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...

"

         "                               

                                                                                                                                                                                                                                                                                                                                         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...