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Questions and Answers
What was the fiscal deficit for the Central government in India in the year 2007–08?
Which economic theory did the expansionary fiscal policy that aims to reduce unemployment originate from?
What was the average GDP growth rate during the fiscal years 2009–10 and 2010–11?
How much did the income generation amount to in total after the tax cut when following the geometric series?
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What was the initial reduction in taxes that led to subsequent income generation of Rs 233.33?
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Which factor contributed to the sudden fall in GDP growth to 4.93 percent in the year after 2007-08?
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What is a potential negative effect of high fiscal deficits as mentioned in the content?
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How much was the service tax reduced from and to during the period discussed?
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What is indicated by a recession in economic terms?
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What phenomenon commonly leads firms to exercise caution during economic downturns?
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Which of the following events significantly jolted the economic world in 2001?
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According to Keynes, what were 'animal spirits' essential for?
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What main issue contributed to the downturn of the US GDP by 2.67 percent in 2008?
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Which situation most directly indicates a lack of demand leading to a recession?
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What was one factor that affected the debt crisis in Greece?
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Which term does Keynes use to refer to the optimism that drives economic activity?
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What is the income multiplier effect observed in an expansionary fiscal policy scenario?
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Which fiscal policy action is implemented during a recession to boost the economy?
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What percentage of their income do individuals typically save in the given government spending scenario?
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Which term describes the GDP level that corresponds with the natural rate of unemployment?
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In the example, how much does the first round of spending amount to after government hires workers for Rs 100?
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What happens to GDP as a result of the geometric series of spending initiated by government employment?
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Which of the following accurately describes the government's role in fiscal policy during high unemployment?
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What would be the impact of a Rs 100 tax reduction on spending in the first round according to the information provided?
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What impact did lowering the repo rate have on the availability of loans?
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What was one reason for the surge in subprime loans in the early 2000s?
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How did the burst of the housing bubble primarily affect borrowers?
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Which factor contributed to the drop in India's GDP growth during the global recession?
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What fiscal policy action did the Indian government take to combat the recession?
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What does monetary policy primarily manage according to the provided content?
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What was a direct consequence of the increased demand for US dollars during the financial crisis?
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What effect did the response of the RBI to the economic downturn have on domestic investment?
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What is the main purpose of expansionary monetary policy?
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What economic condition characterizes stagflation?
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What action did the RBI take in response to double-digit inflation in 2011?
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During which economic period did India experience a drop in GDP growth rate from 9.82 to 4.93?
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Which of the following was a contributing factor to weakened business confidence in India during 2011?
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What characterizes an overheated economy?
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What policy action is typically taken when the economy is suffering from deficient demand?
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Which of the following best describes the 'cost-push inflation' referenced in the context of stagflation?
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Quits in the job market are considered pro-cyclical while firings are regarded as pro-cyclical.
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Cyclical unemployment is connected to long-term structural changes in the economy.
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Higher education applications tend to increase during recessionary periods as graduates seek skill enhancement.
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The data on unemployment in India is collected and published annually.
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Animal spirits in the economic context refer to the pessimism that dampens business investments.
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Pro-cyclical and counter-cyclical factors refer to the same economic trends during the business cycle.
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Fiscal policy is utilized by the government to mitigate unemployment and stabilize the economy during downturns.
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The concept of 'negative externality' in society is not related to unemployment.
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Stagflation involves promoting GDP growth without sacrificing inflation.
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Higher interest rates on working capital loans are implemented by the RBI to combat food price inflation.
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One of the proposed policies to handle stagflation includes the introduction of a single GST to remove tax-on-tax effects.
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Public sector undertakings should be disinvested to lower operational efficiency and budget deficits.
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Corruption and scam cases should be addressed to boost the animal spirits of consumers and producers.
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The policies for handling stagflation emphasize creating barriers to private competition in agricultural markets.
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Regularly publishing unemployment rates can assist in better assessing the economic situation.
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The overall aim of specific policies during stagflation is to ease supply constraints to reduce cost-push inflation.
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Cyclical unemployment is solely caused by seasonal changes in employment.
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The Great Depression experienced a decline in GDP, employment, and prices by about 25 percent in the US between 1929 and 1933.
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Frictional unemployment occurs when workers are actively seeking jobs but cannot find one.
