Saturday, June 20, 2009

Conceptual Ideas!!

What are M1, M2 and M3?

M1 is the sum of the physical money that is held outside banks, travelers’ checks and demand deposits. M2 is M1 in addition to all time-related deposits, savings deposits, and non-institutional money-market funds. M3 is M2 as well as all large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets. M3 is referred to as broad money supply and is usually the number referred to when talking about money supply. M1 is generally referred to as narrow money.

What is the impact of interest rate on the economic growth?

There is a general consensus that the growth of the economy is negatively associated with the interest rates prevailing in the economy. Interest rates in an economy has twofold effect on economic growth as they act as driving force for the investment activity on one hand (supply side) and stimulate the consumption expenditure on the other hand (demand side). In specific, moderately low interest rates not only drive the increased investment activity but also encourage the individual consumption expenditure.

What Does Nonperforming Asset Mean?

A debt obligation where the borrower has not paid any previously agreed upon interest and principal repayments to the lender for an extended period of time (say, 90 days). The nonperforming asset is therefore not yielding any income to the lender in the form of principal and interest payments. Increased nonperforming assets act negatively to the growth of the economy as the scarce capital could be holdup in unviable economic activities. It is a major concern for the emerging economies as they generally face the resource crunch.

What is a fiat currency?

Fiat currency or fiat money is a type of currency whose only value is that a government made a fiat that the money is a legal method of exchange (is usually the paper currency). Unlike commodity money it is not based on any other commodity such as gold or silver and is not covered by any special reserve. It means fiat currency doesn’t have any intrinsic value and its value depends only on the confidence holders have in the economy and its government. Most currencies in the present world are fiat currencies.

What are the leading, lagging and coincidental indicators?

Usually indicators are used to predict the future outcomes, particularly future trends of the certain economic variables. Some of these indicators are published by government bodies/private organizations eg. Inflation rate, …………..and some are observed in the market place eg. Bond yields. Depending on the prediction they make, such indicators are classified into leading, lagging and coincident indicators.

Leading indicators are the pointers towards the future outcomes. Bond yields may be considered the leading indicator for the trends in the equity markets.

Lagging indicators are of useful in reinforcing or confirming the event occurring or expected to occur. Unemployment rate may be viewed as lagging indicator for the performance of the economy. Falling unemployment rates confirms the encouraging performance of the economy.

Coincident indicators reflect the situations they signify. Increased per capita consumption is the reflection of flourishing economy.

What happens to the interest rates during deflation?

Deflation refers to the fall in the general price level. It is usually caused by the fall in aggregate demand which is in turn resulted from the decline of government spending, private consumption and investment spending. Deflation can also be the result of the fall in the supply of credit and increased interest rates. But once the deflationary situation is settled in, investors mostly become the risk averse and seek for the safe heavens such as investing in treasury securities. The increased demand for the treasury securities due to deflationary conditions brings down the interest rates and some times push the interest rates into the negative territory.

How does credit crunch affect consumption?

Credit crunch refers to the reduction in general availability of credit irrespective of the rise in interest rates. It has multifold effect on the consumption expenditure, particularly on the conspicuous consumption. On the plain grounds, lack of credit availability restricts the consumption on durable goods; on the other hand credit crunch dampens the consumer confidence by causing the steep fall in asset prices, reduction in investment rates and increased unemployment rates. The recent credit crunch resulting from the US housing sector crisis brought down the consumer confidence there by consumption expenditure.

What are the important components of the budget?

Indian budget, known as Union Budget is made up of revenue account and capital account. Revenue account comprises of government revenue mainly from taxes and government administrative expenditure. Capital account comprises of receipts and payments. Receipts on capital account include the loans brought about by the government through central bank from the market as well as other government bodies and profits from the government owned enterprises. Components of payments on the capital account include government investment expenditure on assets, infrastructure etc.

What are the direct taxes?

A direct tax is a tax which is imposed directly on the tax payer. It implies that in the case of the direct taxes the immediate impact and incidence of the money burden lies on the same person. The examples of direct taxes are personal income tax, wealth tax, tax on gifts etc. Most of the modern governments earn major chunk of revenue from imposing direct taxes. In India, contribution of direct taxes to the total revenue of the union government is 53.07% in 2008-09. This reflects the significance of the direct taxes as major source of revenue for the state.

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