Financial Literacy...

Article;

http://economictimes.indiatimes.com/opinion/comments-analysis/banking-shadow-and-shadow-banking/articleshow/8919680.cms

Comment;

The article has been written beautifully but the writer misses the main points like financial education, and, the difference between regular banking and shadow banking. The term shadow banking comes from the great recession in the US in 2008 and points to practices that are run behind the regular banking practices. In shadow banking shadow bankers arrange funds on the market rate of interest and lend the money for other purposes like home loans to people who are unable to understand the dynamics of money market. The article lacks the point of generating own resources for microfinance that can avoid the ripples created by loan crises just like what happened in the US in 2008 in case of sub prime loans. People were educated and knew how our financial system works but they could not gauge the magnitude of the crisis. It was huge enough to sweep the incomes generated during prosperity. Financial education or financial awareness or financial consciousness all are equivalent terms in terms of meaning, they convey that people opting for loans understand the risk associated in face of no repayments, their properties, their mortgage will be confiscated… But many times the end receivers of the loans fail to estimate the individual risks associated with such deals due to lack of financial literacy. In India where half of the population is illiterate assuming financial literacy will increase the cases of individual defaults and in the end the burden will come on the shoulders of the government.

Euro-Crisis...

Lehman collapse in 2008 was followed by a fall in the price level. When the credit bubble bursts in the US in 2008 it leaves the economy with falling prices and low economic activity.

But, globally these days the scene is different. We are in the regime of high prices and the central banks world over are raising interest rates to keep a tab on inflation. Therefore, we have the world divided in three parts. Economies that are experiencing high inflation like India, China, and some parts of Europe. Then there are economies which are recovering from the financial crisis like the US. And, then there are economies which are struggling to avert the problem of recession like Greece, Spain, Portugal etc, etc.

Nevertheless, Greece’s problem is not as bad as the US because inflation in Greece is around 3% well above the rate of inflation recorded in the US that sparked concerns about deflation. But the inflation rate for Greece is going down and if its problems are not solved the economy will be gripped in a deflationary situation. During the US’ recession in 2009 inflation was negative whereas Greece’s inflation stood at 1% which suggests that the recession in the US affected Greece, too. We are not sure why we are getting this pattern but we can not deny the impact of foreign trade. To be precise, Greece is in a better position than the US as far as inflation is concerned and if it tries it can pull the economy back on its usual track.

However, Greece’s main problem is debt but debts can be sold-off to other players or we can reduce them by budget austerity. Since Greece is not in that bad situation as the US we can keep the economy afloat. But, the main problem remains same, euro. If government debt is bailed out in Euro it will push inflation up because of increase in the money supply and European Central Bank (ECB) is already increasing interest rate to curb inflationary pressure.

Inflation is always a concern because it affects the real value of money if income is not increasing and since Greece is in recession it is not generating new incomes. However, Greece should push its inflation target to natural rate of inflation and unemployment at 5%.

Moreover, increase in money supply with euro will also benefit countries like Germany and France alongwith Greece through depreciation. But, this time I do not think Greece will be ready to share the fruits of international trade.

Repo Rate and Reverse Repo Rate…

Repo rate is the interest rate at which the central bank lends money to other banks stands at 7.50% whereas reverse repo rate is the rate at which the central bank borrows form other banks has been increased to 6.50%.

A question that arises in an inquisitive mind is that, why there is a difference between the two rates and what does the difference signify?

