Macroeconomic Transmission Mechanism Essay Example for Free

Macroeconomic contagious disease Mechanism EssayMacroeconomic Transmission Mechanism of International Oil Price Rise The Indian Situation In this Article, an effort has been make to trace the impact of an make up in outside(a) petroleum prices on Indian deli real outlining the divers(a) transmission mechanisms. These transmission mechanisms take into sexual conquest some of the important macroeconomic relationships, as relevant to the Indian context, and the administered nature of internal rock embrocate color price in India. The three broad channels through which the internationalist oil prices impact the macroeconomy are identified as the(a) Import channel,(b) Price channel and(c) The fiscal channel. (a) A rise in international price of oil will translate to higher import handbill for oil for the net oil importing countries resembling India (see, Table 1 and 2). Under the reasonable supposition of low price picnic of demand for oil, ceteris paribus, the trade en d will worsen due to an increase in international oil price. Rise in inflation due to increase in oil prices means that the growth in real GDP is even lower. The compression in aggregate domestic demand dampens growth. In figure 1, the import channel is indicated by the radio link from international oil prices to incumbent account balance to nominal GDP. Although managed float, the nominal ex mixed bag rate in India is observed to be resolute solely by the capital account and not by the current account in the pass on Indian context.The second order adjustment to higher import bill and worsened trade balance gets only through contraction in aggregate demand and decline in imports and it does not occur through movements in ex trade rate (depreciation). Finally, it is expected that the slowdown in economic growth would later reduce the demand for imports which, in turn, would partially mitigate the adverse impact of high international oil prices on trade balance. (b) The price ch annel links the international prices to domestic inflation. For a typical developing country like India facing an oil price hike in the international market, an unhindered pass-through of oil price increase leads to a jump in the general price level on account of direct use of oil at higher prices plus increase in costs of toil of final goods using oil as an input. Modelling the passthrough of oil prices through an input-output system, Jha and Mundle (1987) estimated that in India if the administered prices of crude oil, splosh and petroleum products increase by 7 percent, the overall WPI increases by 1 percent (i.e. the total elasticity to be 0.14).Recently the Reserve Bank of India (2011) has estimated that every 10 percent increase in ball-shaped crude prices, if fully passed through to domestic prices, could have a direct impact of 1 persona point increase in overall WPI inflation and the total impact could be about 2 percentage points over time as input cost increases tran slate to higher output prices across sectors. Greater the share of fuel in total consumption basket, larger would be the influence of international commodity prices on inflation. (see, Table 2 for other empirical studies relating to India) In India, a large affinity of the international oil price increase has traditionally been absorbed by the government (and shared with cosmos sector oil producing and retailing companies).The objectives for regulation of price of oil have been three-fold (a) To protect the domestic economy from volatility in international oil prices . (b) To provide merit goods to all households, e.g., clean cooking fuels like LPG, natu ral gas and kerosene to replace use of biomass-based fuels such as firewood and dung and (c) To protect poor consumers so that they may obtain kerosene (through PDS) and LPG at affordable rates. In the recent years, there has been a change in the oil pricing policy with a move towards market determined oil prices. The period of price regulation varies across products in the oil basket, with minimum control existing for petrol and very little pass-through for LPG and kerosene. The domestic price of oil is administered, which is essentially a policy decision, and thereby determines the degree of pass-through of the change in international prices to domestic oil prices.In figure 1, the price channel is indicated by the link from international oil prices to increase in administered prices to WPI inflation. (c) The third channel of transmission of oil price deck considered here is the fiscal channel. In the absence of a complete pass-through, an international oil price sum up will raise the subsidy on oil and therefore the revenue expenditure of the government. Furthermore, in India, the oil prices are subsidised, but they also generate substantial tax revenues both for the centre and the states because of an increase in ad valorem tax collections on oil and petroleum products that would have to be netted ou t to survive at the net addition to oil subsidy given by the government.