Prices, Savings and Interest Rate....

Probably, money demand and money supply are not directly responsible for changes in the price level or inflation, but the availability of goods and services in the economy which is determined by the demand and supply in the goods and services in the market, though the demand and supply of money decide the level of interest rate or borrowing cost in the economy, which has a significant effect on the demand and supply in the economy and the demand and supply of labour in the economy. But, the borrowing cost or the natural real interest and the wage cost or the natural real wage rate after full employment start falling due to the evidence of inflation put by the Phillips curve which could affect savings in the economy, nonetheless, the demand for money as put by Keynes has three functions - consumption, precautionary and speculative demand for money. But, here we are talking about just the speculative demand for money or the savings that go for investment and a rise in the general price level after full employment would affect the savings or supply of money which could further lower real interest rate and savings. We see that any deviation from the natural real rate would magnify itself, either inflation or deflation. In this situation higher borrowing cost would further increase inflation by restricting the supply of the economy. But, it is true that the price level could fall before the full employment because supply could be increased by lowering the borrowing cost and use the excess labour supply or international trade, after it higher nominal wage cost could increase due to tight labour market, labour would demand higher wages to relocate which itself would put a lid on labour demand and wage cost inflation. Higher wage cost would help increase population and demand, but only slowly which could help increase supply and growth in the long run. Higher wages are important at this stage because our population growth is going down and higher supply has depressed the prices globally. Higher inflation, higher wages and higher borrowing cost, at the same time, would make the economy uncompetitive and lose demand supply and growth; still lower borrowing cost would help contain the cost and prices. The evidence from Japan, the US and Europe has shown that prices are not increasing due to the falling population growth rate.

Though, not very clear why there is a difference between price level targeting and inflation targeting since both are the same, probably, inflation is the price level or general price level in the economy... Nonetheless, a higher price level or inflation target could help increase demand, because prices rise when demand increase or higher demand means higher prices, therefore if the Fed targets higher demand it may also increase the price level or inflation target. Similarly, if we have to target higher supply we must again target higher prices, but due to irrational expectations or exuberance the market supplies more which increases price corrections and prices may start falling. But, due to utility or profit making function people still would buy at lower prices which means lower prices increase demand and prices which increase demand and profits, but, again due to irrational expectations or exuberance people also often demand more than supply and prices overshoot... This has been taken from the stock market which is often prone to irrational exuberance and risks, the market skids due to, both domestic and external factors which is very common, even in this age of internet and information, long term investment in a good and cheap stock with higher price target are safe compared to others. Any economy or stock is not fully insulated from external shocks, too, when cheap dollar denominated money has boosted investment and asset prices, not even backed inflation in the emerging markets... Nonetheless, higher prices expectations not supported by demand and supply and fundamentals could force correction in the market or the economy.... Moreover, a 2% price target is too low to increase investment demand, for example the Fed has let only .02 dollar inflation in a dollar which is too low to increase investment employment supply and demand and prices and growth...

26/07/18....

The outflow of dollar from the outer economies would increase local money supply and inflation and depreciation and expectations... The dollar would become stronger also b'coz of tighter borrowing cost in the US... In developing countries price would increase and the nominal exchange rate too due to inflation and in the US they would fall due to higher borrowing cost... making the US competitive in real terms and the developing countries in nominal terms... Economist use both techniques to increase competitiveness reduce real wages by inflation, and increase value of money in the inflation adjusted terms, lower inflation would increase savings and demand... The former is called external devaluation or depreciation and the latter, the internal devaluation... depreciation means cheaper products in the relative terms... In the internal devaluation domestic prices fall due to lower borrowing cost relative to the nominal money or exchange to increase demand for labour and productivity upto full employment and in external devaluation nominal money increases relative to prices due to higher money supply and inflation and expectations... But, in external devaluation or depreciation domestic savings and demand go down, but demand for exports increase due to higher nominal exchange rate... But, both would depend on the excess capacity or excess labour supply because if demand would increase and supply not it increases prices and price expectations and lose market share.... At full employment the central bank might commit to leave the interest rate unchanged which could help stabilize the demand and supply and growth and expectations, if the economy is close to the inflation target and the exchange rate, too.... which would also help stabilize real wages and interest rate and expectations leading to a stable domestic demand and external demand and growth and expectations...

