Affect of Money supply on inflation and GDP.................how our GDP and inflation vary with our Indian economy going up or down...................know thru did prez.........

1. Impact of money supply On Inflation and gdp

2. INFLATION AND MONEY SUPPLY METHODOLOGY ADOPTED: Understanding the type and causes of inflation in India. Understanding monetary policy tools which are being used by RBI. Taking the data of money supply (M3), consumer price indices and wholesale price indices. Through regression calculating that how much change in inflation in CPI & WPI is explained by the changes in money supply. Study the past scenario and trend through various articles and earlier selected data. Studying latest developments in monetary policy by RBI taking inflation into consideration.

3. Inflation in India: Inflation is at an acceptable level and remains much lower than in many other developing countries. Demand pull inflation: aggregate demand > aggregate supply. Cost push inflation: when there is a supply shock E.g. oil shock in 1970s

4. RBI and its role in Inflation Control Objective of monetary and credit policy: maintain price stability ensure adequate flow of credit to the productive sectors of the economy. Stability for the national currency and growth in employment and income are also considered. Control Measures Open Market Operations (OMO) Reserve Requirements CRR is the portion of deposits (as cash) which banks have to keep/maintain with the RBI. SLR is the portion of their deposits banks are required to invest in government securities. Between December 2006 and July 2007, RBI has raised CRR by 2 percentage points to 7% which sucked out Rs. 56000 crore rupees from money in supply from financial system Bank Rate or Discount rate(rate at which the RBI makes very short term loans to banks) Indian bank rate is at 6 per cent down from 10 per cent in 1981 and 12 per cent in 1991 Repo rate (rate at which the RBI borrows short term money from the market)

6. R2taking Money Supply as independent factor:

7. Wholesale Price Index (WPI) to below 3 per cent recently Inflation based on wholesale prices during the period January 1998 - January 1999 was 4.6 percent, one of the lowest in the world. Does it show that that tight monetary policies have been effective in bringing down inflation to within RBI's comfort zone? A closer look: Consumer prices continue to show a rising trend. Large purchases of foreign exchange by the RBI have raised money supply growth. Further, there is empirical evidence of a link between money supply and consumer prices. Bringing consumer inflation under control will require shifting away from the policy of preventing an appreciation of the rupee/dollar rate.

9. The rate has moved down from above 5 per cent in the 1990s to below 5 per cent after 2000 and is seen to be rising again

10. In recent months, the trend values show money supply growth of above 20 per cent and CPI based inflation of above 7 per cent.

11. Declining trend till 2002

12. Rupee appreciation in mid 2002

13. Increase in money supply against rupee appreciation. In 2007, trend money supply growth has accelerated and CPI inflation has accelerated. This negates claims that are now being made about monetary policy being tightened and keeping inflation under control.

14. Why are the CPI and WPI telling two different stories about inflation? Both the appreciation of the rupee and the failure of the government to raise oil prices has resulted in the WPI growing very slowly The WPI consists of a large component of tradables like chemicals, intermediate goods, commodities and various manufactured goods, whose prices have come down after the rupee appreciated. The prices of these goods are essentially determined by local demand and supply conditions. The prices of these goods are likely to be highly correlated with changes in money supply growth. Consumer Price Indices are the best inflation measure in a country, as they measure prices of a basket of goods consumed by a certain sample of households. The prices of these goods are essentially determined by local demand and supply conditions. The prices of these goods are likely to be highly correlated with changes in money supply growth.

15. Causes for increase in money supply: In preceding decades, India had an inflation problem because monetary policy used to support large fiscal deficits by printing money. That problem was solved by politicians who realized that higher inflation reduces political support more than what is gained by higher fiscal spending. Now inflation is caused by large purchases of dollars by the RBI in the foreign exchange market in an attempt to prevent the rupee getting stronger.

16. Recent developments in monetary policies: The approach of cautious optimism. It revised its GDP growth projection to 8.5% 9% from 8% earlier. RBI has focused on rising inflation and inflationary expectations in its review. Though RBI finds the 5% - 5.5% inflation tolerable, it has decided to moderate the growth at 5% in the medium term. To curtail both monetary and credit growth, the central bank has taken following steps: Made money available at its repo window costlier by 25 bps to 7.5%. Increased in the provisioning requirement for standard assets for the real estate sector (excluding residential housing loans), outstanding credit card receivables, loans and advances qualifying as the capital market exposure and personal loans to 2% from 1%. It has increased the provisioning requirement for the banks` exposures to the non-deposit non-banking financial companies (NBFCs) to 2% from 0.4% Reduction in the interest rate ceiling on NRE deposits from 100 bps to 50 bps above LIBOR/SWAP rates for US Dollar of corresponding maturity. This move will result in a contraction of money supply in the economy, which would further help in checking inflation.

