Helicopter-money, and, Fiscal and Monetary Policies...

The idea of “Helicopter-Money” has its origin in the Keynes famous advice to a President of a country of digging and leveling pits and pay for labor and wages which would create effective demand in the economy during recessions, i.e., advocating fiscal-policy during low growth. Some continued this argument with a difference that since this public investment has not actually created a public-asset to justify time and labor spent on the project so it may take another forms like helicopter-money or money under the ground or money in bottles in an attempt to simplify the procedure. Keynes prescribed fiscal-policy during recessions and liquidity-trap to increase demand, spending and growth. Nonetheless, he never added that spending should target inflation which the central-banks are doing rather he assumed that more spending would increase demand and prices by increasing employment and wages during recession.

If the central-banks would target inflation people’s views about real wages might change and they would save more for the future which means less spending. Whenever, wages or incomes increase the money is divided between consumption and saving. Poor people’s marginal propensity to consume is higher than other classes who have a higher propensity to save. Developed economies have fewer poor people and the majority is well-off and they spend less and save more out of a given rise in income as far as helicopter money is concerned. A part of this rise an amount would also be saved and that depends upon inflation expectations. Higher inflation expectations would increase savings and it is undeniable that some people might save all. The helicopter money’s multiplier would be lower than a fiscal-multiplier because this would increase wages and poor people’s incomes with no employment and with a higher propensity to consume. Poor people would spend more. Therefore, fiscal-policy to create public-assets and spending on wages look more enticing.

However, a permanent increase in wages and incomes would increase spending more. This is called by Paul Krugman as the credibility problem. The central-banks could not commit for a forever increase in money-supply because inflation would push them to tighten, but that would rest on the supply-side and, open and free-trade might help to overcome the problem of full-employment and more-supply. Nevertheless, if the central-banks could commit a permanent increase people might spend more. Inflation and inflation expectation would make them save more and lower prices might make them feel richer and spend more. A commitment to increase real wages in the long-run would increase demand. In the short-run, if we commit higher wages and lower prices that might also increase spending in the short-run. Also true for the long-run as mentioned before.

Therefore, if fiscal-policy commits full-employment and wages, and, monetary-policy lower-prices it is likely to increase spending and growth at a higher pace. Both, policies might do their bit to recover fast.

  

Too, reform inflation computing for rate-cuts...

The RBI is under a lot of pressure from all sides to reduce interest-rates for which it has adopted an inflation targeting framework for several years. For Jan 2016 the inflation target was set at 6%, and, for Jan 2017 and Jan 2018 the RBI has set an inflation-target of 5% and 4%, respectively. The RBI has set a range for inflation for the Indian-economy over the medium term, 4% with a band of 2% on the either side and a real rate of return of 1.5-2% to the depositors or savers. The RBI before the joining of the current governor had used the Wholesale-Price-Index (WPI) as the preferred gauge of inflation which is currently in the negative territory and has been replaced by the Consumer-Price-Index (CPI) under the new RBI regime.

However, inflation has two more main indices like Core-WPI or Core-inflation and Core-CPI, i.e. wholesale-prices of manufactured goods, excluding volatile food and fuel prices, and retail prices of manufactured goods, excluding volatile food and fuel prices, respectively. There is always a question or argument among the economists regarding the appropriate index for inflation. Different countries use different indices of inflation as per the requirements for interest-rate decisions. Nevertheless, it is entirely possible that some indices may show higher inflation compared to the other indices.

For example, in INDIA the WPI is negative at -0.91%, but the CPI is at 5.19% and Core-inflation and Core-CPI are around 2-3%. Therefore, if we take into account only CPI there is not much room for rate-cut after making provisions for a real-rate-of-return of 1.5-2%, but if we take into consideration the WPI there is a lot of space for monetary accommodation. The same is true for Core-inflation and Core-CPI below at 3%. Out of the four indices three do not show high inflation.

Nonetheless, the debate between economists for the right index of inflation is not over yet and if we take the CPI as the only index there is not much possibility for rate reductions.

Notwithstanding, our Chief-Economic-Advisor has been vocal about the problems of using WPI or CPI for the computing gross-domestic-product (GDP) which could also be generalized to the other two more indices – Core-inflation and Core-CPI. The problem is, if we use only WPI or CPI or Core-WPI or Core-CPI as GDP-deflator it would not look consistent with the true perception of inflation – producers and consumers, both. Too low or two high index for inflation might retard the methodology used for GDP and inflation calculation.

