The Long-Term...

 In the long-run, all the countries are trying to increase their per capita income and living-standard according to the increase in productivity while maintaining their competitiveness with innovations because labour is relatively scarcer which might restrict the economy’s capacity absorb capital without increasing wages and the general price-level, as found in the general quantity theory of money... But, now there is also a special quantity theory of money observed in the developed countries that is not expected under the general conditions. In a major part of the developed world loose monetary policy has failed to increase prices as expected because demand might not increase due to excess of labour supply which may put a downward pressure on the wages and prices when interest rate or cost are also close to the zero lower bound. More money-supply has reduced the cost of capital with low wages increasing supply despite of low demand which has lowered the general price-level and interest rates pushing the economy at the zero lower bound or liquidity-trap for a longer period. At the zero lower bound cash hoarding increases, not necessarily in banks, because the value of money goes up in the face of lower prices, moreover everybody expects higher inflation in the future because it is the our basic observation that prices increase with time and the will to hold unlimited money also increase savings. The zero lower bound also trims the possibility of increasing investment and employment by reducing the borrowing cost or nominal interest rate, but the central banks are trying to reduce real interest rate and wages with inflation to incentivize the supply-side and profits which would also increase the relative international competitiveness to survive in the market-place. The central banks consciously or unconsciously are favouring the capitalist to reduce unemployment. Nonetheless, when real wages are going down demand too is likely to remain subdued resulting in lower growth rate...  The “long-run” to me exists all the time, which is the truth; it exists always, not subject to short-termism, what everybody does under the similar conditions. The difference between general and partial... 

Japan's higher long-run rates...

It is worth a thought that economic-models assume zero inflation in the long-run. Inflation is a short-run deviation from the equilibrium price-level. Economists think of the long-run as self-correcting. But when deciding long-run rates expected inflation plays an important role because the economy first consumes and then saves for the future; if they expect higher inflation based on the current situation they would also save more for the future too and more savings result in lower spending means lower demand and prices. Interest rate would go down. On the contrary, if they expect deflation based on the current condition they would save less-spend more which might increase demand and prices and interest rate. People expect higher interest rate if there is inflation because the monetary-policy would work to control inflation. Generally, prices and interest rate move in the same direction. Expected inflation would increase the long-run rates, higher than the short-run rates. The long-run rates are higher than the short –run rates which shows that depending on the economic –policy people expect inflation in the long-run which is opposite of what the economic models assume that inflation in the long-run would be lower or zero.  Keynes long ago accepted that labour and other factors of production might not be abundant but capital has no reason to be scarce since the central bank can print money to finance the economy. Gold-Standard off-load was a big move in that direction which was later used to print notes, buy foreign exchange and devalue to gain exports. Keynes foresees capital as not scarce in the long-run. Our zero interest-rate regimes in much of the developed world do support Keynes view that capital is not necessarily scarce. Higher long-run interest rate is against Keynes argument of lower interest rate.  

Higher wages may point overheating in the labour-market...

After increase in the hourly compensation to four-percent the case of a potential rate hike in the US looks close when the Fed meets in Dec. It shows higher wages and cost which may result in higher core inflation, a rise in wage, cost and price of manufactured products which reflect tightening in the labour market that the economy has achieved its potential and further monetary policy stance would be tightening of the capital market too because lose money-supply might increase demand for labour when the economy has reached full-employment and may result in wage cost and inflation which does reflect the reserve bank’s commitment for price-stability and the value of money and demand. The scenario clearly depicts the situation or condition the US economy is going through. The central-bank has had approached the inflation trajectory close to arrive at the hike, but the Fed index of inflation gauge has failed to turn out as expected. The consumer personal expenditure (CPE) with so low fuel prices has failed to increase inflation because of low spending and inflationary expectations have also increased savings. But, higher wages show that there is a competition to attract labour and might also indicate overheating and tightening. Labour is among the scarcest factor of production against the long-held assumption of old models of unlimited supply at a fix price or wage. The supply of labour is the prime cause of low-supply and higher prices in the short-run. Lack of skills too add to the problem of low-supply. Therefore, countries try to update its economy with innovation that increases productivity to overcome labour shortage problem and reduce cost and prices to remain competitive. Full-employment is a major supply side constraint beside food and fuel which may also signal overheating and inflation. However, CPE has been the preferred gauge of inflation for the Fed which shows lower inflation compared to the wage inflation as seen in the hourly compensation. Higher wages and prices indicate higher demand in the labour market but food and fuel prices indicate less demand pressures also due to good supply condition. The US is a developed country, but still constrained by the supply of labour also because of falling population and labour-force participation growth rate...  

RBI's policy...

Almost everybody forecasted a status-quo for the today’s RBI policy review because there were ample reasons to expect RBI to wait and watch the latest data and the outcome is also same. RBI kept repo-rate constant at 6.75 with no liquidity injections. Inflation in the recent data, around more than 5%, after two consecutive months of increase may still indicate food supply problems due to seasonal problems and rains that INDIA face almost every year. Inflation in INDIA mainly emanates from the ineffective supply management of food articles. INDIA suffers from seasonal inflation because it is too much dependent on rains and also excessive rains in some parts which lead to flood and crop damage. Every year drought and floods upset prices of agricultural products. Lack of demand and supply data, and effective action in order to maintain price-stability and demand puts INDIA in a fix and delayed monetary-policy action to increase growth for the past several years. Nevertheless, the situation has improved on account of proper actions to manage food-supply by the government and retail inflation has come down from double digits to below five-percent. However, to avoid seasonal inflation there is alot more to be done to get ontime data and effective actions. Agriculture needs a lot of planning to reduce the lag between demand and supply adjustment. The government has a larger role in the supply-side management rather than tweaking demand by the monetary-policy.