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Animal spirits, as described by John Maynard Keynes, refer to the pessimism and caution among businesses.
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Structural unemployment is an element of natural unemployment that results from long-term changes in the economy.
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Fiscal policy aims to control inflation through the manipulation of interest rates by the central bank.
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Depression is defined as a milder form of recession.
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Monetary policy is primarily concerned with government spending and taxation.
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Lowering the repo rate results in a decrease in money supply and availability of loans.
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The subprime crisis did not affect global stock prices.
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India's GDP growth dropped to 4.93 percent due to a recession in the US and Europe.
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Fannie Mae and Freddie Mac sold subprime loan assets only within the United States.
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After 2008, the Indian government adopted a contractionary fiscal policy.
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The average GDP growth rate in India reached approximately 9 percent in the years following the recession.
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A sudden fall in the availability of credit is primarily caused by a rise in repo rates.
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During the financial crisis, the depreciation of the rupee made Indian exports easier.
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The geometric series for income generation after tax cuts resulted in a total of Rs 233.33.
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Expansionary fiscal policy led to a reduction in GDP growth in India during the years following 2007-08.
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The income expansion through a tax cut is equal to the original reduction in taxes.
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The fiscal deficit for the Central government in India was higher in 2008-09 compared to 2007-08.
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Excise duties in India were reduced from approximately 14 percent to 10 percent during the discussed period.
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Expansionary fiscal policy, as proposed by Keynes, suggests increasing government spending to combat unemployment during recessions.
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The subprime crisis had no effect on India's GDP growth rate in 2008-09.
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High fiscal deficits are beneficial as they prevent crowding-out of private investments.
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The income expansion through a tax cut is lower by Rs 100, as the government does not spend Rs ______ in the very first round.
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In the year 2007–08, the GDP growth rate in India was ______ percent.
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The GDP growth rate fell to ______ percent in the year after 2007–08 due to external economic factors.
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Fiscal deficits for the Indian government reached ______ percent in the years 2008–09 and 2009–10.
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Keynes's revolutionary idea of expansionary fiscal policy aimed to reduce ______ during a recession.
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The Indian government reduced excise duties from a high of about ______ percent to 8 percent.
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The expansionary fiscal policy resulted in a fiscal deficit amounting to ______ percent.
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Accumulated fiscal deficits could lead governments to high ______.
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The business cycle refers to fluctuations in economic activity characterized by periods of economic ______.
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The negative growth rate in 1972–73 can be attributed to the war that created ______.
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War creates uncertainty and fear, prompting businesses to hold back on new ______ plans.
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The biggest trough in GDP growth occurred during the oil shock in the fiscal year ______.
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The devaluation of the Indian rupee by about 20 percent occurred in ______.
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In times of war, consumers often defer major purchases of consumer durables and ______.
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The fiscal year 1966–67 experienced a negative GDP growth rate of about ______ percent.
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The ______ policy refers to a government's approach to managing economic fluctuations through spending and taxation.
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RBI engages in an OMO to buy government ______ from the market.
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The repurchase price in a repo agreement is ______ than the selling price.
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The interest rate derived from a repo agreement is known as the ______ rate.
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OMO-purchase of government securities by RBI leads to a fall in the market ______ rate.
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RBI has created a new and popular window for commercial banks called ______.
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An increase in the demand for government securities raises their ______.
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When RBI buys securities, it results in cash flowing into the ______ sector.
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A fall in the price of a security implies a rise in its ______ rate.
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Animal Spirits refer to spontaneous optimism and urge to action among ______.
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Cyclical Unemployment is associated with the ______ cycle.
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A severe form of recession is referred to as ______.
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Fiscal Policy is the government's approach to alter its ______ or taxes.
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Monetary Policy involves changing the money supply to affect ______, employment, and inflation.
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Involuntary Unemployment occurs when individuals actively seek jobs at given ______ rates.
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Natural Unemployment consists of the frictional and structural ______ types.
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The term 'Booms and Bust' describes the ______ cycles in an economy.
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Handling stagflation involves promoting GDP growth and reducing ______.
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Fiscal and monetary policies offer a trade-off between growth and ______.
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A significant step in handling stagflation is to ease supply constraints to reduce cost–push ______.
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Introducing a single ______ aims to remove tax-on-tax and mitigate price rises.