The difference between the two is 1%. Repo rate which is higher than the reverse repo rate tells us that, now, the central bank wants to lend money to banks on a higher interest rate because it wants the rate of inflation to be equal to its stipulated target at 6%. And, the reverse repo rate shows that the central bank wants to borrow at a lower rate than repo rate. Everytime when inflation is a concern the central bank has mainly manipulated repo rate and reverse repo rate because the banks wants to signal other banks about the condition of the economy regarding the inflation and unemployment scenarios. If inflation is high it increases both the rates and when unemployment is high it somewhat decreases them given the level of inflation. Reserve bank of India is a bank of last resort which always maintains a ratio of funds depending on the need of the economy under various heads. When repo rate is increased it means that the bank wants to decrease the flow of money/finance to the economy and when it increases reverse repo rate it means it wants to increase the availability of finance for the central bank’s use for lending. The central bank is the lender of the government; therefore, an increase in reverse repo rate means the central bank wants to lend to the government at a lower rate than the repo rate. A higher repo rate means that the central does not want other banks to finance the private needs of the economy or financing but at a higher rate. When repo rate is increased it decreases the availability of finance for private use whereas an increase in repo rate shows that the central bank also wants decrease finance for public use. Therefore, we can conclude that the overall condition of the economy does not support the idea of expenditure, public or private, at all.

However, the natural rate of inflation and unemployment for developed economies is 5% and since India is a developing economy therefore the central bank has set higher inflation rate at 6% for the economy. Inflation is nothing but the rate of increase in money supply to finance the needs of the economy, public and private.

When the central bank increases repo rate it means it wants to lend to other banks at higher interest and when it increases reverse repo rate it means it does not wants to borrow and when it increases or decreases them simultaneously it means it wants to keep the situation somewhat intact. The message is clear that the central bank wants to keep the level of inflation constant if it can not decrease it to its target at 6%.

Moreover, the difference between the two i.e. 1% also tells us that the banks should follow the central bank to keep the difference between the deposit rate and lending rate equal to 1%. However, it remains a dilemma whether whom the central bank discourage and whom to encourage to take loans government or private investors?

However, the rate of increase in home loans is around 17% which is equal to our natural growth rate or rate of growth population at 17%. The only growth rate compatible to our growth models that say actual growth rate must equal the natural growth rate. Natural growth rate is the rate of growth of population, and, since, everybody wants to own a house it seems logical and understandable, too…

Ways, India Can Grow…

Some grow and some choose the way to grow. The dilemma India is facing is hurting both the consumers and the producers. Actually, the dilemma is that the government wants the economy to grow at 10% while the central bank has constrained the limits of expansion at 6%.

The main problem facing any economy is finance and India’s growth story is no different when compared with others in the league like China. Since the economy’s finances are regulated by the central bank keeping rate of inflation in mind which is already high somewhere near 8% and the bank is continuously giving us its message that inflation is a concern for poor who’s composition in our demography is high nearly 50% of the total population who earn no salaries but wages.

The difference between wages and salaries is that salaries are determined by companies on the basis of employees’ performance and are revised every year keeping rate of inflation in mind. Generally it happens... Whereas wages are market determined and depends on the bargaining power of unions of any organization. But in India the unorganized sector is vast and unaccounted for which getting the right information about their functioning and parity of wages compared with organized sector is often doubtful. Moreover, workers who work in organized and accounted sectors also get bonuses depending on the company’s performance in every fiscal year. The problem is we do not have any mechanism to ensure parity of wages and salaries in the organized v/s unorganized sectors.

Finance controls nothing but the consumption of the economy. And, half of our population can not purchase consumer durables with their wages if they have not saved enough for the rest of the year.In that case they either resort to banks or local money lenders. We all know the condition of private money lending where exploitation is very high and the interest rate poor people pay is often higher than the market rate of interest. In India, banks are not willing to reach poor people and they either do not have any plans for poor population’s consumption directly in form of higher interest rate on their savings. Indirectly they lend for business purposes where interest are high but our uneducated poor are less shrewd than market and their position are often so tight that they even have to curtail their daily consumption. Another noteworthy difference between wages and salaries is that salaries are more
fixed than wages in a given month whereas wages are earned daily and depend on the availability of work. Therefore, banks are more willing to lend to the salaried class than to wage earners either for purchase of goods or for business. Therefore the point is that those who earn wages should be protected against inflation and price rise. Workers interests are more protected in the organized sector than in unorganized sectors.

A natural question that arises in such a condition is then why inflation is higher than the stipulated 6%, by the central bank?

