The budget has it all except deficit...

Since I have been a spectator of the Indian economy for past several years it is natural for me to form an impression of the budget and I find it worthwhile to put my angle before my audience. Everybody was waiting for a relaxation in the fiscal deficit target which did not materialize, but the thrust for development and growth is clearly evident in the spending without deficit. Almost all the important ideas economists and analysts pointed-out have found space in the budget, be it agriculture, ease of doing business, infrastructure, health, farmers, irrigation, skill-development, job creation and many more… Although, the allocation of resources is always a problem, demand is higher, but the budget is right in the spirit when our FM did not want to sacrifice deficit and macro-economic-stability for more spending and higher growth rate. Probably the specter of last government’s overheated economy prompted our FM not to go overboard and keep the powder dry for the troubled times. But, he has targeted the right places which might need more resources, but resources are scarce with supply side problems in a developing economy and low inflation is important for policy-making and the credibility. If the government gives money to people to buy food and it is not available in the market, it would increase inflation and would cut real wages… Our FM tried to avoid these repercussions of too much spending which was a good take… A sensible budget…

Budget 2016-17...

This year the budget announcement started by comparing the current NDA regime’s achievement with the previous UPA government in terms of inflation, the fiscal and current account deficit and growth. The government has highlighted 9 pillars on which the budget has been built, namely 1) Agriculture/Farm welfare, 2) Rural focus, 3) Social healthcare, 4) Education and job creation, 5) Investment to improve quality of life, 6) Infrastructure focus, 7) Ease of doing business, 8) Fiscal discipline and 9) Tax reforms.

In this year’s budget, as was expected, our FM gave his broad attention to the revival of the rural and agricultural economy by announcing a wide range of financial assistance for the improvement of the farm and farmers. He acknowledged the need to improve the irrigation facilities by announcing outlays and promised to bring more land under irrigation and tried to increase credit facilities by providing interest-rate subvention. For the agricultural-sector he sought to double farmer’s income in the next five years through the budget and wanted to electrify all villages by May, 2018.

FM has launched a health protection scheme for Rs 1 Lakh cover per family and has introduced National Dialysis Services Program under National Health Mission. In the Budget Rs 9000 Crore is earmarked for Swach Bharat Mission. The government has also said to allocate Rs 1000 Crore for setting-up higher education financing agency. In the budget our FM has increased allocation to NREGA by more than Rs 38, 000 Crore. The government also wants to develop skills of 1 Crore people in the next 3 years under PMKVY and seeks to set-up 1500 skill-development institutes by allocating Rs 1700 Crore.. The total outlay for infrastructure is around Rs 2, 21, 246 Crore. The budget has also approved 100 % FDI in food products produce and marketed in the country. In the budget HRA has been increased to Rs 60, 000 and tax exemption for income-class below Rs 5 Lakh is increased by Rs 3, 000. The budget has set aside a sum of Rs 25, 000 for recapitalization of public sector banks. Apart from this FM has also increased taxes on tobacco, cars and some luxury goods.

 In short, this year’s budget looks sound as far as fiscal restraints are concerned and the FM has resolved to maintain fiscal-deficit target of 3.5%, but still also maintained to increase expenditure in case of perverse developments.  

Increase Public-spending on skills, infrastructure...

A big part of the workforce of the Indian economy is occupied by agriculture. The disguised unemployment has been a permanent feature of the Indian-agriculture. The budget should try to derive excess labour supply from agriculture to manufacturing by providing them right skills. Skills directly add to the productivity. No organisation can survive without right skills to produce and market its product... Even our PM believes in the skills-shortage and economists under-score his vision… Skills are also important for productivity and wages/incomes, and, demand, production, employment and growth... Therefore, any policy, even FDI, if leads to these conditions within the domestic economy should be promoted... Public-spending on infrastructure when the private sector is constrained of capital and infrastructure, itself... will also help pick the economy steam, growth, because we are supplying what the economy really needs to increase quality of life... We want inclusive development of all people and regions, and that should be best gained when we increase knowledge and skills, a productive work-force, a true human-capital... he will also pay taxes, revenue will increase... The government is exploring ways to finance the infrastructure-deficit... This best way to finance this is to borrow from the West for long-term where interest rates are record low... That would also help improving foreign-reserves, meanwhile… but, it entails exchange-rate risk which might require hedging through currency derivatives. However, foreign investment could also be secured by offering rupee denominated debt…

Budget and Macro-economic-stability...