RBI in its monetary-policy stated that banks still need to pass-on the previous rate cuts as the interest-rate transmission has been close to half which leaves room for banks to lower the existing rates. Nonetheless, RBI maintained that the monetary-policy would remain accommodative as long as disinflation continues. The RBI proposed to bring methodology to set banking rate as per the marginal-cost of funds. However, the strategy to set bank rates according to marginal cost might not work without opening the sector for more investment and competition. More banks in the market with good regulation may help set rates according to marginal cost. The competition to increase market share results in price-competition among firms. It would also improve transmission... The RBI might try to increase competition in the banking industry...

Deflation and internal-devaluation might also work...

Paul Krugman is arguing about the desirability and plausibility of external devaluation or depreciation over internal devaluation that the first one is easy and quick to achieve instead of cutting nominal wages and prices through the latter. Both are the ways of cutting wage cost, lower prices relative to the nominal exchange rate and increase demand for exports. In depreciation the economy tries to cut real wages with inflation, and, lower cost of production and prices relative to the nominal exchange rate. Inflation also increases the nominal exchange rate. Such a policy aims two things, lower cost of production and prices, and higher nominal exchange rate too. But to achieve depreciation it is important that inflation increase which might not work in the liquidity trap when people save more in expectation of higher future prices because of expansionary policies. But, when savings go up, inflation fails to materialise and instead turn to disinflation or deflation which increases the problem of liquidity trap by lowering prices and interest rate. Even very large amount of money fails to increase inflation. Lower demand increases the relative supply and put a downward pressure on prices in the liquidity trap. However, if inflation goes up it would lower domestic demand due to lower real wages. Therefore, depreciation in liquidity trap world might not work, and moreover inflation and real wage cuts would increase external demand at the cost of domestic demand. In internal devaluation also the economy tries to reduce nominal wages and prices relative to the nominal exchange rate to increase export demand which would also hurt domestic demand, but wages are mostly sticky in the short-run which economists consider responsible for adjustment to store demand. The wage rigidity points to adjustment in other cost, profits and prices to increase external demand which might not be as rigid as wages because all wages are consumed, like low interest rates. But, in the liquidity trap or at the zero lower bound the adjustment cannot be continued without increasing expected inflation which aggravates savings and liquidity-trap by reducing domestic demand and growth. Much of the developed world is going through the liquidity trap and expansionary policies are unable to increase inflation and depreciation. Lose policies have failed to increase inflation and depreciation, but expected inflation and savings have worsened the spending, demand and growth. Therefore, lack of depreciation has not increased external demand and expected inflation has also lowered domestic demand. However, if the policy-makers commit deflation with lose money-supply because lower interest-rate would increase investment and supply, and lower the prices, they might be able to increase both domestic and external demand without increasing inflation, inflationary-expectations, depreciation and nominal exchange rate. It would work same like depreciation by lowering prices and increase the real exchange rate to increase export demand. Krugman should think about the difficulty the Western-world is facing to increase inflation when deflation is more imminent and more money-supply is not pushing inflation up, but rather increasing supply and lowering prices by lowering the borrowing cost. In such a condition deflation could be used as a strategy to increase real exchange rate and external demand. Lower prices would also increase domestic demand. When deflation could help achieve higher real wages and higher exchange rate and domestic and external demand, both, then “why the policy-makers are trying to increase inflation, which would increase external demand by increasing the nominal exchange-rate, but would decrease real wages and internal-demand, when they might choose to increase both by internal devaluation...? Lower prices or inflation would increase real-wages and domestic-demand and higher real exchange rate due to deflation could also increase external-demand...

Wages in Japan...

Japan under Shinzo Abe is still trying to target inflation when unemployment has reached a very low level and the economy is waiting to see rise in wages and inflation in the core or manufactured goods segment when food and fuel inflation failed to respond due to low population growth rate and good supply-side. Japan is now targeting core-inflation with food since oil-prices have come down to half and are not a problem. But low unemployment-rate may signal a labour supply shortage which would increase demand for wages, and, could increase wage cost and inflation. Nonetheless, if Japan increases the borrowing cost it would be able to increase inflation in a proportion of increase in interest-rates. Too low interest rates for more than two decades have removed the constraint imposed by higher interest rates on the supply-side.  Food and fuel prices that generally result in inflation in a country are very low in Japan and supply is not a problem, therefore they do not show demand pressures and inflation. Japan has invested heavily in food and fuel supply.  But, low population growth rate might constrain labour-supply and may poke wages and inflation in the retail price of manufactured products because then the market would compete for labour. Japan’s open economy is too responsible for low inflation. Foreign supply of goods and services has also kept prices and inflation low. In short Japan’s supply side is too good that the economy failed to generate inflation, but very low unemployment would help increase wages which Abe wants to increase inflation. Abe is pleading to the Capitalists that they should increase wages to increase demand and inflation, but they are ignoring because that would increase cost and reduce profits when there is a downward pressure on the price-level and inflation due to low demand. It would reduce their pricing-power during slowdown. Japan is actually doing the same the other countries do in a slowdown... It is trying to cut real interest rate and wages by increasing inflation in order to increase investment spending, but due to inflation-targeting people are reluctant to spend because they are expecting inflation ahead and are saving more for the future which has actually put the economy in the liquidity-trap. Low spending (consumption and investment) has depressed prices and interest-rate pushing the economy in the liquidity-trap. To overcome liquidity-trap inflation targeting is a bad strategy because it would increase savings. Liquidity-trap is mainly an expectation problem; if people expect inflation they would save more for future, but if they expect deflation and higher real wages they would consume more because lower prices would increase demand. And in this situation if lower prices increase demand relative to supply then the economy might also be able to push inflation up in the future. So far the country has tried to increase investment spending and inflation, but low demand due to low real wages has failed to attract supply. Abe wants to increase inflation for the Capitalist and investment spending, but he may also try to increase consumption spending which might also increase demand and inflation. But, this time the economy must commit deflation and not inflation which could increase real-wages and demand. Japan might commit zero interest rate and more fiscal spending as long as deflation persists.  Abe can increase wages or real wages without the Capitalists’ help using the monetary and fiscal policies by committing deflation... He should commit that lose money-supply might also be deflationary when supply increases relative to demand against the long held opinion that more money-supply would only increase demand relative to supply and would stoke inflation. Lose money-supply might also increase supply and lower the price-level. More money-supply may also increase supply by lowering interest rate cost which may also decrease the price-level, and, increase real-wages, demand and growth...

