Macroeconomics

Introduction (Unit 1 Part A)

BMS 2020
 Topics
Unit I: A: Introduction to macroeconomics
• Major Macroeconomic Issues
• Macroeconomic Stability and Business
Environment
• Major Schools of thought in Macroeconomics
 Unit I
Part B: Measurement of macroeconomic
variables:
• National Income Accounts, Gross Domestic
Product, National Income,
• Personal and Personal disposable income;
• National income identities , Macroeconomic
variables in the Indian Context (15 lecture )
Major Macroeconomic Issues
• What determine overall level of
output and employment?
• How cab business cycle be
controlled?
• How can inflation be controlled?
• Understanding International
Interdependence;
• What Makes the economy grow over
time?;
 Overall level of Output and
Employment
• A nation’s well-being depends on the
quantity of goods and services
available to the citizens for
consumption;
• More production goes hand in hand with
more employment of factors of
production;
• So it is of great importance to
identify the factors that determine the
level of production in an economy;
 Business Cycle
• There is fluctuation in aggregative
economic activity all over the world;
• Fluctuations implies episodes of boom
(rising output and falling
unemployment) alternating with
recession (production falls with rise
in unemployment); eg. Post reform India
• Major task is to eliminate or minimize
fluctuations => stabilization policy;
 How can we control Inflation?

• Sustained increase in price level overtime;

• Inflation affects standard of living by
reducing the purchasing power;
• Hyperinflation – Price rises to astronomical
levels within very short period (Germany
right after the WW II, Bolivia during early
1980s);
• Inflation makes poor much more vulnerable;
• Therefore keeping the general price in
control is one of the most important economic
responsibility of the national governments;
 International Interdependence
• Forces of globalization of markets
production and consumption increases
interdependence among nations;
• Economy in isolation is no longer a
valid option in international business;
• Greater integration of economies has
opened up new opportunities for DCs to
get efficient technology and
information;
• Integration increases the risk of
exposure through exchange rate
fluctuation;
 What makes an economy grow
overtime?
• Aggregate volume of production in an
economy is the principal determinant of
economic growth;
• Sustained in standard of living is
possible only if the economy is able to
raise the quantum of its production
steadily overtime;
• How to achieve this difficult task is
the central concern;
 Is it possible to achieve high growth?

• Japan caught up with the affluent industrial

countries of the west through sustained
growth at high rate over a quarter century
after the Second World War;

• Similar experience for Hong Kong, South

Korea, Singapore, and Taiwan;

• Recently high rate of growth has enabled

China to launch a successful attack on the
problem of pervasive poverty;
 Since growth is so important…

Economists have devoted considerable

effort over the years:
• to identify the conditions that are
conductive for sustained long term
growth;

• To advise governments in the developing

countries on policies that will lead to
the fulfillment of the conditions;
Macroeconomic Stability
• The term "Macroeconomic Stability"
describes a national economy that has
minimized vulnerability to external
shocks, which in turn increases its
prospects for sustained growth;
 Macroeconomic Stability
• Macroeconomic stability acts as a
buffer against currency and interest
fluctuations in the global market;
• It is a necessary, but insufficient
requirement for growth;
• Exposure to currency fluctuations,
large debt burdens, and unmanaged
inflation can cause economic crises and
collapse in GDP.
 Macroeconomic stability
• Both the IMF and the EU place an
emphasis on macroeconomic
stability;
• According to the Maastricht
criteria, stability is measured by
five variables.

(Maastricht criteria: The Treaty on EU, The

macroeconomic criteria required of all member
nations have come to be known as the
Maastricht Criteria)
 Macroeconomic Stability

• High performing countries - Good

macroeconomic management for economic
development and growth
• Stable and predictable macroeconomic
environment and getting macroeconomic
instruments right;
• Induce private sector to invest
successfully in physical and human
capital formation;
 Stability is measured by 5 variables

1. Low and stable inflation indicates healthy

demand in the marketplace; however, high or
unstable inflation threaten growth.
• High inflation alters the value of long term
contracts.
• Volatile inflation creates uncertainty in the
market place, increasing risk premiums.
• Since many tax rates are adjusted by average
inflation, volatile inflation can severely
alter government revenues and individual
liabilities.
• The Maastricht criteria capped inflation at
3%.
 2.Low long-term interest rates

• Low long-term interest rates reflect

stable future inflation expectations.
• While current inflation rates may be
acceptably low, high long-term rates
imply higher inflation to come.
• Keeping these rates low implies that
the economy is stable and is likely to
remain so.
• The Maastricht criteria restricted
long-term rates to the range of 9%.
3. Low national debt relative to GDP

• Low national debt relative to

GDP indicates that the government will
have the flexibility to use its tax
revenue to address domestic needs
instead of paying foreign creditors.
• low national debt permits lenient
fiscal policy in times of crisis.
• The Maastricht criteria capped debt at
60% of GDP.
4. Low deficits prevent growth in the national
debt.
• The Maastricht criteria capped the deficit at
3% of GDP.

5. Currency stability allows importers and

exporters to develop long-term growth
strategies and in reduces investors' needs to
manage exchange-rate risk.
• For national accounting, currency stability
reduces the threat posed by debt issue in
foreign coin.
• The Maastricht criteria permitted fluctuation
of at most 2.5%.
 Instability
• A chaotic economic situation riddled
with uncertainty hamper growth by
discouraging long term investment;
• Reduce incentives for economic agents
to strive for improvement in
productivity;
• Because return from costly investment
and productivity enhancement effects
become highly uncertain;
• Can be extremely damaging in the long
run prospect of an economy;
Symptoms of Macroeconomic Instability

• Excessive and Ill designed Government

Intervention;

• High Inflation;

• Fiscal Insolvency

• Financial Fragility

• Exchange rate management

Excessive Ill Defined Government Intervention
• Government set the rules/policies which abide
by all the private players, on which
individual players act. These policies exert
a very powerful influence on country’s
economic performance;

• Bureaucratic intervention when carried to

excess, has shown a tendency to turn
counterproductive and harm nation’s interest
by reducing the profitability of private
business projects;

• Example : India before 1991

 High Inflation
• When the prices are rising
continuously, cost benefit analysis
becomes difficult and as a result
private investors will postpone their
investment decision;
• Demand and supply decision gets
adversely affected;
• Government in most countries intervene
with policies to control inflation
 Fiscal Insolvency
• Persistent budget deficit
• Public debt keeps piling up;
• The financial solvency of the
government is threatened
• Fiscal burden increases
 Financial Fragility
• Development of financial Sector leads
to economic growth;

• Inefficiently functioning financial

market affects growth adversely as it
fails to channelize savings to
investment;

• Magnify macroeconomic business cycles

Thank You