Budget presents the account of the government, its expenditure, revenue and deficit depending on the economic, social, political and other requirements in the face of limited resources. Every government tries to choose between the deficit and surplus as the economy requires keeping the objectives of price-stability and full-employment in the mind. The economy increases spending during the downturn and low growth and increases consolidation during the high growth. Every economy goes through credit-boom and trade-cycles and might use spending and consolidation as policies to keep the growth rate highest with low inflation and unemployment. The consumer-price-index of inflation which is important for policy making is around 5.69% and unemployment is also low which do not necessitate aggressive budget announcements.   The significance of price-stability is known because it reduces the purchasing power of the people, but full-employment is also very important. Now, every government investment proposal would estimate the employment generation potential of the project. Employment is very important for every type of inclusion and to reduce poverty and inequality. The growth-rate of the Indian-economy, at 7.3%, although lower than its past performance, but highest among peers, is an important determinant of investment in any economy which our Finance minister would definitely try to increase since it has been revised downwards in the past several quarters. The low global demand and growth may also force the government to get the economy going through more public-spending. The economy works through multipliers and we might expect the expenditure at one place to increase expenditure and growth at other places. It is likely to be an expenditure oriented budget with emphasis to curb wasteful expenditure and increase revenue through dis-investment and other sources.  

 In the yearly budget the government may try to focus on the removal of constraints over the economy’s productivity and growth rate. It might seek to de-bottleneck investment within the domestic economy which has been lagging behind due to higher interest rate in the past when the economy is yet recovering from a downturn. Both, agriculture and industry are crucial for low inflation and low unemployment in the economy. Investment in agriculture is of prime importance because the higher prices of agricultural products are still a main source of inflation in the economy and the budget should definitely allocate resources to correct too much dependence on rains for irrigation. The agricultural growth rate of the economy is below 2% which is very low and must be increased to propel the overall economic-growth-rate. A depressed agricultural economy due to droughts and erratic rains is a major demand setback for the economy because almost 50% percent of the population in INDIA depends on agriculture for livelihood. The last two droughts in the past two years have kept the rural demand low which is clearly reflected in low industrial activity and growth rate. Industrial growth is vital for employment generation and low unemployment. The prosperity of agriculture and industry are interdependent, unless the agricultural economy is sound the industry would face higher inflation and borrowing cost. INDIA’s agricultural or rural economy constitutes a major source of demand for industrial products. The agriculture and industry might play a big role in achieving price-stability and full-employment. When food inflation would go down, interest rate will follow which could help industry create more jobs.

The US economy this year...

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 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 or borrowing cost and price. They missed that supply might also increase which will lower the price-level, opposite of the old theory. Therefore our central banks 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. 

A 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. The central-banks 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...

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... 

There is still unanimity among the economists, even the Fed officials, about rate-hike. 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...

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... 