17. GDP and MONEY SUPPLY What is GDP? Its relevance. Real and nominal GDP. What is money? Its uses. Medium of exchange. Store of value. Standard of deferred payments. Speculatory purposes.

18. GDP and MONEY SUPPLY Components of money supply Currency in circulation Cash with banks Currency with public ‘Other’ deposit with RBI Bankers deposit with RBI Three major components of GDP Trade, hotels, transport & communication Financing, insurance, real estate & business services Community, social& personal services

20. The process of money creation in an economy-India(1990-91)

22. State of Final system equilibrium- desired state- state of economic boom & prosperity

23. deposits at the original bank= reserve money

24. Money supply multiplier= amount of new money created / change in reserves In 1990-91, 1824604.76/358720 = 5.086 = 1/CRR =1/.1966 = 5.086

26. Sum of each component in all years founded

27. proportion of each in that year w.r.t to all 56 yrs. Sum of that comp.

28. For each yr. value of total money supply = sum of all components taken in that yr.

29. all three rise slowly from 1950-51 to 1980-81

30. From 1981-82, 3 rise with high acceleration

31. value of (broad money component> narrow money component> reserve money component)

34. Much lesser amount of money available for Exchange.

35. During 1983-84, it tries to increase CRR thus increasing the reserves

36. Sill, we observe –reserves is much farther away from reaching the sum of broad and narrow money

37. Thus there is still a long way for India to achieve a state of economic boom.

39. Growth of money supply &nominal GDP-1950-51 to 2006-07

41. From 1982 onwards till date–

42. money supply rises &real GDP both rise rapidly

44. From 1978 onwards- till date

45. both rise rapidly

47. Hence , inflation considered affects the GDP.

48. As a result , India’s GDP increased.-we can say that virtual GDP is much more than real GDP due to inflation.

50. Rising CRR-rising multiplied money- Hence rising created money- rising money supply

51. Result- high liquidity –due to Light credit conditions-lower interest rate

52. High borrowing- high investment- high production-real GDP rises

53. high employment-high income

55. Regression & t –test-on money supply & GDPs Considering real GDP Independent variable-Money supply Dependent variable- Real GDP R2 =0.939- is proportion of variance in real GDP predicted by variable MS. Hence, 93.9% of variance in real GDP can be predicted. The regression Equation can be written as- Real GDP =1087177.0+ 0.398 *money supply 6. For a unit increase in MS, real GDP will increase by 0.398 Considering nominal GDP Independent variable –Money supply Dependent variable- Nominal GDP R2 =0.994 henceforth, 99.4% of variance in nominal GDP can be predicted. The regression Equation can be written as- Nominal GDP= 12250.449+0.524 * money supply 6. For a unit increase in MS, nominal GDP will increase by 0.524

56. Do the money supply really predict GDP t-test P- value is found-compared to alpha-level of significance=0.05 P value=0 in both cases Since , 0 < 0.05 money supply will significantly predict both real and nominal GDP. We say ,variable MS is statistically significant. Test of level of significance- Also – 95% confidence interval considered,between upper bound and lower bound limits- Real GDP- lies between 0.370 and 0.475 Nominal GDP lies between 0.513 and 0535 Since ,each of the interval does not include 0, hence- it is statistically significant.

58. By correlation ,we proved the direction of change in the two.

60. Effect of excessive money supply The Indian rupee has been witnessing a continuous rise in its value against the US dollar. An increase of approximately 13.5 % has been witnessed in the last one year.

61. The Ripple Effect With rupee appreciation against dollar unrelenting, India’s first quarter export growth in the current fiscal decelerated to 7 per cent in rupee terms Import growth on the other hand has been continuing its increasing trend as imports for April-June 2007 was $54.9 billion as against $40.88 billion for the same period last year. As a result, trade deficit during the first quarter of the current fiscal surged to $20.6 billion, which was substantially higher than the deficit of $11.8 billion during April-June 2006.

62. Measures by Government On Aug 7, the finance ministry capped external commercial borrowings (ECB) at USD20mn per corporate per year for funds not spent overseas (on imports, outward foreign direct investment, etc.). Government increased subsidies to exporters by increase in DEPB rates. Regulations as to repayment of foreign debt were changed so as to attract repayment of debts.

64. foreign exchange reserves,

65. political factors,

66. natural factors- like famine may lead to recession,

67. a sudden broke out of a war- may lead to increase in GDPHence , RBI along with the government of India should take measures to expand the GDP growth potential of India to achieve the 3 ultimate objectives of any economy- Stable prices Low unemployment Rapid growth in real GDP This will eradicate all poverty and will lead to economic upturn and prosperity of the country.