Lower inflation and inflationary-expectations in the US...

Interest-rate depends upon the money-supply, the price level and expectation of changes in it, because of the price-stability objective of the monetary-policy or the central-banks. They manage money-supply to adjust interest-rate and demand/supply which jointly determines the price-level or inflation. But, interest-rate in turn is also determined by inflation and inflationary expectations, both short-run and long-run. Higher inflation and inflationary expectations also make the central-banks fine-tune money-supply and interest-rate. Normally central-banks job is to ensure price-stability, but when growth-rate is tumbling it might set higher-inflation-targets, because it is a sign of higher demand/supply and economic-activity. Generally, booms and high growth-rates coincide with higher prices and interest-rate. Nonetheless, busts and slow-downs in the economic-activity and growth-rate calls for lower interest-rates, but to cut interest-rates during down-turn it is important to tighten during higher inflation otherwise it would feed bubbles by increasing the gap between nominal and real prices of assets because of inflation. The fear that lose money-supply and interest-rate might create asset-price-bubbles in the US is baseless since inflation is too low. Moreover, the fear of risky investment because of too low rates is again overdone since banks lend only after assuring feasibility of the project. Nevertheless, low interest-rate on retirement-funds also depends on inflation and inflationary expectation, and, low interest-rate would also mean that inflation in future could remain low which means higher real-interest rates, and the argument that pension funds might lose because of low rates may also be overblown because it would also signal that inflation could remain low in the future so that less savings would be needed. In the US economy low inflation is responsible for low interest-rates which may push the case for more money-supply since it has been a year now when the Fed ended its QE program and inflation is still below the official target of 2%. The effect of QE is fading since inflationary expectations are still low with oil from the Shale-revolution, which had put the expansion of the US economy in shambles many times before. Lower oil-price expectations in the economy has kept inflationary expectations and interest rate low,  which is likely to stay because the US is now a big oil producing country. Most of the prior recessions in the US economy were associated with oil-price booms and inflation. Lower oil-prices are a major contributor to low inflation and inflationary expectations after Shale. Higher oil-prices in the future would also make high-cost shale-exploration more viable, and, thereby more production and supply leading to further low oil prices, inflation expectations and interest-rate.    

Brazil...

Brazil’s case is clearly an example of fiscal splurging which has made the both, domestic and export sector, uncompetitive by increasing the prices internally, although it has increased depreciation, but higher interest rates have also worked against depreciation by increasing the borrowing cost, even though it has cut down on real-wages by inflation. Its policies are contradicting themselves, they lack a definite direction. Depreciation through inflation would have worked if interest rate was kept steady. Higher interest or cost of borrowing is restraining the competitiveness from depreciation that has resulted in low exports and domestic investment. The difference in fiscal-policy and monetary-policy is that the latter increases supply and demand, both, whereas that former only increases demand and infrastructure, and not goods and services which have made inflation out of control. The fiscal-doles and freebies by the government instead of improving the supply-side by the private sector has indeed crowd-out the private investment by increasing the interest-rates. Too much government spending has not only increased the borrowing cost for the private-sector which has a greater role in supply of goods, moreover it has also made the exports dearer by increasing the capital-cost. The economy’s inflation and high interest have kept demand/supply low for the internal and the external sector. To curb inflation the economy must increase the supply by lowering interest rate, but this time fiscal spending might be saved for the time when the private sector is reluctant to invest, which would also provide the government an opportunity to lower its fiscal burden. Budget pruning that lowers employment is not recommended because it is already above the natural rate and the growth rate is going down. The interest-rate cut would help reduce unemployment and improve the supply-side to reduce inflation against the argument that rate cut would aggravate inflation, but new government spending may be avoided because that would crowd-out private invest as it has done before. The inflation we are seeing in the economy could be attributed to too much government spending. Sensible economics says that the selic must be brought down to increase private investment and control fiscal slippage.

Irving Fisher...

This is by Fisher...

           
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To understand the above lines it is important to grasp “how debt could create deflation?” Fisher said deflation is caused by over-debt, therefore we might expect real interest-rates to be high as opposed to only nominal interest-rate, which also has an element of inflation or deflation. Inflation or deflation might increase or lower the real interest-rate which may affect indebtedness. Higher inflation means lower real interest-rate and deflation may increase real interest rate and vice-versa. Fisher, here, is concerned about debt, deflation and higher real interest rate, which might make the currency appreciate that may increase indebtedness because the value of money would increase. However, to decrease over-indebtedness and increase demand/supply, and restore equilibrium, the economic-policy could lower real interest-rate by increasing the price-level. But, to increase the price-level the policy must be able to decrease real interest rate, and not increase it, because that would also lower the price-level by limiting demand/supply, thereby increasing real-interest rate further. To overcome indebtedness the economy might try to reduce real interest rate which might increase the demand/supply and prices.