The method of figuring-out the mean or the average of all the inflation-indices to find-out GDP-deflator and inflation might seem more credible form the point of view of analysis. The mean of the combined inflation-index comprised of all the four main indices may truly reflect the general-price-level and the general perception about it.

     

We have come too far without irrigation facilities...

INDIA and the US have now emerged as the two growth-pillars of the global economy when others are undergoing a slowdown. After the rate-hike delay in the US, investors amid the global recessionary and deflationary bias in the commodity prices in several regions breathe easy and are looking for similar accommodative action from the Reserve Bank of INDIA to give an impetus to the stock-market and slow recovery in the economic-growth-rate subject to the constraints of inflation and interest-rate. The RBI governor has retained a pause on rate cuts after a 50 basis-points rate cut in September last year even when the stock-market tumbled several rounds after that, however, a balanced budget has done its bit in improving the market sentiment and analysts are now expecting further easing from the RBI.

Even though the Reserve-Bank has cut down the base-rates by a cumulative 125 basis-points last years, but the commercial-banks are reluctant to pass on the full-benefit to the borrowers when the industry is still clamoring for more rate-cuts in order to boost employment and wages, and demand-supply and growth. Nevertheless, the marginal-cost formula to set the lending-rates might force the banks to pass on the interest-rate-cut-transmission.

The government has committed higher wages and incomes through the Minimum-Wages-Act, the 7^th-Pay-Commission and more spending for the rural and the agricultural sector, but if the industry fails to supply demand owing to higher interest-rates it may backfire resulting only in higher inflation.

However, in INDIA prices of food-items are largely irresponsive to changes in interest-rate due to monsoon conditions which has had been a major source of worry and concern to the farmers. Although, the government has put interest-rate-subvention in place for the agriculture, but the unexpected weather- circumstances coupled with lack of irrigation facilities have turned the tide against the development and growth efforts through monetary and fiscal policies. Therefore, even if interest-rate is low, it barely corrects the monsoon vagaries and the irrigation gaps. It looks meaningless to tackle the problem of weather and irrigation through higher interest-rates.

The inflation we experienced during the last few years of the UPA government may be ascribed to misdirected expenditure to increase demand and growth with supply-side bottlenecks in food-management. We have come too far with half of the agriculture devoid of irrigation and good weather which we have to take with a pinch of salt. None of the government after the Independence ever showed their full-commitment to this big-problem. We have been too much dependent on rains for irrigation and food. Nonetheless, the current government at the Center has taken the stock of the situation of the agricultural-economy, wages, incomes and demand which rests too much on the rains.

We hope the present government would show its will-power to implement its plans for the rural and agricultural welfare, and, demand and economic-growth.   

  

The Fed-review this week...

The monetary-policy review this week by the Fed is a major event which might trigger a renewed emerging market equity sell-off due to a strengthening US economy and improved economic indicators – wages, consumer-spending, inflation (CPI and Core CPI), unemployment and economic growth-rate – all point to a recovery which might push the Fed for a rate-hike soon, but may not be necessarily in the next meeting. The slowdown in Japan, Europe and then in China and the expansionary monetary-policy used by their central-banks may deteriorate exports by a further stronger dollar. A worsening external global economy especially weak Chinese growth and demand may force the Fed to tighten slow and delay rate-hike when they are hurting exports and growth. Nevertheless, the US is adding more jobs every quarter than expected by the Fed and wages have increased at a faster pace to increase wage-cost and inflation which is evident in the Core-CPI. Nonetheless, the households’ expectations about inflation have remained benign with low fuel or oil-prices which had been an important source of price-rise in the past. Oil-prices probably touched their bottom due to supply-glut and are likely to reach their peak very slowly when the shale-oil has a potential to increase supply in case of higher oil-prices. The higher cost of production of the shale-oil has helped other oil producing countries with low cost of production to retain their market-share by price competition and lower prices. However, the expectation that oil-price would again reach $ 100 a barrel is a very remote possibility in the next few years which could keep inflation expectations low with more shale-oil production at higher prices. Under these conditions we might expect the Fed to remain slow on rate-hikes, but full-employment and, wage-demand and inflation may push the Fed to increase the borrowing cost to avoid a wage-price spiral. However, the efforts to increase innovation and productivity through factor saving production-functions would help to keep inflation low in the future and boost production and growth in line with the demand.  

