Batch: Eco Optional Feb + June 2024 Batch

Q1
a) Assess the significance of the 'glide path' approach recommended by the NK Singh
Committee for achieving fiscal targets. How does this approach facilitate gradual
progress toward fiscal consolidation?
b) Evaluate the impact of the FRBM Act’s fiscal targets on India’s fiscal health. How
effective has the Act been in reducing the fiscal deficit and managing public debt?
c) How do the constitutional limitations and borrowing practices of states affect their
fiscal health in India? What reforms could be implemented to improve the fiscal
stability of states?
Answer
a)
The 'glide path' approach recommended by the NK Singh Committee is significant for
achieving fiscal targets as it promotes a steady and manageable progression towards fiscal
consolidation.

 The 'glide path' approach suggests making gradual changes to fiscal targets, like
reducing the fiscal deficit and debt levels slowly over time. This method helps avoid
sudden shocks to the economy and makes the process of fiscal consolidation
smoother.
 By setting small, yearly targets that become stricter over time, this approach ensures
that the goals are realistic and can be met without causing too much strain on the
economy or government services.
 Gradually adjusting fiscal policies helps keep the economy stable. Abrupt changes can
lead to economic instability, affecting growth and investor confidence. A steady
approach helps maintain a stable environment.
 Clear, staged targets make it easier for businesses and investors to plan. Knowing
what to expect in the future helps them make better decisions and supports overall
economic confidence.
 This approach allows the government to adapt its plans if unexpected economic
problems arise. Instead of having to make sudden changes, it can adjust its strategy as
needed.
 A gradual, well-planned approach shows that the government is serious about
managing its finances responsibly. This builds trust with investors and financial
institutions.
 The glide path approach focuses on improving fiscal health over the long term. By
reducing debt and deficits gradually, it ensures that public finances remain sustainable
and manageable.

Thus, the glide path approach helps in making steady, manageable progress toward fiscal
goals, ensuring stability and trust while allowing flexibility for changing economic
conditions.

b)
The Fiscal Responsibility and Budget Management (FRBM) Act of 2003 aimed to improve
India's financial health by setting clear targets for reducing fiscal deficits and managing
public debt.

The Act aimed to lower the fiscal deficit to 3% of GDP. This goal was set to narrow the gap
between the government’s spending and its income. Over time, the Act helped in reducing the
deficit from around 5.9% in 2004 to 4.5% by 2008. However, sticking strictly to the 3%
target has been difficult, especially during economic slowdowns and crises. For example, the
fiscal deficit rose to 6.8% in 2021-22 due to increased spending during the COVID-19
pandemic.

Another goal was to cut public debt to 50% of GDP. While the Act has helped in managing
public debt better than before, achieving this target has been tough. The debt-to-GDP ratio
has improved from higher levels in the early 2000s but still remains above the target due to
ongoing borrowing needs and economic pressures. The FRBM Act also brought in practices
for better financial management, such as regular reporting on fiscal performance. This has
helped in making government finances more transparent and accountable.

The FRBM Act has played a crucial role in guiding India towards better financial
management. Though it hasn’t always met its targets, it has improved fiscal discipline and
financial stability in the long run.

As such, the FRBM Act has had a positive impact on India’s fiscal health by encouraging
better management of deficits and debt, even if some targets have been challenging to meet.

c)

Constitutional constraints and state borrowing practices play a crucial role in determining the
fiscal health of Indian states. Article 293 of the Indian Constitution governs state borrowing,
stipulating that states must look for the Union government's consent for borrowing if they
have outstanding loans. This rule helps prevent excessive state debt that could destabilize
finances or impact national stability. However, it also restricts borrowing flexibility,
especially for states that have cleared their debts, potentially allowing them to take on more
debt with less oversight.

States often turn to market borrowings and Public Sector Undertakings (PSUs) for funds.
While these sources can provide immediate capital, they may bypass constitutional limits,
creating fiscal risks. For instance, using PSUs for debt can obscure the true level of state
borrowing, leading to misleading figures and potential financial instability.

High levels of state debt can harm fiscal health, increasing debt servicing costs and limiting
funds for essential services like health and education. Excessive borrowing can also impact
national economic stability by raising interest rates and contributing to financial instability.

Potential Reforms for Enhancing Fiscal Stability:

1. Incentive-Based Framework: States with improved fiscal practices could be granted

higher borrowing limits. This would encourage better financial management and
enhance overall fiscal health.
 2. Technology-Driven Monitoring: Implementing a real-time monitoring system using
AI and blockchain could improve oversight of state finances, track borrowing
patterns, and provide early warnings of potential issues.
3. Fiscal Insurance Pools: Creating a collective insurance fund based on fiscal
performance could help states manage economic shocks and reduce excessive
borrowing.
4. Cross-State Mentorship: Pairing stronger states with weaker ones for mentorship
could spread best practices in fiscal management, improving overall state fiscal
health.
5. Independent Fiscal Councils: Establishing independent bodies to review state
budgets and offer recommendations could ensure better fiscal management and
adherence to sound practices.

As such, while constitutional constraints and borrowing practices impact state finances,
reforms like incentive-based frameworks, advanced monitoring systems, and fiscal insurance
pools could significantly enhance fiscal stability.