It is vital to figure-out that how over-indebtedness can increase deflation. Over-indebtedness means higher interest-rate or real interest rate because the monetary-policy would be tightened to control demand/supply and prices. Therefore, to reduce indebtedness real interest-rate might be reduced which would increase demand/supply and prices. Indebtedness would increase real interest rate which could lower demand/supply and prices. Deflation is caused by high debt and real interest rate. Therefore, to control debt, real interest rate might be cut to increase inflation, which would again cut real interest rate.

Nonetheless, zero-lower bound constrains lowering interest rate, but real interest rate could be cut by increasing demand/supply and inflation.

Fisher says high debt or interest rate causes deflation which worsens the debt situation further. Therefore, to tide-over indebtedness real interest rate should be reduced to increase demand/supply and prices. Increasing real interest rate to reduce borrowing would increase deflation which might aggravate the suffering. Debt situation can only be improved by lowering real interest rate and attempts to control debt may result in further misery. Measures aimed to control demand/supply by increasing interest rate would result in even deflation and higher real interest rate.   

This pattern is evident in the US economy where the central-bank has cut interest rate to zero and is trying to increase inflation to reduce real interest rate. Very low interest rate and low prices or deflation has made the Fed to adopt expansionary policy which also makes a strong case for expansionary fiscal-policy because both might be able to increase inflation and lower real interest to increase demand/supply, but low inflation has made the policy-makers pursue expansion longer than expected.

It is still new to my understanding that measure to control debt and inflation by increasing interest rates might further result in indebtedness by increasing disinflation and the real interest rate. Attempts to control debt and inflation may create deflation which economists consider a bigger problem than inflation. However, they say little deflation is not bad as lower prices would increase consumption and savings. Low inflation or deflation would also help to keep interest rates low. Deflation is good for the poor and inflation is good for the capitalist. Lower-prices or deflation would lower the cost of borrowing or interest rate and the general price-level. Lower cost of capital also helps to lower prices to a considerable extent; the capital-cost goes down. And, as we know lower prices or interest rate are more expansionary than inflation and higher interest rate...

Friedman and devaluations...

This is from Milton Friedman...

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         "                               

                                                                                                                                                                                                                                                                                                                                         In the above paragraphs, Friedman is mostly concerned with disturbances in the external- sector or how to correct a trade-deficit or increase surplus... He is arguing that a policy to lower internal-prices would require unemployment to up and/or decrease wages to curb imports and demand for foreign exchange to offset a deficit... Clearly, we need higher interest-rates or tighter fiscal conditions to furnish such an outcome which would increase unemployment and deflation within the domestic economy... The above discussion in the para’s is mainly concerned with the external-sector and its effect on domestic-economy has been ignored that “what we do when the domestic demand and economy is in trouble?” Even though Friedman has accepted wages as less flexible, he further admits that a severe unemployment may decrease wages too... However, evidences around the world point to nominal-downward-wage-rigidity... Nonetheless, a deteriorating external environment may also be bad for domestic demand and employment, and a higher interest-rate to reduce domestic demand would deteriorate external situation further... A higher interest-rate or tight money could also lower employment and wages, which would reduce demand for imports, as Friedman says...  However, no country chooses domestic unemployment to reduce external deficit and this is not just an inefficient method to correct balance of payments crisis, it is also the wrong way... The purpose of monetary and fiscal policies is to reduce unemployment and increase wages and demand in the domestic economy and the global-economy... Therefore, to correct external imbalance economist apply more money, lower interest-rates, lower unemployment, higher inflation and depreciation to increase exports instead of cutting imports only... the external-devaluation...

Exchange rate or internal-prices are two, but connected with each-other and changes in them are brought by changes in money-supply, by monetary-policy or fiscal-policy... A lose money-supply is likely to lower interest-rates, increase inflation and depreciation which could decrease imports and/or increase exports to reduce deficit, but decreasing imports might again deteriorate the external situation, demand for exports might also go down... Inflation and depreciation also cuts real-wages which would also reduce imports... It is contractionary... 

Friedman is talking about internal-devaluation to achieve external balance which is constrained by wage-rigidity and also by economic-policies, because the policy-makers would not let domestic employment and wages go down too much... But, borrowing cost could be brought down which would lower cost of production and prices... Interest-rate here could be a flexible price here, but depends upon inflation and inflation again depends on interest rate because it affects the supply-side... A low interest-rate and open economy regime might help improve the supply-side... Nevertheless, a higher inflation would increase interest-rate and a lower inflation would lower interest-rate... Therefore, low interest-rates because of low inflation or little deflation is likely to correct both internal and external demand... Low inflation would keep wages low; thereby increasing competitiveness... Lower cost of capital would also lower prices and make exports competitive...

Internal-devaluation or external devaluation to curb imports and increase exports, both reduce domestic-demand and increase the external demand... But, why a country chooses to increase external demand at the expense of the domestic demand? Which it should not do...

Of the both, internal devaluation seems more plausible because it helps reduce prices with downward-nominal-wage-rigidity and economic-policies to achieve full-employment, which might save domestic demand... Moreover, in external-devaluation, inflation and depreciation cut real wages to increase exports competitiveness which hurts domestic demand... In my view domestic demand should not be sacrificed for external-demand...