Inflation-targeting would lower demand...

Economists think that deflation or lower prices make people delay spending which is against the sales logic that lower prices would help clear the market… During a sale or low price period the seller is expected to sell more. That is equivalent to say that higher prices or their expectation in the future would decrease demand and it might also increase savings which is against the spending reason. Higher inflation or inflation expectations in the future could also make people spend less, purchasing power goes down, number of goods and services relative to the money-quantity or amount in the hand goes down, and they also save more for the future. Economists say that the relative comparison between two nominal variables makes a real variable. Inflation hurts demand is very simple to understand when it can reduce demand by increasing the price-level. Simply, we know that lower prices increase demand and higher price reduce it (Tobin) which is true for both, the domestic economy and the external economy. Lower prices make you competitive in the market. Moreover, Pigou has also put his theory in a similar way that lower prices would increase real-wages thereby increasing demand. Ordinary people talk about nominal variables but an economist likes to look at the real picture, real-wages, real interest-rate, real-prices of assets, real GDP and so on, i.e., inflation adjusted values of variables. The central banks are trying to reduce unemployment by cutting on real wages, external devaluation to increase exports, and real interest rate through inflation to make businesses and investors spend more in order to clear the market but inflation targeting has also failed to increase domestic demand by reducing real wages and income to increase external demand at the expanse of the former at a time of global headwinds and slow recovery in the US. Inflation-targeting by the central-banks has reduced domestic demand by lowering real wage expectations and also increase savings, in the face of higher inflation, for the future.  

More on negative-nominal-interest-rate...

The negative interest rate adopted by some of the World’s developed countries’ central-banks has started a new discussion among analysts and economists as what would be the interest-rate trajectory for the economies reeling under recession, several rounds, when they have cut down nominal-interest-rate below zero in an attempt to boost consumption and investment spending to increase demand and growth keeping inflation and unemployment low. It is true that several important central-banks of the developed-world has cut down nominal-interest-rate below zero and are receiving money from deposits opposite of the usual practice of paying interest rate for their deposits which is primarily intended to boost consumption instead of savings during recession. But, these banks have missed to reconcile consumption and investment, both. They are trying to increase consumption by dis-incentivizing savings, but, have made no effort to increase investment by also reducing the borrowing cost in the negative which means banks should literally pay for new loans, means interest-rate payment for availing loans when they are getting money from deposits. The banks are now earning from deposits, but they must also try to increase loan demand by incentivizing through interest-payment, and that’s what negative interest rate should do in order to increase employment, demand and growth. Only then negative interest would make a complete sense to increase economic-activity because the Capitalist must also be incentivized to increase employment through more investment when the households are encouraged for more consumption. However, if the banks manage to increase consumption without investment that would create inflation and unemployment, in the place of deflation and unemployment, which is again an awkward position from the view-point of stability. Nonetheless, the objective of the monetary-policy and interest-rate management is to shoot for the natural interest rate at which the economy is on full-employment and there is neither inflation nor deflation.

Negative interest-rates...

Negative interest rates these days in Europe and then in Japan is the latest unconventional tool of the monetary-policy to increase demand and growth with a persistent deflationary bias in the general price-level attributed to low demand and spending, consumption or investment. Deflation is a prime cause of low interest-rate and the central-banks are trying to reduce real interest rate in order to adjust to natural interest-rate which would keep unemployment and inflation at the targeted or NAIRU-level while increasing the growth-rate to catch the potential. In their efforts to converge interest-rate to the natural rate the central-bank has adopted the negative interest path when inflation has failed to materialize to cut-down the real-rates. The banks as negative rates sound are charging its savers and customers for their deposits in order to dis-incentivize savings and incentivize consumption and investment. The negative interest-rate used by the central banks has charged on deposits but we have not heard banks paying for loans.  Negative interest also means reversal of incentives to invest or spend from the creditor to the debtor. It also means that the banks might have to pay more for spending or investment. Only then it is consistent with the outcome we want, more consumption more investment (or spending)... Is it happening...?