Batch: IES July 2024 Batch

Q1. How is the rate of interest and level of income determined simultaneously in the
Keynesian IS-LM Model? Explain the condition of stability of equilibrium and policy
relevance in the IS-LM framework. (20
marks)

The IS-LM model is a graphical representation of

a Keynesian model of the macroeconomy. The
model solves for equilibrium in both the goods
market and the money market, taking certain
parameters as given. The IS line represents the
goods market, and the LM line represents the
money market.
 The IS line shows the combinations of
interest rates and levels of income that
satisfy the equilibrium condition in the
goods market, which is that planned
expenditure equals actual output. The IS
line is downward sloping because a lower
interest rate stimulates investment and
consumption, which increases real output.
 The LM line shows the combinations of interest rates and levels of income that satisfy
the equilibrium condition in the money market, which is that money demand equals
money supply. The LM line is upward sloping because a higher level of income
increases money demand, which requires a higher interest rate to equate money
supply.

The rate of interest and level of income are determined simultaneously by the intersection of
the IS and LM curves. At this combination of income and interest rates, both the goods
market and the money market are in equilibrium simultaneously.
The condition of stability of equilibrium in the IS-LM framework is that the IS curve is flatter
than the LM curve. This means that any shock that shifts either curve will cause a larger
change in output than in interest rates. This ensures that any deviation from equilibrium will
be corrected by movements along the curves rather than away from them.

Policy relevance in the IS-LM framework lies in its ability to analyse the effects of fiscal and
monetary policies on income and interest rates. The model allows policymakers to understand
how changes in government spending, taxes, or the money supply affect the equilibrium
levels of income and interest rates.

Q2: How is Expectations augmented Phillips Curve different from the original Phillips
Curve? (15
marks)

Answer

The Expectations-Augmented Phillips Curve builds on the original Phillips Curve by

incorporating the role of expectations about inflation. Here’s how they differ:

Original Phillips Curve:

The original Phillips Curve, developed by economist A.W. Phillips, shows an inverse
relationship between inflation and unemployment. It suggests that when unemployment is
low, inflation tends to be high, and vice versa.

Phillips observed this relationship in the short run based on historical data, which indicated
that policymakers could choose between higher inflation and lower unemployment or vice
versa.

Expectations-Augmented Phillips Curve:

The Expectations-Augmented Phillips Curve, introduced by economists like Milton Friedman

and Edmund Phelps, modifies the original curve by adding expectations of future inflation. It
argues that people form their expectations about inflation based on past and anticipated
inflation rates.

Unlike the original Phillips Curve, which assumed a stable trade-off between inflation and
unemployment, the Expectations-Augmented Phillips Curve recognizes that this trade-off is
only temporary. In the long run, the curve is vertical at the natural rate of unemployment.
This means that any attempt to keep unemployment below its natural rate with higher
inflation will only lead to accelerating inflation.

In this model, if inflation exceeds what people expect, unemployment can temporarily drop
below its natural rate. However, as people adjust their expectations to the higher inflation, the
short-term gains in lower unemployment are eroded, and inflation continues to rise.

Therefore, the Expectations-Augmented Phillips Curve accounts for the dynamic nature of
expectations, showing that the inflation-unemployment trade-off observed in the short run
does not hold in the long run, leading to a vertical curve at the natural rate of unemployment.
Batch: RBI DEPR March 2024 Batch

Q1. Evaluate the various Revealed Preference methods of valuation of natural

resources. What are the difficulties in measuring environmental values?

Answer

The revealed preference method infers the value of environmental goods based on actual
behaviours and choices people make. The primary techniques used under this method of
valuing natural resources are mentioned below:

Hedonic Pricing Method:

The Hedonic Pricing Method looks at how environmental factors, such as clean air or
closeness to parks, affect property prices. The basic idea is that people are willing to pay
more for properties with better environmental conditions. By comparing property prices, this
method helps show how much people value these environmental features. However, it can be
hard to separate the impact of specific environmental features from other factors that
influence property prices.

Travel Cost Method:

The Travel Cost Method estimates the value of recreational sites by looking at how much
people spend to travel there. By analysing travel expenses, this method helps gauge how
much people value visiting these sites. It works well for places with clear patterns of
visitation, such as popular parks or beaches. However, it assumes that travel costs are the
main factor influencing the decision to visit, which might ignore other factors like personal
preferences or opportunity costs. This can sometimes limit the accuracy of the valuation.

Averting Behaviour Method:

The Averting Behaviour Method measures the value of environmental improvements by

looking at how much people spend to avoid environmental harm. For example, it might
analyse how much individuals invest in air filters to reduce pollution in their homes. This
method shows how much people are willing to spend to protect themselves from
environmental risks. However, it can be challenging to link these expenditures directly to
specific environmental improvements, and it might assume that all spending is solely driven
by environmental concerns, without considering other factors that might influence people's
spending decision.

Difficulties in Measuring Environmental Values:

 Obtaining accurate data on behaviours, expenditures, and environmental conditions

can be tough. For example, property data might not always capture environmental
attributes precisely.
 It is hard to separate the impact of environmental attributes from other factors
influencing market prices or behaviours.
 Methods may not fully capture all personal motivations or preferences, such as
opportunity costs in travel cost methods.
  Revealed Preference methods often struggle to value non-market aspects like cultural
significance or intrinsic value.
 Changing economic conditions and social behaviours can affect the accuracy and
relevance of valuation methods over time.

Batch: RBI DEPR July 2024 Batch

Q1.