Macroeconomic Problems

BySudarshan Kadariya

JMC

Discussion

• Capital goods are allocated incorrectly

• Capital investments are inappropriate

• Labor is misallocated, thus,

• As a result, the economy underperformed from the point of view of realizing the mutual gains from exchange, employing resources efficiently, and satisfying the demands of consumer sovereignty.

Macroeconomic Problems

Inflation• Inflation is a rise in the general level of prices of

goods and services in an economy over a period of time.

• When the general price level rises, each unit of currency buys fewer goods and services i.e. an erosion in the purchasing power of money.

• The current rate of inflation 8.8% (as of Jestha 2068) as disclosed by NRB.

• Demand pull inflation: Increase in price level due to excess demand over supply

• Cost push inflation: Increase in price level due to rise in cost of production

• Effects on production activities

• Effect on output and employment

• Effects on economic growth

• Effects on distribution of wealth

In sum, moderate level of inflation is boon for the economic growth (contradictory views) but, the excess level of inflation/hyper inflation is economically unsound, politically dangerous, and moral disastrous.

Measures of Inflation

• Basically, inflation occurs due to the excessive supply of money, excessive expenditure and scarcity of goods.

• Thus, the measures of inflation focus on reducing the supply of money, optimizing the expenditure, and increasing level of level of production

Tools of measuring inflation• Monetary measures: CRR, SLR, interest rate, open market

operation, etc

• Fiscal measures: Budgetary measures – reduction of govt. expenditure, imposition of taxes, public borrowings, etc

• Income policy: Wage policy with consideration of trade unions because wages have cyclical effects on all the economic activities in the economy.

• Other measures: Increase in level of production, direct price control, quota, etc

Issues:

What’s the effect of inflation on GDP?(Increase, decrease, stable ???)

Discuss the role of current price hike on petroleum products on inflation & GDP?(Inflation & GDP – increase, decrease, stable ???)

Year Inflation GDP Growth rate Year Inflation GDP Growth rate1980 9.8 -2.32 1995 7.68 3.471981 13.45 8.34 1996 7.18 5.341982 10.38 3.78 1997 8.1 5.261983 14.2 -2.98 1998 8.33 2.941984 6.21 9.68 1999 11.38 4.481985 4.13 6.15 2000 3.39 6.121986 15.85 4.57 2001 2.44 5.631987 13.29 1.7 2002 2.9 0.121988 11.02 7.7 2003 4.74 3.951989 8.08 4.33 2004 3.96 4.681990 8.93 4.64 2005 4.54 3.481991 7.94 6.37 2006 7.96 3.371992 21.06 4.11 2007 6.2 3.411993 8.87 3.85 2008 6.69 6.111994 8.95 8.22 2009 12.63 4.411995 7.68 3.47 2010 9.56 4.551996 7.18 5.34

Correlation coefficient between GDP Growth rate and Inflation is -0.14 which shows that there is significant (p = 0.45) negative relationship between the variables.

Is there any single measure sufficient to curve the inflationary pressure?

• Of course not!

• No one measure is sufficient to control the inflation.

• Both the monetary and fiscal measures are prime to curve the inflationary problems. Along with, the income policy and the other measures are equally important.

What is the solution to these problems?

• Classical– Market discipline/regulated market

• Keynesian– Government correctives• Fiscal policy• Mix of fiscal and monetary policy

• After Keynes– Market equilibrium

Terms to be noted: Liquidity trap & Crowding out

• Keynesian World View: Liquidity trap makes monetary policy ineffective

• Monetarist World View: Crowding out makes fiscal policy ineffective

Business Cycle

• Business cycle: The recurring and fluctuating levels of economic activity that an economy experiences over a long period of time (?).

• The five stages of the business cycle are growth (expansion), peak, recession (contraction), trough and recovery.

• At one time, business cycles were thought to be extremely regular, with predictable durations, but today they are widely believed to be irregular, varying in frequency, magnitude and duration.

• Since the World War II, most business cycles have lasted three to five years from peak to peak.

• The average duration of an expansion is 44.8 months and the average duration of a recession is 11 months.

• As a comparison, the Great Depression - which saw a decline in economic activity from 1929 to 1933 - lasted 43 months.

Note: these data are based on US economy

• Expansion: The phase of the business cycle when the economy moves from a trough to a peak. It is a period when business activity surges and gross domestic product expands until it reaches a peak. Also known as an "economic recovery".

• Peak: The highest point between the end of an economic expansion and the start of a contraction in a business cycle.

• Recession: A period in which real output falls for 6 months or more.

• A significant decline in activity across the economy, lasting longer than a few months. It is visible in industrial production, employment, real income and wholesale-retail trade.

• The technical indicator of a recession is two consecutive quarters of negative economic growth as measured by a country's gross domestic product (GDP).

• Depression: Recession merges into depression when there is a general decline in economic activity. There is a considerable reduction of output, employment, income, demand and price.

• A severe and prolonged recession characterized by inefficient economic productivity, high unemployment and falling price levels.

USA

• Trough: The stage of the economy's business cycle that marks the end of a period of declining business activity and the transition to expansion.

Recovery: A period of renewed growth of real output following a recession.

A period of increasing business activity signaling the end of a recession. Much like a recession, an economic recovery is not always easy to recognize until at least several months after it has begun.

Economists use a variety of indicators, including GDP, inflation, financial markets and unemployment to analyze the state of the economy and determine whether a recovery is in progress.

Some loopholes of Business Cycle• Do you identify the periods of business cycle? i.e.

growth to growth, recovery to recovery, peak to peak, etc

• Does the cycle follow the consistent phases? i.e. Recovery – peak – recession – trough – recovery.

• Would it be possible to jump from one phase to other?

• Do you identify the starting period of each phases of business cycle?, etc

Thank you