Internal Balance

MACROECONOMIC FUNDAMENTALS
Internal Balance:
- in economics is a state in which a country maintains full employment and price level
stability. It is a function of a country's total output,
II = C (Yf - T) + I + G + CA (E x P*/P, Yf-T; Yf* - T*)
Internal balance = Consumption [determined by disposable income] + Investment +
Government Spending + Current Account (determined by the real exchange rate, disposable
income of home country and disposable income of the foreign country).
- Situation in which the consumption in an economy roughly equals production.
May be characterized by both full
employment and low inflation, though not all economists believe this is possible.
Maintaining internal balance is considered sustainable.
- A situation where the economy is operating at FULL EMPLOYMENT and the general level of
prices is constant (PRICE
STABILITY). The achievement of full employment and price stability are two importantmacro
economic objectives of the government.
External Balance:
- signifies a condition in which the country's current account, its exports minus imports, is
neither too far in surplus nor in deficit. It is signified by a level of the current account which
is consistent with the maintenance of existing (or growing) levels of consumption,
employment and national output over the long term. It is notated by
- XX = CA (EP*/P, Y-T, Yf* - T*)
External balance = the right amount of surplus or deficit in the current account.
Maintaining both internal and external balances requires use of both monetary
policy and fiscal policy.
- A situation in which the money a country brings in from exports is roughly equal to the mon
ey it spends on imports.That is, external balance occurs when the current
account is neither excessively positive nor excessively negative.An external balance implies c
apital movement. That is, a country needs to have both imports and exports to maintainan e
xternal balance; it is not sufficient simple to note no balance by not buying and selling goods
. An externalbalance is considered sustainable.
- a situation of BALANCE OF PAYMENT
EQUILIBRIUM that, over a number of years, resultsin a country spending and investing abroa
d no more than other countries spend and invest in it. The achievement of externalbalance i
s one of the macroeconomic objectives of the government.
Fiscal Balance:
- Amount of money government has from tax revenue and the proceeds of assets sold, minus
any government spending. When the balance is negative, the government has a fiscal
deficit. When the balance is positive, has a fiscal surplus.
Correcting Macroeconomic Crisis
Macroeconomic imbalances can lead to economic crises. This is especially true in a monetary union due
to the restrictions it imposes on the tools available to economic policymakers. The years leading up to
the outbreak of the global economic crisis were characterized by divergent macroeconomic
developments within the euro area, which meant that the impact of the crisis varied from Member State
to Member State and that, subsequently, unexpected challenges have arisen for the single monetary
policy and coordinated fiscal and economic policy. In order to prevent such developments in future, a
procedure for preventing and correcting macroeconomic imbalances, analogous to the Stability and
Growth Pact, was created within the framework of the European semester. The preventive arm of the
procedure is designed to detect and analyze potential macroeconomic problems. If the procedure flags
up excessive imbalances for a Member State, the corrective arm will come into effect, under which
the relevant Member States will be required to submit plans for corrective measures. If Member States
then fail to comply with the recommended corrective actions, sanctions may be imposed. The new
procedure constitutes a considerable boost to economic policy coordination within the EU and the euro
area. Nonetheless, it has yet to prove itself in practice.
Programs of Economic Stabilization

A stabilization policy is a package or set of measures introduced to stabilize a financial system
or economy. The term can refer to policies in two distinct sets of circumstances: business cycle
stabilization and crisis stabilization. In either case, it is a form of discretionary policy.
Supply Side Growth

Supply-side economics is a macroeconomic theory that argues economic growth can be most effectively
created by lowering taxes and decreasing regulation.[1][2] According to supply-side economics,
consumers will then benefit from a greater supply of goods and services at lower prices, and
employment will increase.[3] It was started by economist Robert Mundell during the Ronald
Reaganadministration.
Effective Functioning of Markets
Characteristics of Well-functioning Markets

The economic analysis of markets concludes that, in most sectors of the economy, active competition is
the most effective means to achieve, 1) efficiency and innovation in the supply of goods and services;
and 2) consumer protection, by providing choice among competitive offerings. Well-functioning
competitive markets are characterized by several important attributes,
1.1Ease of Market Entry and Exit
Free entry and exit makes markets function efficiently. Barriers to entry (e.g., restrictive
licenses, very large investment requirements, etc.) reduce possibilities for participation in the
market, thereby limiting the extent of competition (and thereby market efficiency) that is
possible.
1.2Absence of Significant Monopoly Power

In a well-functioning competitive market, no firm has power to dominant the market. The
existence of significant monopoly power in a market restricts the participation opportunities of
smaller competitors and potential new market entrants. The market pressure for competitive
efficiency and innovation is reduced; consumer choice and price protection are weakened.
1.3Widespread Availability of Information

All parties in the market, including firms and consumers, must be well-informed in order to
make effective decisions. Timely and relevant information must be easily accessible. Barriers to
information weaken the ability of markets to function efficiently.
1.4Absence of Market Externalities

If all the costs of producing a good or service are not borne by the firms supplying it, the
additional social costs (e.g., pollution) are external to the market. If the benefits to society are
not all captured in the prices that consumers pay and the revenues the firms collect, the social
benefits (e.g., public health and safety) are external to the market. In a well-functioning market,
the social costs and benefits are fully recognised within the market. There are no spill-over
effects of consequence.
1.5 Achievement of Public Interest Objectives

When the market achieves its goals of efficiency, innovation and consumer protection, it will at
the same time achieve any special public interest objectives as well. There are no special public
interest objectives to satisfy (e.g., universal coverage) that go beyond the capabilities of a well-
functioning market.
Role of IMF
Role of WB
Role of Government
i) Allocation Function:
Government has to provide for public goods. Public

goods such as national defense, government
administration and so on are different from private
goods. These goods can not be provided through market
mechanism but are essential for consumers and
therefore, government has to provide them. Because of
that government has to allocate resources between
private goods and public goods.
Private goods are limited to some individual or
individuals but public goods are available to all. Secondly,
private goods are available to those only who can buy
them but this is not the case with regard to public goods.
These are available to those also who can't afford them
financially,
(ii) Distribution Function:
Through its tax and expenditure policy government affects distribution of personal income of
households in a manner which is just and fair. As such it taxes the rich and spends for the schemes
which benefit more the poor.
(iii) Stabilization Function:
Economy of a country is affected by economic fluctuations such as conditions of boom and depression.
Such changes benefit some and harm others. In such a situation appropriate policy measures are
required by the government to affect the levels of aggregate demand. Such measures are called
stabilization measures. These measures aim at avoiding the situations of inflation and unemployment.

Internal Balance

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MACROECONOMIC FUNDAMENTALS

Programs of Economic Stabilization

Supply Side Growth

Effective Functioning of Markets

Characteristics of Well-functioning Markets

1.1Ease of Market Entry and Exit

1.2Absence of Significant Monopoly Power

1.3Widespread Availability of Information

1.4Absence of Market Externalities

1.5 Achievement of Public Interest Objectives

Government has to provide for public goods. Public

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