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Expediting the disinvestment of public sector ______ aims to promote operational efficiency.
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Private competition against monopolistic ______ markets is encouraged to improve agricultural trade.
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The RBI engages in selective credit control to ______ food price inflation.
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Improving output delivery of MGNREGS increases not only employment but also agricultural ______.
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Study Notes
Fiscal Policy Explained
- Expansionary fiscal policy boosts GDP by increasing government spending or reducing taxes.
- Tax cuts generate income expansion in multiples of the initial reduction, but the government misses out on the initial amount.
- High fiscal deficits can crowd out private investment and increase both trade and government debt.
Examples from India
- In 2007-08, India experienced a 9.82% GDP growth rate with a 2.5% fiscal deficit.
- The 2008-09 fiscal deficit increased to 6% due to expansionary fiscal policy measures like increased spending on MGNREGS, highway projects, and the Sixth Pay Commission, as well as tax cuts.
- This expansionary policy helped India recover from the 2008 subprime crisis, which caused a 4.93% GDP growth rate in 2008-09.
- The Indian government's expansionary fiscal policy and the Reserve Bank of India's expansionary monetary policy (lowering the repo rate) helped boost the economy, resulting in an average 9% GDP growth rate in 2009-10 and 2010-11.
The Subprime Crisis and its Impacts
- The subprime crisis was triggered by low interest rates in the US, which led to risky loans being granted to borrowers with poor credit histories.
- These loans were packaged into mortgage-backed securities (MBS) and sold to foreign investors, creating a housing bubble.
- When the bubble burst, borrowers defaulted, leading to massive losses for banks and investors.
- The impact on India included a decline in stock prices, a depreciation of the rupee, and a decline in exports.
- The recession in the US and Europe further dampened business confidence in India, leading to a decrease in production and investment.
Recession and Stagflation
- A recession occurs when GDP falls for two consecutive quarters.
- Recessions are often caused by insufficient demand for goods and services, leading to inventory buildup and reduced production.
- Stagflation is a combination of inflation and unemployment, which occurred in India in 2011 due to cost-push inflation and deficient demand.
Keynesian Economics
- John Maynard Keynes believed that economic activity is driven by "animal spirits," a type of confidence in future prospects.
- When animal spirits are dimmed, demand for goods and services falls, leading to a recession.
- Keynes advocated for expansionary fiscal policy to counter recessions and stimulate demand.
Monetary Policy
- Monetary policy manages interest rates, money supply, and credit availability.
- Expansionary monetary policy aims to boost economic growth by lowering interest rates and increasing money supply.
- Expansionary monetary policy has been used by central banks worldwide, including the Reserve Bank of India, to combat recessions.
Inflation
- Inflation is a general increase in prices.
- Cost-push inflation occurs when production costs rise, leading to higher prices.
- High levels of inflation can erode purchasing power and hurt economic growth.
Unemployment
- Unemployment occurs when people who are actively seeking work cannot find jobs.
- The natural rate of unemployment is the level of unemployment that exists even when an economy is at full employment.
- High unemployment indicates a lack of demand for labor, which can have a negative impact on economic growth.
Fiscal Policy
- Impact of Tax Cuts: A tax cut of Rs. 100 can generate income in successive rounds, totaling Rs. 233.33, which is 2.33 times the initial reduction.
- Government Spending: When the government cuts taxes, initial spending does not increase by the full amount of the tax cut, as the government itself does not spend the initial Rs. 100.
- Expansionary Fiscal Policy: This tool can stimulate GDP growth by multiplying the initial spending or tax cut effect.
- Indian Fiscal Policy, 2007-2011: India witnessed a fiscal deficit of 2.5 percent in 2007-08, with a GDP growth rate of 9.82 percent. However, the following year, the GDP growth rate fell to 4.93 percent due to the global subprime crisis.
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Government Measures in Response to the Crisis: To counter the recession, India employed expansionary fiscal policies, including:
- Increasing spending on MGNREGS, highway projects, and Sixth Pay Commission disbursements.
- Reducing excise duties from 14 percent to 8 percent.
- Lowering service tax from 12 percent to 10 percent.
- Impact of Expansionary Fiscal Policy: The expansionary fiscal policy led to fiscal deficits of 6 percent and 6.3 percent in 2008-09 and 2009-10, respectively. However, it helped boost the GDP growth rate back to an average of 9 percent in 2009-10 and 2010-11.
