Important Budget Terms

Subject: Economy

Section: National Income

Concept:

Nominal GDP and Real GDP

Nominal GDP refers to the current year production of final goods and services valued at current year prices.
Real GDP refers to the current year production of goods and service valued at base year prices. Base year prices are constant prices.
Currently, the base year for GDP calculation is 2011-12.

GDP Deflator

The ratio of nominal to real GDP is a well-known index of prices. This is called GDP deflator.
GDP Deflator = Nominal GDP/ Real GDP
The GDP deflator is, therefore, a measure of inflation.
If GDP deflator is 2, then it means prices are doubled as compared to base year.
The GDP deflator is considered the better measure of price behavior because it covers all goods and services produced in the country.

Crowding out and Crowding in Effect

When the government pursues expansionary fiscal policy (higher spending financed by borrowing) there are two possible effects :
Crowding out – higher government spending financed by borrowing leads to a fall in private sector saving. This is for two main reasons
With expansionary fiscal policy, private sector savers buy government bonds and so have fewer savings to fund private sector investment.
Also, higher government borrowing tends to push up interest rates and these higher interest rates reduce investment.
Crowding in – this relates to how higher government spending encourages firms to invest more.
This is due to the income effect of higher government spending.
If the economy is in a recession or below full capacity, expansionary fiscal policy can increase the economic growth rate and create a positive multiplier effect, which leads to greater private sector investment.

Sticky Inflation

Sticky inflation is an undesirable economic situation where there is a combination of stubbornly high inflation and often stagnant growth.
Sticky inflation is often associated with cost-push factors, i.e. factors which cause a rise in the inflation rate but also lead to lower spending and economic growth.
In 2008 financial crisis, we experienced a rise in inflation, but economic growth fellleading to recession.
In 2011, we had a similar rise in inflation, but a fall in the growth rate.