Macroeconomics and Policy

The current account is that part of Balance of Payment (BOP) account which details the balance of goods and services traded with the rest of the world. The excess of imports of goods and services over their export is referred to as Current Account Deficit (CAD). Robust demand for gold and continuing high crude oil prices (which India imports a lot), along with decelerating growth in emerging and developing economies, are responsible for adversely affecting India's trade balance. High rate of inflation persisting in the economy attracts cheap imports and makes export costly in the international market. High fiscal deficit run by the government is one factor behind the high inflation.

Indian currency (INR) has depreciated close to 22% in the last 1 year. The persistent decline in rupee is a cause of concern. Factors that pushed INR into the well are: 1. Continued Global uncertainty: Owing to uncertainty prevailing in Europe and slump in international market, investors prefer to stay away from risky investments (flight to security). 2. Current Account Deficit: While a country like China will be more than happy with a depreciating currency, the same doesn't apply for India. China exports more than it imports, thus a depreciating currency makes its exports cheaper in the International market, in turn making China more competitive. 3. Capital Account flows: Deficit countries need capital flows and surplus countries generate capital outflows. India needs dollars to finance its current account deficit. 4. Persistent inflation: India has experienced high inflation, above 8%, for almost two years. If inflation becomes a prolonged one, it leads to overall worsening of economic prospects and capital outflows and eventual depreciation of the currency. 5. Interest Rate Difference: Higher real interest rates generally attract foreign investment but due to slowdown in growth there is increasing pressure on RBI to decrease the policy rates. Under such conditions foreign investors tend to stay away from investing. 6. Lack of reforms: Key policy reforms like Direct Tax Code (DTC) and Goods and Service Tax (GST) have been in the pipe line for years. A retrospective tax law (GAAR) has already earned a lot of flak from the business community.

Devaluation worsens the balance of payments when the Marshall-Lerner condition is not satisfied - i.e., when the sum of export and import demand elasticities is less than 1 (both individually less than 1 in this case). Low elasticity means devaluation increases import expenditure more than export revenue, deteriorating the trade balance. This is common for developing countries trading in essential goods.

The correct matching pairs economic concepts with their theoretical frameworks: the absorption approach analyzes the income effect of devaluations (how spending-absorption changes affect trade), the elasticity approach examines price effects (how devaluation affects trade through price competitiveness), depreciation is a direct policy tool to correct BOP disequilibrium, and S.D. Rs (Special Drawing Rights) constitute international liquidity. The absorption approach focuses on spending-income relationships while the elasticity approach focuses on relative price changes.

The correct matching links monetary theories to their proponents: Stability of money demand function is Friedman's monetarist cornerstone, Demand inflation theory is Bent Hansen's contribution (inflation from excess demand), Interest elasticity of transactions demand for cash is James Tobin's insight (transactions demand responds to interest rates), and Real balance effect (Pigou effect) is Don Patinkin's formulation (wealth effect from real money balances). These match foundational thinkers in monetary economics with their key insights.

Core inflation represents the long run trend in the price level. In measuring long run inflation, transitory price changes should be excluded. One way of accomplishing this is by excluding items frequently subject to volatile prices, like food and energy.

A temporary increase in marginal tax rates reduces the incentive to work and invest because it lowers the after-tax return on labor and capital. According to supply-side economics and neoclassical theory, this leads to lower output in the short run. The effect is particularly relevant for the marginal tax rate which affects the decision to work additional hours.

The LM curve represents money market equilibrium, showing combinations of interest rate and income where money demand equals money supply. An increase in money supply shifts the LM curve to the right because at any given income level, a lower interest rate is now needed to maintain money market equilibrium. Investment, consumption, and saving affect the goods market and thus the IS curve, not the LM curve.

The International Monetary Fund (IMF) was established with the primary mandate of ensuring international economic and financial stability. Its key functions include monitoring the global economy, providing technical assistance and training to countries, and lending to countries facing balance of payments crises to prevent financial contagion. While the IMF's work may indirectly contribute to growth and price stability, its core mission is maintaining stability in the international monetary system.

The IS curve shows the relationship between interest rates and output in the goods market. When investment is NOT interest-sensitive (IS is vertical), monetary policy cannot affect output. When IS is NOT vertical (investment IS interest-sensitive), monetary policy CAN change aggregate demand by altering interest rates. The reason correctly states that monetary policy requires interest-sensitive spending to be effective.

The Second Five Year Plan (1956-61) faced multiple crises that hampered growth: rising inflation due to increased money supply, the Suez Crisis (1956) which disrupted trade routes and increased oil prices, and rapid depletion of foreign exchange reserves from heavy imports of machinery and capital goods. The plan's ambitious industrialization targets required massive imports, draining forex reserves.

It is deflation. At the time of deflation, purchasing power of people is reduced. Hence, at that time the supply of money in the hands of public must be increased like increase in old age pension, increase in unemployment compensation etc. Thus, people will demand more as money supply increases. This will boost the economy.

It is concerned with earning profit by government by issuing currency. Seigniorage is the profit earned by the government by issuing currency. It is the profit earned on the difference between face value of currency and its production cost. For instance, if the cost of production of a ten rupee coin is 50 paisa and its face value is Rs. 10, then a profit of Rs. 9.50 is earned on it.