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...

Old quantity-theory a partial-condition...

In economics the conclusions change as the evidences change. The evidences from the western-world have changed the views of economists at, “how money works in the long-run?” The old quantity theory of money that increases in money-supply in circulation will create a proportional increase in price of goods and services, is only partially true. Our recent study shows that despite huge increase in the money-supply, price-level in the developed world has gone down and there is a deflationary bias in all almost all the developed economies. The trend has shown that as the time has passed more money-supply has reduced interest-rate and borrowing cost which actually reduced the prices in these economies. The old quantity theory is by classical and supply-side economists, but they took only demand-side into account. They concluded that more money-supply will result in higher demand and prices. But, they failed to bring supply in the perspective because more money supply may also reduce interest-rate on borrowing cost and price. They missed that supply might also increase which will lower the price-level, opposite of the old theory. Therefore our RBI governor should focus on the supply argument to lower inflation instead of controlling demand which might lower country’s growth-rate, an underlying objective of monetary-policy. By increasing both demand and supply the governor would do a favour to the economy’s growth-rate. We are already in the interest-rate-cut-cycle, but timing is also important because supply comes with a lag. Interest-rate transmission, too...