And, the answer lies in the fact that government has tools to extract money for its expenditure. Government levies taxes and then it spends on development projects like MNREGA to build infrastructure for the economy. Inflation results from an increase in money-supply either by central bank or by the government. To be more clear, inflation results when too much money chase too few goods, or, when demand exceeds supply. The money spent on development projects finds its way in our markets and the real supply of goods, mainly food articles, decreases in comparison to demand which is bound to be high since India is an economy of a billion people and where almost 50% are poor, and,when they get money they run straight to their local grocery shops which are already deficient in food supply and therefore prices rise more than they are expected to rise and inflation now stands at 9%.

However, the government has increased minimum wages under MNREGA but will the government do it next year, too. If it does inflation will go up some more next year, too. If it does not that would be unfair.

The economy desperately needs a mechanism which ensure that if inflation increases wages increase too or consumption will lag behind...

Moreover, we need to ensure availability of goods, food and non food items, both. We desperately need labor reforms and FDI in retail to keep the economy sound and steady on its growth path, and, to converge it towards the equilibrium…

Dialectical-Materialism…

In dialectical materialism we find a synthesis of two words dialect and matter. Dialect means any situation or effort that conveys two messages for two different people or two messages for a single person in an introspective mood. Whereas matter or materialism is the science of matter and/or its distribution, atleast for Marx and Lenin (we can see the dialect arising in case of matter “and/or”). The purpose of the above lines is to relate it with the situation the Indian economy is facing, poverty and unemployment at very high levels almost.

The current situation suggests that the Indian government is trying to reduce poverty by pumping more money in the system through fiscal measure, taxes and expenditure, whereas, the central bank is continuously raising interest rates to convey its separate message. The purpose, of the government is to reduce poverty and of the central bank is to contain inflation and increase employment, given the constraints of real supply of goods and services… Their action says this thing too.

The efforts at the government level produce dialect. We all understand the goal of efforts by the government, poverty reduction, and they are justified from the point of view consumption, investment, and, savings. Actually what the government is trying to do is to increase public investment/expenditure through welfare schemes to affect the level of income, and, higher level of employment and consumption. But at the same time inflation is bound to rises and is rising which is decreasing the value of money. The relationship between quantity of money and its value is negative. Then a natural question that arises is then why we should increase money base within the economy if it is eroding past wealth what people have accumulated. When inflation rises, it relatively decreases the value of amount of money in hands which we call real value of money.

The central bank of India has, however, committed to low inflation and high employment levels. Even this task is not without dialect, since, lower money supply will lead to lesser amount of investment and jobs which is also responsible for high inflation we experienced in the recent past due to increase in money base. The problem remains unsolved poverty... If the central bank increases interest rate it will increases unemployment and if it allows employment to occur inflation will spurt.

Therefore we are in a twin situation. “If inflation increases it will reduce the value of money in our hands and if employment increases it will shoot inflation, again. We are literally experiencing a dialect regarding the efforts on the part of the government and on the part of the central bank, too."

We are stopped at the very first stage...

Some say that inflation is a tool for redistribution of income between profit and wages while others say it erodes the past wealth. While, economics, economist, and market talk about marginal products and factor rewards.

The main problem is who is deciding the factor rewards be it labor or capital, and the prompt answer that comes to sharp minds advocating capitalism is MARKET!!

But when it comes to market very few and mainly classical economist know that market work through its hands and moreover with invisible hands. Then a natural question that comes to mind is then why there is so much inequality in the distribution of the rewards of factors of production. A common man will, as they naturally do, ask that look! we have two physical hands are we are not able to take care of ourselves then how market with its invisible hands is considered so efficient that we should leave our worries to its shoulders, and invisible too, to perform the task every body has entrusted it. Actually, this is not a common man’s question, he is a never allowed to ask questions, but question being consistently asked by great minds like Marx and Lenin. And, even they could not find a solution and resorted to revolutions that history and its students would not forget.