Increase in the US' rate of the population growth will increase the rate of growth of the workforce/year... Means more demand, investment and growth... The country's actual, warranted and potential growth rate will increase... Actual growth rate is what the economy achieves... Warranted growth rate is what the forecasts say, the projection... And, potential is what is the economy's capacity. In case of higher population growth rate these all might go-up... The US does not have an age-limit for education and gap in it... actually getting degrees, good jobs and good pay-checks... Money may increase capacity for more children... More demand, more supply will help achieve full employment... The non-accelerating-inflation-rate-of-unemployment... also means price-stability, because of the non- accelerating-inflation-rate, words and meanings... But, when population increases money-supply should increase to keep wages and income atleast constant... If we will try to pay out wages and income from the money-supply in the past period it will reduce money-supply in everybody hands which will also reduce demand because if we assume that more people have joined the workforce, suppliers will supply more. Then supply relative to demand will go up, prices will fall, because now there are more goods and less money, value of money will go up, demand will go up... If this is the conclusion that prices will fall in the future, especially price of capital people will delay investment and less and less investment will put the economy in a downward spiral for a period... Similarly, the fear of higher interest rates soon may push the investor for investment soon... People view lower prices as a disincentive for investment, but they forget that lower prices will help everybody in terms of cost of living... The central-banks job is to match demand and supply of money by maintaining the right level of money-supply to keep demand and employment highest (possible) with prices stability in the economy to achieve highest growth rate to attract more investment and remove supply-side problems because that will make you capital costly because of inflation and high interest rates, again a disincentive... The central-bank has a monopoly over commercial banks to adjust price of capital to suit the economy... Fiscal or Government policy has the same role, price-stability and full employment... The economy has several players including the private sector... No economy can ever be a complete market economy... The US also used to subsidize agriculture not long-back ... Even oil market is restricted to export which has alot of potential now after shale... Lower oil prices will also make incomes in other countries soar and more demand for US exports. According to Keynes-Ramsay-rule economy should choose that capital-labour ratio which maximizes the present consumption in a domestic economy... hope it is true for the external-economy, too... Indirectly he is saying that supply demand as much as you can, means more supply, which also means lower prices or inflation, the law of supply... and Keynes always talked about short-run because he said “in the long-run  we all die”... And, lower prices have a direct relationship with lower interest rate... Keynes was aware of inflation and international trade... But, until Fisher and Wicksell real-interest-rate was not known to many and the central-banks later also tried to manage real variables- real interest rate, real wages... Keynes besides fiscal-policy was well aware of interest rate potential to achieve-full employment, but not in the liquidity trap... In the liquidity trap when nominal interest rate is zero, the banks try to cut down real interest rate by shooting inflation because when inflation will go up and nominal interest rate constant, real-interest rate will go down. Higher inflation will reduce real interest rate. However, reduction in nominal interest rate also reduces real rates. Nominal interest rate is normally cut to increase spending, but again not after the zero lower bound... The Fed understands the significance of real variables in increasing investment but not in increasing private demand... Private demand will increase when prices will go down and real wages increase... The Fed should now not commit inflation but deflation which will increase private demand... I think we are done with the investment and supply side...Now this time for the private demand....

The US now has become an oil producing country instead of a big importer of oil like before. It has cut down alot on oil-imports because of increase in the domestic oil production. Nonetheless for a considerable number of times the expansion of the US economy was constrained by oil-price rise because they directly add to the other prices in the economy and stoke inflation, which is tamed by increasing interest rate and reducing demand/supply and employment. Price stability and full-employment are important for a just distribution of income according to product which is the goal of Political-Economy or Economics. Therefore to achieve this objective it is important that oil-prices remain under control. Just like the US lower oil-prices are also important for growth of other countries because of the aforesaid aims. The discovery of the Shale-oil in the US is like a big innovation over oil production. It is extracted from sand and will be helpful in increasing supply of oil to the other countries and lower prices will help demand and employment. But, so far the US has almost restricted exports of oil from US. It is prohibited. Lower price of oil has also affected production and employment in the US. Oil is now a bigger industry in the country and also creates alot of employment. However, as far as Shale-Oil is concerned its cost of production is higher than normally. But, since it is creating employment with in the economy which has a direct effect on demand for labour, income and growth it should be done and excess should be exported to other countries. Oil prices (few quarters back) were trading near $ 40 and the normal cost of drilling normal oil is around $ 5-10. Therefore, if the cost of production of Shale-Oil is even double, it will be profitable to supply at $ 30 or 40 or 50 or over and increase competition. As we have seen oil-producers manipulate supply to avoid loss, the US can do the same.  Participating in competition is rewarded. Therefore, the oil-production in the US should continue to reduce slack in the labour market. It has a lot of potential to create employment. Only started...Moreover, when it will be exported it will also reduce the limit posed by higher inflation and interest-rate and growth in other economies...    

