Description
This is presentation highlights the objectives of economic policy with respect to growth, unemployment and inflation in the indian context
• Topic: Objectives of economic policy: Growth, inflation and unemployment in Indian context • Dwivedi D.N., Macroeconomics, Mcgraw Hill, 2nd edition, Chapter 21,22,23
Conflicts between objectives
• Rapid growth and low inflation • If an economy grows too quickly, especially if it is due to excessive consumer spending as it tends to be in the UK, then demand will outstrip supply and prices will rise. • Equally, the steps taken to keep inflation low, like relatively high interest rates, can often restrict growth via reduced consumer spending and investment. It is difficult to achieve both aims.
Contd..
• Low unemployment (or full employment) and low inflation • These two variables have, in theory, an inverse relationship. • If a government tries to reduce unemployment through lower interest rates or increased public spending, then the resulting reduction in unemployment will push wages, and then prices, higher. • On the other hand, when the government tries to control high inflation with higher interest rates and reduced spending, the resulting reduced consumer spending and lower investment will result in job losses.
Contd..
growth and the environment • The faster the rate of growth, the higher the level of production, and so the level of pollution from factories, cars, etc. rises. Also, vital rain forests tend to disappear, not just because we consume the wood; new factories, towns and housing are built on the resulting land.
Macroeconomic Issues in India
Inflation
• Considerable and persistent rise in price level over long period of time. • Too much money chasing too few goods • A price rise of 2 to 3% in developed countries and 4 to 5% in developing countries is considered to be desirable rate of inflation
Types of inflation
• Moderate or creeping – single digit • Galloping – double digit and triple digit • Hyper – more than three digit Examples 1. Germany in 1923 2. Argentina, Brazil, Mexico. Peru, Yugoslavia
Contd..
• Hyper inflation goes beyond mental vision. Following statements about German inflation would suggest the same. 1. People carried basket load of money to market and brought goods in pockets. 2. It was cheaper to burn currency notes to make tea rather than buying tea in the shop 3. Price of house in the pre-inflation period was just sufficient to pay a day’s rent in post-inflation period 4. At the time of entering the café, the price of a cup of coffee was 4,000 marks which rose to 8,000 marks before one could finish his coffee. 5. Similar experiences of hyper-inflation in Argentina, Brazil and Peru
Causes of Inflation
• Demand pull – demand increases much rapidly as compared to supply. This may be due to monetary (increase in money supply in excess of increase in the potential output) or real factors – such as increase in govt expenditure, without change in tax rate, cut in the tax rates without change in govt expenditure, more investment, less savings, more exports, less imports.
Contd…
• Cost push inflation – supply side factors 1. Wage push – strong labour union activities 2. Profit push – exercise of monopoly power 3. Supply-shock – crop failures, unexpected disturbance in supply of key industrial inputs 4. Minimum wages legislation 5. Administered prices
Why worry about inflation?
• imposes significant socio-economic costs - burden of inflation is large on the poor, high inflation by itself can lead to distributional inequality. • high inflation distorts economic incentives by diverting resources away from productive investment to speculative activities. • inflation reduces households saving as they try to maintain the real value of their consumption. Consequent fall in overall investment in the economy reduces its potential growth. • if domestic inflation remains persistently higher than those of the trading partners, it affects external competitiveness. • as inflation rises beyond a threshold, it has an adverse impact on overall growth. The Reserve Bank’s current assessment suggests that the threshold level of inflation for India is in the range of 4-6 per cent. If inflation persists beyond this level, it could lower economic growth over the medium-term. These costs, therefore, necessitate monetary policy response to control inflation.
• Monetary Policy Dilemmas: Some RBI Perspectives (Comments of Dr. D. Subbarao, Governor, Reserve Bank of India at the Stern School of Business, New York University, September 26, 2011) • Monetary Policy Response to Recent Inflation in India - Speech by Deepak Mohanty, Executive Director, Reserve Bank of India, delivered at the Indian Institute of Technology (IIT), Guwahati on 3rd September 2011
Inflation in India
• Phase I. October 2009- March 2010 • Initial phases of global recession, emerging market economies (EMEs) were to be better positioned due to substantial FOREX reserves and banking sector. • But slowly spill over effects on trade, finance and expectations. • So many measures by RBI to ease monetary sector – to increase domestic and foreign liquidity • All the monetary and fiscal stimulus measures were inflationary in nature.
• The year-on-year headline WPI inflation accelerated from under 2 per cent in October 2009 to above 10 per cent by March 2010 • Reasons - severe deficiency in rainfall during 2009-10, which adversely affected the food prices, global commodity prices and fuel prices rose significantly during this period. Manufactured non-food products inflation also began to increase
• The Reserve Bank, in October 2009, highlighted the need for exit from recession-time easy monetary policy and to bring the rates back to pre-crisis period. • At the same time, monetary policy had to recognise that the economic growth was recovering from the crisis time slowdown • any aggressive monetary tightening at that point would have affected the recovery
• • • •
Phase II. April –July 2010 10% inflation Inflation from cereals, vegetables, pulses was less. But still, food inflation did not decline as price pressures were from the protein-rich items such as milk, egg, meat and fish. • The demand for these items has been growing with increasing per capita income and changing dietary patterns. • Another major contributor to increase in prices during this period was the increase in administered prices of petroleum products and deregulation of petrol prices in June 2010.