Domestic economy comes first...                      

                            

Keynes, 1923...

This is Keynes, 1923...

“In the first place, Deflation is not desirable, because it effects, what is always harmful, a change in the existing Standard of Value, and redistributes wealth in a manner injurious, at the same time, to business and to social stability. Deflation, as we have already seen, involves a transference of wealth from the rest of the community to the rentier class and to all holders of titles to money; just as inflation involves the opposite. In particular it involves a transference from all borrowers, that is to say from traders, manufacturers, and farmers, to lenders, from the active to the inactive. 

But whilst the oppression of the taxpayer for the enrichment of the rentier is the chief lasting result, there is another, more violent, disturbance during the period of transition. The policy of gradually raising the value of a country’s money to (say) 100 per cent above its present value in terms of goods … amounts to giving notice to every merchant and every manufacturer, that for some time to come his stock and his raw materials will steadily depreciate on his hands, and to every one who finances his business with borrowed money that he will, sooner or later, lose 100 per cent on his liabilities (since he will have to pay back in terms of commodities twice as much as he has borrowed).Modern business, being carried on largely with borrowed money, must necessarily be brought to a standstill by such a process. It will be to the interest of everyone in business to go out of business for the time being; and of everyone who is contemplating expenditure to postpone his orders so long as he can. The wise man will be he who turns his assets into cash, withdraws from the risks and the exertions of activity, and awaits in country retirement the steady appreciation promised him in the value of his cash. A probable expectation of Deflation is bad enough; a certain expectation is disastrous. For the mechanism of the modern business world is even less adapted to fluctuations in the value of money upwards than it is to fluctuations downwards.”         (Keynes 1923).

In the above lines, Keynes is talking about two groups, which can be named as the creditor and the debtor...  He says deflation is good for the creditor and inflation is good for the debtor... He failed to recognize that he is talking about the same economy... Both, the creditor and the debtor are rich people and both belong to the same Capitalist-Class, both have money... Therefore, in a way he is talking about the re-distribution of income within almost the same class within the same economy... He has failed to bring in poor people in to perspective who probably are neither creditor nor debtor, but the working class... This class saves very little to group as the creditor... Banks are the real creditor... Businesses do not borrow directly from people; rather they borrow from banks, which collect deposits from the public... Moreover, they are also not the debtor or businessmen... In this scene if there is deflation in the economy, then it is likely to benefit the working-class, the larger group in terms of numbers... Lower-prices would increase consumption and savings which means higher demand and supply, and thereby profits... Moreover, within the same economy, with a given level of income, inflation or deflation would affect everybody in the same way... Everybody consumes and saves, but everybody is not a debtor or businessman; however people may take loans for other goods and services, which also might be lower because of lower prices... Capacity to take loans would increase... Lower prices also mean lower interest-rate, which is actually good for businesses too...

Keynes, possibly, missed that the economic-policy and distribution of income may be there to reduce poverty and inequality, and, increase consumption and savings, for which deflation, and not inflation, is the right strategy...

Lower-prices and lower interest-rate would help everybody... Keynes also did not take interest-rates into account... They are also important for investment spending and loans by house-holds...

His classification of the economy in the two groups and not the economy as a whole has made his theory out of context...

    

Europe's inflation-target...

Recently Ben Bernake, the former Fed-chief, pointed-out in the Economist (magazine) that inflation targeting in the US failed to reinforce inflation and inflationary expectations despite more money-supply and the zero-lower-bound when the GDP is still undershooting the potential growth. An important question that comes to the mind that why the Fed has committed inflation? From my side, inflation is a signal for wage and demand increase which would attract more investment and employment, and growth. However, inflationary-expectations make people expect inflation which increases their savings and more savings turn spending or consumption (today) low. People would save more and inflation would go down. However, if people expect deflation they would save less and it might increase inflation. Therefore, the Fed so far has committed inflation when its inflation-targeting is working against spending now. In another way, the Fed has committed itself for more money-supply and income, but it has also targeted inflation. Therefore, it is giving both signals, of increasing income and of inflation, which might create confusion among the agents and when the future is uncertain you save more. The signals are mixed. The Fed is doing and undoing its job at the same-time. Nevertheless, deflation would make people spend also because supply is limited and might increase inflation when demand overtakes supply. ECB is trying to repeat QE in Europe but this time it should abandon inflation-targeting to make people spend and save little with a little deflationary bias in the economic-policies. Deflationary-expectations would also infuse confidence in the economy’s budgets, both, micro and macro. It would increase demand when money-supply and wages increase...

Domestic demand in Japan...

Inflation increases when wages and income and demand increase after full-employment which constrains domestic supply... And, when demand outstrips supply it is controlled by raising interest-rates... But, in Japan inflation is down... Full-employment shows that demand is not a problem... Then we might expect supply to be responsible for low prices... But, lower prices may not be sufficient to attract demand... money-supply is important to increase wages and demand... actually, real-wages and income... Japan's low real wages are a major reason for low demand... Actually, it has cut wages to make the economy competitive... But, domestic competitiveness, lower prices has been neglected by adopting inflation targeting... People in Japan might think that inflation would go up so they save more for future... Nonetheless, if people expect that prices would go down they might save less today... Nevertheless, economists argue that lower prices or deflation would delay spending, but lower prices are an opportunity to buy soon and not delay because supply is limited... Therefore, deflation is an opportunity to buy now and not delay... If policy-makers commit deflation instead of inflation people might save less and spend more... Deflation would increase real-wages... Increasing money-supply may not be important... Real wages might go up without increase in money-supply because prices would go down...