The Quantity-theory-of-money (QTM) has had been the holy-grail of economics for more than a century and is said to have a link with the Albert Einstein’s famous e = mc2... because both have connections with a mass and a velocity of something...  The equation of the quantity theory, MV =PT, also has mass or quantity of money (M) and velocity of circulation of money (V) which decides the level of inflation (P), and, real prices of goods and services in the economy (T) or nominal prices (N). Or we can also write it as MV = N, where the nominal-level of prices equals real-prices multiplied by inflation, which says mass of money and its velocity decide the level of prices in the economy... The same quantity-theory of money explains that money-supply decides the level of inflation and interest-rate in the economy. The interest rate or price of capital remains the most important price for the economy’s growth rate. There are many types of interest rate, but economists mostly view real-interest, nominal interest rate minus inflation, as more significant in deciding the level of investment and growth. However, ordinary public regard nominal or market interest rate, vital for spending. But, indeed, there is a difference between nominal and real interest rate, and if you want the real picture, real interest rate reflects the real-gain or real-sacrifice for the public. The majority does not know about it and everybody is not an economist. It is a kind information-asymmetry between economists and the general-public, but still important for agent’s actions and the outcomes... Nonetheless, money-supply and interest-rate has a direct effect on demand and supply to achieve full employment and higher economic-growth with increase in the value of money and not just price-stability, because increase in the value of money or deflation could help increase demand, which in the future might increase inflation and interest rate to cross the liquidity-trap visible in the developed-world. In the liquidity-trap interest-rates remains close to zero for a long-period of time due to low prices. In the developed world, our recent study shows, that despite so massive increase in the supply-of-money prices have shown a downward-slide, especially price of capital which should otherwise increase in case of a valid quantity theory of money. Prices or expectations of changes in it have a direct effect on the economic-growth. In other words, prices play an important role in economic-growth, and lower prices are more expansionary because it increases demand (Tobin). It may also be called law of prices. But, it works with both demand and supply. When prices fall demand increases and when they rise supply increases. It is expansionary both ways, but more expansionary downwards. And, we know well that lower price of capital or interest-rate is also expansionary in terms of investment and demand-supply, and economic-growth. In almost all the prior models a higher money-supply and higher savings result in lower interest rate which is very important for investment and economic expansion.  In the recent version of the quantity-theory-of-money, prices decrease and not increase when the monetary-volume increases. The central banks are trying to increase the money-base and reduce interest rate or price of capital, just reverse of the Fisher’s equation of exchange (MV = PT) that more money-supply would increase inflation and interest-rate. Under the new circumstances the quantity-theory-money and the equation of exchange do not hold the same conclusions as before. Since, in the new version increase in the quantity of money is likely to reduce price-level with low level of interest-rate. Increase in the monetary-base would reduce price or cost of capital and the general price-level. The long held opinion that increase in money-supply reduces the value of money (because of inflation) might not be true under the present case, because more money-supply is likely to reduce interest cost of production, which also increases supply and more supply may reduce the price-level, the law of supply. But, when demand is deficient more supply could reduce the price-level, and, the economy would fall in lower prices and interest rate, and probably will push economy in the liquidity trap. The central-banks are increasing money-supply, lowering interest-rate, increasing supply and also targeting inflation, which might not work because supply-side is improving, but excess of labour-supply and low wage growth may be responsible for weak-demand. Inflation-targeting could increase prices or inflation which might hurt real-wages and demand. The banks might try to reduce unemployment by increasing money and reducing interest-rate or cost of capital, but when cost is going down how inflation would pick. Inflation would increase when labour becomes scarce and demand higher wages to switch to other profitable locations. Higher money-supply and lower interest-rate also point that capital is not scarce, but after full-employment labour becomes scarce and might demand more wages which may also result in higher demand, inflation, interest-rate, and possibly exit from the liquidity-trap. Nevertheless, the results of the equation of exchange of the quantity theory of money have changed in the past few decades. Moreover scientists still use Newton’s method to launch rockets instead of Einstein which also might change in effects and interpretations...