• Industrial production showed declining trend indicating “supply shock induced inflation” • So monetary policy actions were geared towards normalisation of policy rate.
• Phase III. August-November 2010 • This phase was marked by slowing down of price pressures as headline inflation declined to 8.2 per cent by November 2010 from above 10 per cent in the preceding phase. • The increase in WPI during this phase was also moderate compared to the previous two phases. Of the increase in WPI, a major part came from the primary non-food articles, mostly raw cotton and minerals.
• Phase IV. December 2010 Onwards • The moderately declining trend in inflation changed course significantly during this period: first, due to 1. Increase in food inflation as unseasonal rains in some parts of the country 2. increase in input costs • Monetary policy also had to recognise that over the long-run, high inflation is bad to sustained growth • It was indicated by the Reserve Bank that bringing down inflation, given its generalised nature, even at the cost of some growth in the short-run, should be right policy
Conclusion
• India recovered from the crisis sooner than even other emerging economies, but inflation too caught up with us sooner than elsewhere. • It was a result of both supply and demand pressures. Supply pressures due to domestic food prices and rising global prices of oil and other commodities. • The source of demand pressures was an economy with low per capita income which recovered sharply from the crisis.
Contd..
• Monetary policy – more effective to manage demand side inflation • If inflation is high, tighten monetary policy; and if inflation is low, loosen monetary policy. • But monetary policy options in the face of supply shocks are less straight forward. • liquidity injection through OMOs happened at a time when we were tightening policy rates to combat inflation. • This was to bring inflation down, and at the same time, to ensure that flow of credit for productive purposes was not choked.
unemployment
• A situation in which those who are able and willing to work at the prevailing wage rate, do not find a job. • Types 1. Frictional 2. Structural 3. Natural 4. Cyclical
Frictional
• Lack of information about the job • Cost of training • Cost of transportation in case of movement of labour • Monopoly power of trade unions Upward movement of in wages is quick but downward adjustment is slow. So uncleared labour markets
Structural
• Structural changes in the economy • Change in the sectoral composition of economy • Change in technology • Downfall or decay of certain kinds of industries
Natural
• Unavoidable • Exists even when economy has full employment
Cyclical
• Related to business cycles.
doc_982819661.pptx
This is presentation highlights the objectives of economic policy with respect to growth, unemployment and inflation in the indian context
• Topic: Objectives of economic policy: Growth, inflation and unemployment in Indian context • Dwivedi D.N., Macroeconomics, Mcgraw Hill, 2nd edition, Chapter 21,22,23
Conflicts between objectives
• Rapid growth and low inflation • If an economy grows too quickly, especially if it is due to excessive consumer spending as it tends to be in the UK, then demand will outstrip supply and prices will rise. • Equally, the steps taken to keep inflation low, like relatively high interest rates, can often restrict growth via reduced consumer spending and investment. It is difficult to achieve both aims.
Contd..
• Low unemployment (or full employment) and low inflation • These two variables have, in theory, an inverse relationship. • If a government tries to reduce unemployment through lower interest rates or increased public spending, then the resulting reduction in unemployment will push wages, and then prices, higher. • On the other hand, when the government tries to control high inflation with higher interest rates and reduced spending, the resulting reduced consumer spending and lower investment will result in job losses.
Contd..
growth and the environment • The faster the rate of growth, the higher the level of production, and so the level of pollution from factories, cars, etc. rises. Also, vital rain forests tend to disappear, not just because we consume the wood; new factories, towns and housing are built on the resulting land.
Macroeconomic Issues in India
Inflation
• Considerable and persistent rise in price level over long period of time. • Too much money chasing too few goods • A price rise of 2 to 3% in developed countries and 4 to 5% in developing countries is considered to be desirable rate of inflation
Types of inflation
• Moderate or creeping – single digit • Galloping – double digit and triple digit • Hyper – more than three digit Examples 1. Germany in 1923 2. Argentina, Brazil, Mexico. Peru, Yugoslavia
Contd..
• Hyper inflation goes beyond mental vision. Following statements about German inflation would suggest the same. 1. People carried basket load of money to market and brought goods in pockets. 2. It was cheaper to burn currency notes to make tea rather than buying tea in the shop 3. Price of house in the pre-inflation period was just sufficient to pay a day’s rent in post-inflation period 4. At the time of entering the café, the price of a cup of coffee was 4,000 marks which rose to 8,000 marks before one could finish his coffee. 5. Similar experiences of hyper-inflation in Argentina, Brazil and Peru
Causes of Inflation
• Demand pull – demand increases much rapidly as compared to supply. This may be due to monetary (increase in money supply in excess of increase in the potential output) or real factors – such as increase in govt expenditure, without change in tax rate, cut in the tax rates without change in govt expenditure, more investment, less savings, more exports, less imports.