Black-money, disinvestment and rupee...

Any policy is a dis/incentive for a particular outcome... It is true that the black-money is a product of tax-evasion... But, the money flows to other countries' banks... However it may have entered the country from other channels... anyway FDI, FII... foreign banks do invest in g-secs of other countries... The government could incentivize return of the money to the Indian-banks which would increase their lending capacity to lend low... The government might offer zero-tax on the condition that money will be lent to the Indian banks at zero interest rate... Taxes might be sacrificed to lower interest rate... There is always a trade off...

Disinvestment should be calibrated; otherwise it would reduce investment and growth... Timing of public-investment is also important... Disinvestment during downturn might weaken demand and growth... However, timely reallocation to other uses may help growth... Infrastructure is important... Re-capitalizing PSBs could lower interest-rate but more investment in infrastructure would also crowd-in more private investment to improve supply and reduce inflation... Inflation constrains demand and economic-growth by increasing interest-rates... Money from disinvestment must be purposefully deployed...

Rupee depreciation might be sensitive to other factors than a mere increase in money-supply... Like devaluation in dollar due to Fed's rate hike delay... UK may also increase only in 2017... Easy money-policy for longer than expected might increase depreciation of their currencies too... Things have changed alot after China... Everybody is trying to stay afloat... Strong rupee shows the strength of the INDIAN economy... It means money is flowing in...

Explore deflation tactfully...

Corporate also demand resources in the market... Lower prices of resources would lower cost thereby more profits... Deflation has not been explored properly since we assume that in the long-run increase in population would increase demand and prices with scarcity of resources... But, the conclusion seems to be reversed with decreasing population growth rate in many developed countries... In the light of this evidence we might conclude that slowing population growth-rate could lower demand and increase supply which could also lower prices and probably deflation... As observed in the US, Japan, Europe... In these developed countries deflation shows that supply-side is not a problem with zero-nominal interest-rates... Economists know that deflation is good for the poor and not for Capitalist... But lower input cost might help save more to invest more for the Capitalist... However, after full-employment prices or inflation might increase because wages could increase to attract labor... Central bank can lower capital-cost to zero to incentivize supply but it can not cut wages unless it cuts real-rates with inflation, but not to zero... Deflation with downward nominal wage rigidity is likely to increase real-wages which is good for demand... Low prices may also increase savings...  

Real-life is complex...

Analysts are wondering that even after 50 basis points cut in the repo-rate and increase in money-supply has not depreciated the rupee (in INDIA) as explained in the economics text-books... Nevertheless, the same is true for inflation... because inflation and inflationary expectations are down even after increase in money-supply... But, it is true that inflation and depreciation have not been increased by higher money-supply... This discrepancy in the text-book and real life situation might be ascribed to the conditions under which theory has been constructed... Real-life situation is different and far more complex because of a variety of variables... Nonetheless, we are here talking about a real situation in INDIA... where even a higher money-supply has resulted in a stronger currency... However, depreciation is normally worked-out through inflation... To understand this we need to understand what is depreciation or devaluation? Depreciation is higher inflation to cut the real wages compared to other countries... So, has inflation actually increased to cut real-wages? It has not... So, how depreciation might increase? Depreciation is actually the result of inflation... Unless inflation increases it would not increase depreciation and exports... Cut in real-wages makes you competitive, but inflation has not increased... Therefore, there is no depreciation in the rupee... Inflation also increases nominal exchange rate which also increases exports demand... Exports might not respond without inflation and depreciation... Moreover, slowdown in many parts of the globe has made their central-banks pursue easy money and depreciation, and increase exports which also might be a reason for a stronger rupee... Notwithstanding, if the RBI directly purchases dollar in the market, it would also increase its demand and price making it strong and the rupee depreciated... It is another way of increasing depreciation... apart from more inflation... INDIA’s strong prospects of growth when other countries are faltering has increased demand of the rupee to invest in the economy and thereby making it strong instead of depreciated...      

High rates to lower demand might also reduce supply...

IMF has recently declared INDIA a hot-spot for global investor and even better among emerging markets due to its equanimity underscored by its reliance on domestic demand for growth, low global commodity price regime because it is mainly an importer, its upcoming rate-cut-cycle, the idea to explore manufacturing and exports possibility with low wages compared to the peers, its high rate of population growth rate, a reservoir of labor and demand, low fiscal and current-account deficit and its pace of expansion and growth, both actual and potential, present best investment and business returns... However, regulations still constrain the ease of doing business... Nevertheless, INDIA has improved alot on competitiveness in a recent rating-report and the government is conscious about problems of doing business, both foreign and domestic... Businesses employ people which is good for demand in the market through multiplier which creates income and tax to improve human-lives... Notwithstanding, the burden of a large number of poor-people, also due to high population  growth-rate and unskilled and unproductive labor-force could not be underestimated... Nonetheless, unprecedented public-spending in a developing economy would increase demand and prices (inflation)... The supply of money either by fiscal or monetary-policy should match or increase availability of goods and services... If the policies only aim at increasing money it would not solve the problem, but might lower demand-supply and growth by increasing inflation and interest-rate... The economy might start de-accelerating... Higher prices keep demand and supply low because interest-rate will increase... The question naturally arises that if inflation is high then why the central-banks restrict supply by increasing interest-rate when they may actually increase supply by cutting rates? Low cost of capital might help improve supply and lower prices... lower cost will also lower prices and inflation... When central-banks try to decrease demand to lower inflation it also lowers supply which puts the economy on a down-path... a contraction... Demand and supply are not independent from each-other rather they are different names to address the same economic-activity... When central-banks try to regulate demand by increasing interest-rate it also decreases supply and thereby worsening inflation... However, zero-lower-bound (of interest-rate) is the limit for interest-rate-cut to increase domestic supply after that foreign supply comes into play which might help to store supply and demand and price-stability, actually lower prices to increase economic-activity and growth-rate... So far economists have attributed high inflation to high money-supply and demand, and, not to the actual supply and demand of goods and services which might be positively correlated with low interest-rates... 