- Keynesian Economics: John Maynard Keynes advocated for expansionary fiscal policy as a method to reduce unemployment and increase demand during a recessionary period.
- Limits of Fiscal Policy: There are limits to how much government can spend or cut taxes. Excessive expansion can lead to high fiscal deficits, which can crowd out private investments, increase trade deficits, and lead to government indebtedness.
Business Cycles and Unemployment
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Procyclical and Countercyclical Factors:
- Job Quits: Job quits increase during economic booms (procyclical) and decrease during recessions.
- Job Firings: Job firings increase during economic downturns (countercyclical) and decrease during booms.
- Demand for Higher Education: Demand for higher education tends to be countercyclical, as individuals facing job losses may seek skill enhancement opportunities.
Unemployment
- US vs. India Unemployment Data: The United States has been calculating monthly unemployment rates since 1940, while India only provides data every five years.
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Methods of Measuring Unemployment in India: The Indian government uses three approaches:
- Usual Principal Status (UPS) - Most liberal approach.
- Current Weekly Status (CWS)
- Current Daily Status (CDS) - Most stringent approach.
- Government Intervention in Unemployment: Government intervention is needed to address unemployment issues through fiscal policy (government spending and taxation) and monetary policy (central bank actions).
Subprime Crisis and its Impact on India
- Low US Interest Rates: Low interest rates in the US from 2001 to 2005 encouraged the granting of loans to subprime borrowers (those with poor credit history).
- Real Estate Bubble: High real estate prices and the use of these assets as collateral against loans fueled the bubble.
- Securitization: Banks sold these subprime loans to government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac.
- Repackaging and Sale of Mortgage-Backed Securities (MBS): GSEs repackaged these loans into MBS with higher credit ratings, which were sold to foreign investors.
- Housing Bubble Burst: The housing bubble burst, leading to price declines, interest rate increases, loan defaults, and foreclosures.
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Impact on India: The crisis triggered a global selloff of investments, including those in India.
- Stock prices plummeted across the globe.
- The rupee depreciated, making exports difficult.
- India's exports declined due to recession in the US and Europe.
- Business confidence in India faltered, leading to decreased production and investment.
- Indian Government Response: India countered this recession with expansionary fiscal policies (cutting excise duty and service tax) and RBI's expansionary monetary policy (lowering repo rates), boosting domestic investment projects.
- Economic Recovery in India: The Indian economy rebounded in the following two years with an average GDP growth rate of 9 percent.
Monetary Policy
- Monetary Policy Objectives: Monetary policy involves managing market interest rates, controlling the money supply, and regulating credit availability.
- Impact of Monetary Policy on GDP: Monetary policy can influence GDP growth. Lowering interest rates can stimulate economic activity.
Stagflation
- Handling Stagflation: Managing stagflation (stagnant economic growth combined with inflation) is a complex problem, as fiscal and monetary policies often involve a tradeoff between growth and controlling inflation.
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Strategies for Addressing Stagflation: To combat stagflation, specific policies can be implemented to address supply constraints and boost economic confidence:
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Reducing Supply Constraints:
- Allowing multibrand foreign direct investment (FDI) in the retail sector.
- Introducing a goods and services tax (GST) to eliminate cascading taxes.
- Promoting operational efficiency through public sector undertaking divestment.
- Expediting corruption investigations.
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Boosting Confidence and Economic Reform:
- Publishing regular unemployment rates for better economic assessment.
- Promoting competition in agricultural markets.
- Implementing selective credit control to curb food price inflation.
- Improving MGNREGS output delivery for enhanced agricultural productivity.
- Introducing new agricultural technologies, infrastructure development, and lowering customs duties.
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Reducing Supply Constraints:
Definitions
- Animal Spirits: Spontaneous optimism and eagerness to invest, influenced by socio-economic and political factors.
- Booms and Bust: Cycles of high growth and low or negative growth in the economy.
- Business Cycle: Fluctuations in the economy, characterized by periods of expansion and contraction.
- Cyclical Unemployment: Unemployment linked to economic booms and busts.
- Depression: A severe economic downturn with significant decline in GDP, employment, and prices.
