (broadmoney)Note:(„Other‟ deposits with RBI (= deposits of UTI, IDBI etc; deposits offoreign central banks/governments etc) are also a part of M1;statistically very small)12
  13. 13. 13PercentYearMoney Supply per unit of GDPM1/GDP M3/GDP
  14. 14. Modern banks• As banking developed, banks realized thatthat they need not keep 100 percent ofdeposits as reserves since all thecustomers will not withdraw their depositsat the same time• Under the modern fractional reservebanking, banks actually create moneysince total bank deposits is a multiple ofbank reserves14
  15. 15. Who creates Money?• RBI:– Determines the monetary base (also knownas reserve money, base money, highpowered money)• Banks:– Create money through multiple expansion ofbank deposits based on cash reserves15
  16. 16. Major Monetary Policy Instruments inIndia• Reserve requirements as % of NDTL (netdemand and time liabilities)• Cash reserve ratio (CRR) – cash balance with RBI• Statutory liquidity ratio (SLR) – safe & liquid assetssuch as government securities, cash, gold• Liquidity adjustment facility (LAF):• RBI sets two rates - repo and reverse repo andoffers to buy securities or sell securitiesrespectively16
  17. 17. Policy Rates and Reserve ratios(, 31/10/2012)Repo rate 8 %Reverse repo rate 7 %17Cash Reserve ratio 4.5 %Statutory Liquidity ratio 23 %
  18. 18. Target of Monetary Policy• Change interest rates and creditavailability to influence aggregate demand:– Expansionary (“loose”/“easy”) monetary policyin a demand constrained economy(recession):• ↓ CRR/SLR• ↓ Repo– Contractionary (“tight”) monetary policy in asupply constrained economy (inflation):• CRR/SLR• Repo18
  19. 19. Effectiveness of Monetary Policyduring recession• Banks don‟t reduce lending rates and/ordon‟t want to lend more even when repoand CRR reduced• Households and firms don‟t borrow moreeven when lending rates fall• Fiscal policy – Keynes‟ argument19
  20. 20. Problems of using Monetary Policyto control inflation• Demand pull inflation or Cost-pushinflation• Risk of Stagflation• Problem of sectoral inflation• Growth vs inflation• Question of Inflationary expectations20
  21. 21. 21Year-on-year Inflation - WPI
  22. 22. 22PercentMonth/yearRBI ratesRepo CRR