Rajan cuts repo-rate...

Raghuram Rajan, our RBI Governor, keeps-up with his surprise element in the decision making process. Rajan said he is expecting inflation to remain benign, close to 5.8% in the September, even without the favourable base- year effect, lower than the target (6%) set by the government and the RBI... Nonetheless, the government’s commitment to stick to fiscal-deficit target would keep inflation low giving more room to easing... Low global commodity prices have given Rajan confidence of lower domestic and imported inflation... Lower crude-oil prices would keep the current account deficit in check by lowering demand for foreign-exchange and inflation... However, rate cut might increase depreciation and export-competitiveness in an adverse demand situation globally which the governor tried to supplement with increase in domestic demand when he cut-rates... Lower global and domestic demand has probably made Rajan to try to increase both... Interest- rate movements do affect exchange rates, too...  Exports have also tumbled recently... Lower growth projections in a subdued global scenario resulted in a near aggressive rate-cut by the RBI... Rajan has cut double than the expectations... According to the Taylor-Rule a 50 basis points cut in rate by the central-bank may increase growth by 1% which could improve ahead... INDIA is in a rate-cut cycle but that would continue to depend upon inflation... Rate-cut cycle ends when inflation starts growing more than wages, and, hurt demand and growth... If both inflation and wage increase equally then its effect on demand will be negligible... Growth depends upon demand and supply which are interdependent and should be incentivized to gain more growth with price-stability... Both, price-stability and full-employment is important for domestic- demand because price-stability affects the value of money and therefore demand, and, full-employment signifies that everybody is employed and has an income... Price-stability lowers demand for wages and interest-rates hike which also help to contain cost and price, and ultimately demand, domestic and external... Lower-prices are imminent for economic-expansion and growth; otherwise it will increase cost and price, and, hurt competitiveness... Lower interest-rate today could reduce prices by lowering capital-cost and increasing supply... 

Case for rate-cut, INDIA...

After delay in hike by the US’ Fed, analysts, now, are trying to figure-out what might happen to the Indian scene where inflation and inflationary expectations are on a downside with fiscal- rectitude commitment by the government because it directly increases demand in the market by increasing employment and wages/incomes and inflation under all supply-constraints, higher interest-rates too...

The government was responsible for too much demand creation in the economy... Public-spending mainly aims at the poor which increase their consumption who almost spend all of their wages which increases the value of multiplier... Public-spending on the poor directly adds to demand and therefore to inflation and higher interest-rate which crowds out private-investment... However, the crowd-in effect of infrastructure can not be ruled-out which also needs lower interest-rate so the government could borrow more and spend... Therefore, low interest-rate is a pre-requisite for more investment and supply... Lower interest-rate also reduces cost of investment and inflation, also by increasing the supply...

Nonetheless, monetary-policy manages supply and demand, and, inflation and unemployment by changing money-supply and interest-rate which depends upon inflationary expectations... Interest-rate depends on inflation and inflationary-expectations... In INDIA the RBI is also trying to mould these two by adopting inflation-targeting recommended by the Urjit Patel committee-report... The RBI has set an inflation glide-path to shape expectations about inflation and interest rate... The central-bank has committed itself to lower inflation... And, low interest-rate is also helpful in taming inflation because it would increase supply... Low cost of capital is positive for supply which is also important for low prices... Cost of capital and inflation might go down...

 It is still upto the Governor to decide for a rate-cut, since the monetary-policy-committee is yet to arrive which might strip the chief’s veto over the committee... The governor is still independent to deliver a rate-cut out of the policy date... However. September inflation data might be expected by the RBI on which the base-year-effect is yet to resolve...  Nonetheless, base year effects off will increase inflation which may deter RBI from cutting rates aggressively... Moreover low inflation is a sin-e-qua-non for low interest rates, RBI has cleared repeatedly...

We are in a rate-cut cycle because we are expecting prices to go down... Interest-rate is set according to inflation expectation, both long-run and short-run... Nevertheless, we are expecting lower inflation ahead therefore everybody is expecting a rate cut... And as the cost of investment will go down supply may improve...  

Wait till the potential-rate is achieved (US)...

There is still unanimity among the economists, even the Fed officials, about rate-hike possibility. Price-stability and full-employment are the two main objective of the monetary-policy and the underlying objective of the above two is economic-growth-(rate). The Fed’s point is that the present rate of growth shows that the economy is on a sustainable-path and the rate hike would showcase confidence in the present and future growth. But, that might diverge the economy to a lower growth-rate because demand and supply will go down due to increase in the borrowing-cost. Higher interest-rate, actually real-interest-rate because of low inflation, may result in higher savings and less spending. By increasing the borrowing-cost the Fed could create some inflation, but, again higher prices will result in lower demand. Low demand will further result in lower inflation and possibly deflation. Economists are arguing that inflation and inflationary expectations are biased lower so there is no need for a hike which could be right strategy under the present-case because demand is yet to pick because the country’s growth potential is above 5%. The Fed should wait the economy to get that pace. Why the Fed would like to hike rates when the economy is growing much below the long-run potential, inflation is too low and the external environment is deteriorating. The Fed might wait till the economy achieves price-stability, full-employment and full-growth... The first two have been achieved...