Coming to our main point, distribution of income, and especially when we are in an introspective mood like this one the whole life comes to a stand from where we can only see our past and the poverty, instead of prosperity, we have accumulated around ourselves in countries like INDIA. By the way it is a mixed economy. We know that when we read the preamble of our constitution. We will see words like …Socialist, Republic… (and all that). As a whole, we are a Democracy (multi-party), an institution that is of the people, by the people and for the people. By the way a democracy has real hands, our elected representatives. In strict sense economic sense, “democracy has an advantage over market and capitalism, as far as hands are concerned”. At-least, somebody is responsible. Poverty is nothing but the result of failure of any mechanism that is entrusted with the task of redistribution of national income and INDIA has no such mechanism except a Central-Bank which is only responsible for managing business booms and swings and is only indirectly responsible for employment and the prosperity it brings to a common man’s life by regulating finance of the economy.

Actually, in real terms, as far as distribution of national income is concerned employment generates real wealth, if inflation is properly anchored, than mere regulating the finance which is subject to inflation. Everytime when central banks increases finance to the economy it generates inflation depending on the real supply of goods and services. By real supply we mean physical/core supply of real goods and services.

The main problem is we do not have any mechanism to ensure skills and employment to the poor population. We are not only concerned about any particular geographical region and inequality since we are living in an interdependent world where prices and incomes of one region affect the demand and supply of necessary goods and services in some other location. And, the problem aggravates with an illiterate population.
As far as, illiteracy is concerned it is at the backbone of all our problems because the poor man does not know what benefits the government is accruing to pull them out of poverty, be it skills, finance, employment, food, civil rights…… The list goes endless but it stops at the very first stage education.

I hope we are prepared to ensure education, skills, and finance to our poor population with inflation being properly anchored to lowest to keep them and our economy away from inequality…

Japan vs US

Article;

http://krugman.blogs.nytimes.com/2011/06/01/1937-in-2011/

Comment;


Reading the paper one finds that committing to R2 raises the growth rate of the Japanese economy, while, R1 gives complete price stability. Committing to an inflation rate tells us that that economy wants to grow at a higher growth rate. In growth-economics we try to equalize natural growth rate with other rates of growth. To be clear, natural growth rate is the rate of growth at which the population and workforce increases. The paper completely neglects this aspect. Nevertheless, the rate of growth of Japanese population is 0.1%. Therefore we can expect that when the economy will grow it will grow as per its’ natural growth rate without any fiscal expenditure. And, if we add public expenditure to this state of affairs we calculate the actual growth rate of the economy, natural growth rate plus rate of growth of public expenditure. This is why the Japanese growth rate tumbled when it stopped its expansion program in 2000s. The same thing happened with the US in 1936. No body can underestimate the effects of monetary expansion, at-least mathematically.Nonetheless, the Japanese economy could grow at rate of 0.1 percent anytime, other fiscal expenditure constant. For now, it can be said that the reconstruction will improve the economic condition of Japan, both, mathematically and also in the real.

The actual solution for the US lies in the comparison of the population growth rate with Japan. Japan’s population growth rate is 0.1% where as of the US is 9.7 % and allowing for frictional employment to obtain actual growth rate, with which the economy can grow, for Japan is -4.9%(negative) and for the US it is 4.7% (positive). Frictional unemployment which Keynes said stands at 5% is a variant of natural-rate-of-inflation-and-unemployment. But if we add the effect of public expenditure in this scene it depends on the commitment of both the countries about the rate of inflation. If Japan wants an inflation rate of 0% it will have to add money supply, anyways, equal to 4.9% of its national income. On the other hand, the US can grow naturally, will grow, without any public expenditure by reducing money for the private sector, but not without quantitative easing (new money). Just to point out, in quantitative easing you do not tax others to pay your expenses, anyways, so the reserve for private investment does not reduce. Anyways, again, in the US demand is low and fiscal deficit is burgeoning so we do not want to affect them, atleast in the short-run. However, the need of the US economy is to grow atleast 9.7 percent to sustain income saving and consumption levels, with inflation at zero, in the long-run.