Keynes predicted the euthanasia of the creditor or rentier of the capital because he thought that land and labour are scarce, but capital has no reason to be scarce, because the central-bank can print money to stoke demand/supply to achieve full-employment. In the developed-world the central-banks have pumped so much money in the system that has made money so cheap that pushed interest-rate rock-bottom (Japan, US, Europe). In these countries, capital is cheap and not scare, at all; interest rates are at zero-lower-bound. These economies are very close to that (Keynes’ concept of) euthanasia, when interest rates are almost zero. If we take Japan as an example which is reeling under recession for past two decades and interest-rate near zero, euthanasia of the creditor seems very plausible. In all the three economies interest-rate is near zero and they are also probably in the famous Keynesian liquidity trap in which people accumulate reserves, when nominal interest-rate is zero and cannot fall further and in the expectation of lower prices forth they delay purchases.  Prices reflect scarcity and higher-prices reflect higher scarcity, even prices of labour (wages) and capital (interest-rate). During downturns both are not scarce as there is a cut down on investment and interest-rate (or increase in money-supply) and employment and wages (or increase in unemployment and labour-force).  In an attempt to increase demand and growth, these banks failed to understand the importance of savings which is also a function of real interest-rate (nominal interest rate minus inflation). It has also led to capital-fight. Moreover, in another attempt to make economy competitive we have also cut-down on real-wages (nominal wages minus inflation). The continuous increase in money supply and inflation has kept real-interest-rate-and-wages and demand low. Moreover, slowing population growth rate has also affected demand negatively. The central-banks are trying to push the economy through money-supply which is supposed to increase spending and inflation, but this is even going to hurt demand by lowering real-interest-rate-and-wages and might not work in the liquidity-trap. Savings also do have a positive effect on demand through lower interest rate and higher investment. Moreover, inflation will also lower real-wages. These banks policies might have a negative effect on demand by increasing inflation. The Fed is trying to push prices up which is opposite of the argument that increase in real-wages will also increase demand, the Pigou-Effect.  The effect is also helpful in the liquidity-trap by increasing real wages and demand. Growth-rate of the economy will increase. The Fed should try to release the repressed demand by increasing real-wages and stop inflation targeting and let the prices fall to increase demand. Lower interest rate, as they are, will help increasing investment. The interest rate in these countries might remain very low, probably zero, for an indefinite period of time (may be forever) because in these capital rich countries, capital is not scarce anymore...

The best way to help the labour is to increase the value of their wages, actually real wages, by reducing inflation and prices overtime. Samuelson states that real-wages should rise in the long-run, one of the stylized-facts. A stylized fact is based on evidences. Nominal-wages are downward rigid which means they do not go down easily because that would cause conflict and friction between capitalists and labour and would be a moral issue. Labourers are poor- people compared to the Capitalists. There is always a tussle between (them) that Capitalist will keep wages low and labour to keep them high. And in this battle labour is paid a raise only as much as inflation has increased which has kept their purchasing-power constant but not increasing. The real wages has remained subdued where they were years ago. It is true that the number of good-things in life has increased but they are still beyond the reach of everyone. This means that there are more goods relative to money in people-hands which makes money scarce than goods cheap. Prices should fall, but this has not happened which means that real wages has gone down means less demand (due to inflation) for the industry itself because prices has increased more than wages that points that the distribution of income is far from equitable. Another stylized-fact is that share of labour and capital would remain constant in the long-run and. Economic policies should aim equitable income distribution according to productivity.

