Macro & Micro economics Table of Contents 1.0 Article Summary 3 2.0 Introduction 3 3.0 Analysis 4 3.1 Monetary policy 4 3.2 Fiscal Policy 6 3.3 Structural growth in the economy 7 4.0 Conclusion 8 References 10 1.0 Article Summary The article by the title “India cuts interest rates for third time this year” has been published online in the BBC News on 3rd May 2013…
Structural constraints faced by the economy have also been highlighted in the economy. 2.0 Introduction The GDP growth in India has been below potential in the last financial year (2012). Real GDP in the country has grown at the rate of 6.5 percent (according to 2012 estimate) (CIA, 2013). In 2011, the rate has been 6.8 percent (CIA, 2013). Hence there has been a 0.2 percent fall in the real GDP growth. According to a report from a leading newspaper of the country, the manufacturing sector is the major factor that is pulling the country’s growth rate downwards. This sector accounts for almost 17 percent of the country’s GDP. In the third quarter of the last year, the manufacturing sector grew by a meagre 0.8 percent. While India is mainly an agrarian economy, agriculture has grown at the rate of 1.2 percent in this quarter. This is definitely a gloomy picture that suggests that the government has a role to play to push the country’s growth status. The government of India has taken expansionary monetary policy to spur economic activities in the country. 3.0 Analysis 3.1 Monetary policy In the last year (2012) the government of India had increased interest rates to control inflationary pressure since rates of consumer price inflation fluctuated around 7.5 percent in the first two quarters of 2012 (Trading Economics, 2012). However, this policy failed to reduce inflation rates to the desirable extent. The most undesirable side effect has been felt on the level of private investment activities; fresh investment (as measured by the Gross fixed capital formation (GFCF)) was found to be only 33 percent of the GDP (Choudhury, 2012). GDP forecast for FY2013-14 has been scaled down from 6.2 percent to 6 percent by international brokerage firm Barclays (Economic Times, 2013a). The government has therefore taken expansionary fiscal policy to boost up investment activities in the country. The reserve bank of India has cut interest rates by 0.25 percent in May 2013, thereby reducing the repo rate from 7.5 percent to 7.25 percent (BBC, 2013). India is the third largest country in Asia and the government has cut interest rates in order to “stimulate a fresh wave of economic growth” (BBC, 2013). This policy has been adopted in an endeavour to swell money supply in the economy. Thus banks would possess more money for lending out to borrowers (NASDAQ, 2011). Rate of interest “is the opportunity cost of holding money” (Boyes and Melvin, 2008, 339). Low interest rate can be interpreted in this way; there is little opportunity cost of holding money. Money demand has negative relationship with rate of interest (Walsh, 2003). Therefore the money demand curve has a downward slope. As interest rate shrinks quantity of money demand rises. It is illustrated by the following figure: Figure: Money demand is a negative function of rate of interest (Source: Author’s Creation) As interest rates are reduced, supply of loanable funds increase. This increases investment and consumption activities in the country. Figure: Lowering of interest rate supply of loanable funds rise (Source: Author’s Creation) Higher availability of lendable funds reduces interest rates from i1 to 12 and quantity of money demanded rises from L1 to L2. Downward trend of inflation in mid 2013 ...
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