Contd…
• Cost push inflation – supply side factors 1. Wage push – strong labour union activities 2. Profit push – exercise of monopoly power 3. Supply-shock – crop failures, unexpected disturbance in supply of key industrial inputs 4. Minimum wages legislation 5. Administered prices
Why worry about inflation?
• imposes significant socio-economic costs - burden of inflation is large on the poor, high inflation by itself can lead to distributional inequality. • high inflation distorts economic incentives by diverting resources away from productive investment to speculative activities. • inflation reduces households saving as they try to maintain the real value of their consumption. Consequent fall in overall investment in the economy reduces its potential growth. • if domestic inflation remains persistently higher than those of the trading partners, it affects external competitiveness. • as inflation rises beyond a threshold, it has an adverse impact on overall growth. The Reserve Bank’s current assessment suggests that the threshold level of inflation for India is in the range of 4-6 per cent. If inflation persists beyond this level, it could lower economic growth over the medium-term. These costs, therefore, necessitate monetary policy response to control inflation.
• Monetary Policy Dilemmas: Some RBI Perspectives (Comments of Dr. D. Subbarao, Governor, Reserve Bank of India at the Stern School of Business, New York University, September 26, 2011) • Monetary Policy Response to Recent Inflation in India - Speech by Deepak Mohanty, Executive Director, Reserve Bank of India, delivered at the Indian Institute of Technology (IIT), Guwahati on 3rd September 2011
Inflation in India
• Phase I. October 2009- March 2010 • Initial phases of global recession, emerging market economies (EMEs) were to be better positioned due to substantial FOREX reserves and banking sector. • But slowly spill over effects on trade, finance and expectations. • So many measures by RBI to ease monetary sector – to increase domestic and foreign liquidity • All the monetary and fiscal stimulus measures were inflationary in nature.
• The year-on-year headline WPI inflation accelerated from under 2 per cent in October 2009 to above 10 per cent by March 2010 • Reasons - severe deficiency in rainfall during 2009-10, which adversely affected the food prices, global commodity prices and fuel prices rose significantly during this period. Manufactured non-food products inflation also began to increase
• The Reserve Bank, in October 2009, highlighted the need for exit from recession-time easy monetary policy and to bring the rates back to pre-crisis period. • At the same time, monetary policy had to recognise that the economic growth was recovering from the crisis time slowdown • any aggressive monetary tightening at that point would have affected the recovery
• • • •
Phase II. April –July 2010 10% inflation Inflation from cereals, vegetables, pulses was less. But still, food inflation did not decline as price pressures were from the protein-rich items such as milk, egg, meat and fish. • The demand for these items has been growing with increasing per capita income and changing dietary patterns. • Another major contributor to increase in prices during this period was the increase in administered prices of petroleum products and deregulation of petrol prices in June 2010.
• Industrial production showed declining trend indicating “supply shock induced inflation” • So monetary policy actions were geared towards normalisation of policy rate.
• Phase III. August-November 2010 • This phase was marked by slowing down of price pressures as headline inflation declined to 8.2 per cent by November 2010 from above 10 per cent in the preceding phase. • The increase in WPI during this phase was also moderate compared to the previous two phases. Of the increase in WPI, a major part came from the primary non-food articles, mostly raw cotton and minerals.
• Phase IV. December 2010 Onwards • The moderately declining trend in inflation changed course significantly during this period: first, due to 1. Increase in food inflation as unseasonal rains in some parts of the country 2. increase in input costs • Monetary policy also had to recognise that over the long-run, high inflation is bad to sustained growth • It was indicated by the Reserve Bank that bringing down inflation, given its generalised nature, even at the cost of some growth in the short-run, should be right policy
Conclusion
• India recovered from the crisis sooner than even other emerging economies, but inflation too caught up with us sooner than elsewhere. • It was a result of both supply and demand pressures. Supply pressures due to domestic food prices and rising global prices of oil and other commodities. • The source of demand pressures was an economy with low per capita income which recovered sharply from the crisis.
Contd..
• Monetary policy – more effective to manage demand side inflation • If inflation is high, tighten monetary policy; and if inflation is low, loosen monetary policy. • But monetary policy options in the face of supply shocks are less straight forward. • liquidity injection through OMOs happened at a time when we were tightening policy rates to combat inflation. • This was to bring inflation down, and at the same time, to ensure that flow of credit for productive purposes was not choked.
unemployment
• A situation in which those who are able and willing to work at the prevailing wage rate, do not find a job. • Types 1. Frictional 2. Structural 3. Natural 4. Cyclical
Frictional
• Lack of information about the job • Cost of training • Cost of transportation in case of movement of labour • Monopoly power of trade unions Upward movement of in wages is quick but downward adjustment is slow. So uncleared labour markets
Structural
• Structural changes in the economy • Change in the sectoral composition of economy • Change in technology • Downfall or decay of certain kinds of industries
Natural
• Unavoidable • Exists even when economy has full employment
Cyclical
• Related to business cycles.
doc_982819661.pptx