Rate-hike by the Fed may lower demand and increase deflation...

Low inflation means there is a deflationary bias in the economy which points to the lack of aggregate-demand and interest-hike may even lower demand more, and the economy could fall in a deflationary-trap. Higher and higher interest rate might lower and lower demand, more and more and prices will fall. But, if the Fed continues with its stance it would increase demand by lowering prices and increasing wages as we approach full-employment... Deflation is a problem when we fall in a downward-spiral and prices decrease at a fast speed and decreases supply. Moreover, we also know that deflation also increases demand by lowering prices which is likely to exceed supply and may increase prices in the future. Low and stable inflation as it is now and lower interest-rate when we are close to full-employment and higher wages will reinforce demand and growth... In this situation if the Fed wants to increase demand it can choose to increase nominal and real-wages by increasing the money-supply when inflation is too low... The level of interest-rate or real interest rate is determined by the inter-play of demand and supply for money... Lower interest rate may be a signal of low demand and also for high supply and both show that demand is low relative to supply; therefore it must increase by increasing money and wages... which seems to be a little dovish as compared to the Fed’s current stand, but it might be good for the economy in terms of demand and future inflation and growth...  

Deflation, Japan...

Japan has been facing deflation since a long time now even after with so much of fiscal and monetary easing... The policy makers think that inflation, as a sign of economic-activity, is must for increasing the growth rate of the economy... But, this is not happening... Inflation materializes when demand outpaces supply and then all the prices increase in the same direction... even the interest-rates and wages that decide demand and supply, and, inflation and unemployment in the economy... And deflation occurs when supply outstrip demand... Since Japan uses core-CPI as an index for inflation we need to view the problem from that standpoint... Generally, core-inflation is the inflation in the manufactured-goods-segment, excluding food and fuel... and CPI is the consumer-price or retail index and when we add them together it becomes core-CPI which is the retail-price of manufactured goods, excluding food and fuel... But Japan’s core-CPI excludes food and not fuel... It uses core-CPI with fuel... Prices, normally, increase when food and fuel prices go up, which are important for price-control, but Japan is a developed-economy and food-prices are generally not a problem therefore it uses core-CPI with fuel... Core-CPI shows inflation in manufactured-products which largely depends upon interest rate and wages costs... The reasons for low core-CPI is the low interest-rate in the economy for decades and is even after full-employment in the economy wages has been relatively stable even after increase in productivity... Therefore, when the cost of manufactured-products is not increasing, including fuel, then how inflation will ensue... The economy will face low inflation... When wages are not increasing how demand and inflation will go up... The economy has, actually cut down on nominal and real wages... Japan in an attempt to make its economy competitive for exports has even hit in its foot itself... Japan, like the US has kept wages low even after increase in productivity of the masses... Japanese core-CPI, including fuel, after consumption-tax shows lower inflation because of low demand which means Japan’s tendency to invoke core-CPI, including fuel, has not lost completely... If the Japanese economy tries to increase nominal and real-wages according to the productivity, it might be able to stoke core-CPI in the future...

China crash and INDIA...

Analysts used to say that market was bit expensive therefore the current crash might be an opportunity to invest more in equities. The market today in INDIA has shown a similar trend by recovering 400 points, the next-day of the crash. The rout in China might make INDIA a beneficiary in terms of receiving capital because it is the fastest growing economy with sound fiscal and monetary conditions. Capital flight from one country to the other also takes time. Capital will flow in. The same trend also supports the above point that INDIA will be at the capital receiving end. In the same line the expected delay in increase in US rates due to below target inflation and the slowdown in China will also save INDIA from capital flight. We might expect it to be the major recipient of capital of the current global slowdown US, Europe, Japan and now China. INDIA’s story is based on the domestic consumption, insulated from slowdown in exports; therefore we can expect it to be relatively stable.  The whole argument between Keynes and Pigou was about the self-correction feature of the market-mechanism. Keynes said deviation from full-employment might be corrected by government expenditure. However, Pigou said lower prices will help the economy achieve demand and full-employment, again. In China both monetary and fiscal policy is under the communist regime. Attempt to restore growth might work against the market-mechanism. More money and wage inflation may erode economy’s competitiveness... 

China for demand...

IMF is backing China for devaluing the yuan when it aspires to be a SDR currency. A currency the IMF and others will use to forward loans for countries in need. IMF is saying that devaluing yuan is a step in that direction. But, a reserve currency status is likely to increase yuan’s demand; therefore it should appreciate, and not depreciate. Dollar’s reserve currency status makes it strong. Actually, China wants to stop sagging growth rate by increasing export-competitiveness, but at the cost of domestic-demand by cutting real-wages with inflation. Does it sound good or any way better (?) when you are favouring foreign-demand against the domestic demand. This does not sound (too) good to go about it. In a way the Chinese are taking money from domestic-consumers and giving it to foreigners. The downward-nominal-rigidity makes wages hard to cut, but it is always easier to cut on real wages by increasing inflation in order to make the economy competitive. The economy is experiencing deflation which means low relative demand or high supply. To overcome this situation Chinese might try to increase demand by increasing real-wages by lowering the price-level which is also likely to increase export-competitiveness. Using lose money-supply in a low unemployment country, and higher wages and inflation will make you globally uncompetitive. Economists know that a reserve-currency status and strong yuan will depreciate dollar and help US’ exports...