- Fiscal Policy: Government actions to regulate spending and taxation to influence economic variables.
- Frictional Unemployment: Temporary unemployment resulting from job transitions or skill mismatch.
- Involuntary Unemployment: Individuals actively seeking employment but unable to find jobs at prevailing wage rates.
- Labor Force: People who are employed or actively seeking employment.
- Monetary Policy: Actions taken by a central bank to control the money supply and interest rates for economic regulation.
- Natural Unemployment: The combination of frictional and structural unemployment, representing a normal level of unemployment in an economy.
Business Cycle
- Free market economies experience periods of growth and decline, known as the business cycle.
- The business cycle is illustrated by fluctuations in GDP growth rates.
- Wars can drastically affect the economy due to uncertainty and fear, leading to a decline in investment and consumer spending.
- The oil shock of 1979-80, caused by the Iranian revolution and price hikes by OPEC, resulted in a significant drop in GDP growth due to a shortage of crude oil.
- The Indian economy experienced a bleak period in 1991, leading to a devaluation of the Indian rupee by 20%.
Monetary Policy Tools
- Open Market Operation (OMO): The Reserve Bank of India (RBI) can buy or sell government securities to influence the money supply.
- Buying government securities increases the money supply, leading to a decrease in market interest rates.
- Repo rate: The interest rate at which banks can borrow money from the RBI for short-term purposes.
- The repo rate is a key tool used by the RBI to manage monetary policy.
Fiscal Policy
- Expansionary fiscal policy: The government can stimulate the economy by increasing spending or reducing taxes.
- Expansionary fiscal policy can lead to a higher fiscal deficit, which could crowd out private investments and worsen the trade deficit.
- The Indian Government used expansionary fiscal policy in 2008-09 and 2009-10, specifically by increasing spending on MGNREGS, highway projects, and the Sixth Pay Commission, and reducing excise and service tax rates.
GDP Growth and Fiscal Deficit
- In 2007-08, India's fiscal deficit was 2.5% and GDP growth was 9.82%.
- The global financial crisis of 2008 led to a significant decline in GDP growth to 4.93% in 2008-09.
- India's expansionary fiscal policy in the following years helped to stimulate the economy, leading to an average GDP growth of ~9% in 2009-10 and 2010-11.
Stagflation
- Stagflation occurs when an economy experiences both high inflation and slow economic growth.
- Policies to address stagflation need to tackle both supply constraints and demand issues.
- Key policy recommendations include:
- Allowing FDI in the retail sector to reduce middlemen costs and price inflation.
- Implement a single Goods and Services Tax (GST) to simplify the tax system and reduce price rises.
- Expedite the disinvestment of public sector undertakings to improve efficiency and lower budget deficits.
- Fast-track handling of corruption cases to restore confidence in the market.
- Regularly publish unemployment rates to better assess the economic situation.
- Promote private competition in agricultural markets to lower food prices.
- Use selective credit control to discourage hoarding of food and control food price inflation.
- Improve the output delivery of MGNREGS to increase not only employment but also agricultural productivity.
- Introduce new technology into agriculture, such as genetically modified foods, to increase food production.
Definitions
- Animal Spirits: Refers to the confidence and optimism of businesses, which influences investment and economic activity.
- Booms and Bust: Describes the cyclical nature of business cycles, with periods of high growth and low growth.
- Cyclical Unemployment: Unemployment that rises during periods of economic decline and falls during periods of expansion.
- Depression: A severe economic recession, characterized by sharp declines in GDP, employment, and prices.
- Fiscal Policy: Government actions, such as spending and taxation, used to influence the economy.
- Frictional Unemployment: Temporary unemployment experienced by individuals between jobs.
- Involuntary Unemployment: Occurs when individuals are actively seeking jobs but cannot find one.
- Labour Force: Includes both employed and involuntarily unemployed individuals.
- Monetary Policy: Actions by a central bank, such as changing interest rates and adjusting the money supply, to influence the economy.
- Natural Unemployment: The level of unemployment that exists when the economy is at full employment, including frictional and structural unemployment.
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Description
Explore the implications of expansionary fiscal policy and its effect on India's GDP growth. This quiz examines key examples from the 2008 financial crisis period, highlighting the government's strategies and their economic impact. Test your understanding of fiscal policies and their role in economic recovery.