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.

The Liquidity problem...

The debate in the air that the economy has a liquidity-deficit owes a lot of attention because it would ultimately hinge on the credit cost, investment and higher growth rate, closest to the potential even when the policy rates are on a downtrend. The central bank has reduced repo-rate cumulatively by 1.25% or 125 basis-points but the commercial banks have passed only a 60 basis-points which failed to give a strike in terms of credit take-off and growth. The commercial banks are demanding more liquidity to pass on the policy rate transmission because that would increase the scale by adjusting the rates lower and give investment a fillip. Lower interest rates would increase the demand for investment, but the banks are insisting on higher rates which are holding the recovery of the economy back. In one way it is totally equivalent to the demand for lower policy rates. Banks put liquidity-deficit as an answer to higher rates even when the policy rates have gone down and the RBI is in the midst of rate-cut. Policy rate cuts also mean more liquidity; it means the commercial banks can borrow at lower rates, besides their own deposits. If banks can borrow lower they should pass on the benefit to the investor so that they may increase spending. Moreover, lower borrowing cost would help the banks to increase their market share. Lower borrowing cost might increase the scale. The banks are looking at the RBI for more liquidity but the Governor is clueless that the situation rose even after the rate cuts. However, the commercial banks always persist for higher rates. Bond traders also demand more liquidity and lower yields because that increases bond-prices. Commercial banks should revaluate their strategy. RBI is cutting rates and lower policy rates also mean higher liquidity.    

Effective action required...

The monetary-policy-review was along the expected lines because inflation has shown an upward bias depending on the food inflation which has become a permanent feature of the agriculture economy devoid of sufficient irrigation facilities. Every year prices of food items become a headache from the point of view of inflation, every season. Prices of one or two food items almost always deteriorate the household expenses. The government and the RBI are aware of the fact that certain food items are creating hurdle for economic growth because of delayed rate cuts, but they are largely ineffective in providing solutions. Whenever, economists propose imports it is sidelined by arguing in favour of domestic producers to protect them from foreign competition even in the face of skyrocketing prices and speculation. Sometimes some governments also decline to curb exports even in the case of higher domestic prices. But, it may work to keep prices stable and not curbing agriculturists’ profits altogether. It might try to gauge or expect demand through data in a period to facilitate supply in the same period. Prices are determined by the interaction of demand and supply. Imports are an important part of the supply chain and the price-stabilization fund must be used to curb too much volatility and ensure the price-stability which is also expected from the monetary-policy. Inflation is closely watched as an indicator of the health of the economy and investors, especially foreign investor, prefer low inflation because it would increase the value of investment in real terms and exchange rate term. Notwithstanding, inflation is also important to incentivize domestic investors by cutting down real interest rate (nominal interest rate minus inflation) which reduces the cost of capital and also labour because inflation would cut down real wages. Recent increases in inflation with a 125 basis-points rate reduction by the RBI last year have reduced the real interest rates, but the industry has failed to recognise that opportunity. The RBI has maintained that it would try to keep real rates around 1-1.5% in a dovish stance and 1.5-2.0% on a hawkish tone. If we calculate the real interest rate, it has come down to 1.15% which should catalyse investment spending but it has not. In INDIA people mostly track nominal interest rate as a cursor for investment. But probably the show stopper of economy, the construction, is constrained by bad assets and over-supply because of high inflation and higher interest rate and lower demand in the past. Nevertheless, house for all by 2022 is a giant step in the direction of keeping the real estate moving. It generates a lot of employment. The 7th pay panel would also increase demand. Bad assets/supply of the construction has become a drag on the economy’s demand which is only likely to revive with incomes and demand which the government spending might provide when the economy is still picking-up from a down turn. However, our RBI governor has made a loud pitch to stick to the fiscal-deficit and inflation targets. Downturns are good for spending and upturns are a moment for consolidation. If the government spending helps improve incomes during the downturn it would increase demand for the construction, too...