Higher interest rate and rate expectations when the economy is highly leveraged makes the situation more risky... in this condition a stable interest rate and rate expectations might contain the risk of default and recession or slowdown...

The Fed itself is creating trade cycles, but if it chooses only the forward way to increase demand then prices then supply and lower prices and again increase demand and the growth.... it may target lower borrowing cost and lower prices which could increase demand investment employment supply and would contain price and the growth for further demand... and growth....

If Corporate tax cuts are just passed on to lower prices of the Corporations products instead of increase in wages it would help increase demand... This had increased real wages by lowering the general price level... it would also lower interest rate and expectations... it would increase domestic depreciation, the real exchange rate would go up... and increase exports... all due to lower price level... in this situation there is an oppourtunity to increase the market share and profits... .

INDIA…

For farmers costs, including the living cost and wage cost have increased, but profit margins have been low due to government intervention and chain of the middle man who have a better capacity to hold... Storage and brokerage have further increased agri-costs... Credit, too... Marginal farmers might be provided basic income... Irrigation is absent and again costly...The middle man chain has also increased the cost to the market... Higher prices for farm products would not increase inflation much if volatility is curbed through proper supply side management, through imports and price stabilization fund, too... It would generate demand in the rural economy for the industries.... It is important to connect farmers directly to the food and food processing industry or market...

The Precedents....

The lower r* or natural or neutral real rate of interest or borrowing cost because of lower historical inflation and inflation expectations would further reinforce lower inflation expectations due to higher supply as experienced by the US, but after full employment and higher w* or natural or neutral real wage rate could increase wage cost inflation and prices and expectations which could result in higher demand and higher price and price expectations... Still the Fed needs to decide whether it wants to increase demand and supply, both, upto full employment. Nonetheless, if the Fed goes for higher demand, supply and prices and inflation and expectations it would reinforce demand and supply negatively… When prices would go up it would be a precedent for lower prices in the future or lower price expectations because of higher interest rate and expectations, the reverse would set a precedent for higher price expectations which results in boom and busts and trade cycles as put by the Knife-edge problem... Nonetheless, attempts to contain prices at full employment has been the goal for economic policies, but when intervention is made it produces cycle in the opposite and the economy moves from booms to bust to boom within the accepted price or inflation targets or bands set by the central bank in the time frame, same as in the stock market... The stock prices (too) are free to move within the price bands due to changes in demand and supply and normally prices may move 10% up and down in a day, but in some cases they may change 20%... It is true that prices help increase or lower demand or supply to clear the market which is also true for the labour market and other markets, as well. Higher supply lowers prices which increases demand and prices and higher demand increases prices and then supply... The market moves between higher supply and higher demand and between lower prices and higher prices... Lower and higher prices help clear excess supply and demand, since at lower prices people demand more and at higher prices people supply more which are the precedent for each other... Notwithstanding, if the Fed tries to stabilize or prices at the full employment by effective rate guidance people would stop investment and demand because of higher interest rate and interest rate expectations following its price band... The prices at lower end would increase rate cut and rate cut expectations and at higher end it would increase interest rate and interest rate expectations to curb volatility and maintain price stability at full employment… A too narrow price band would imply frequent changes in the monetary policy stance… and could deter demand and supply adjustments and growth…

The Fed has consistently underscored that rate hikes would be gradual under the argument that savings needs to be encouraged with higher nominal interest rates and expectations due to higher inflation and inflation expectations which increases savings and lowers spending due to inflation and expectations that would also lower interest rate and interest rate expectations that is against the expectations... the Fed wants to carve... higher inflation and inflation expectations and lower real interest rate and expectations, but that would lower savings and investment and increase unemployment and lower growth.... If the Fed creates lower nominal interest rate and expectations, but higher real interest rate and expectations due to higher supply and lower prices it would increase demand - employment, consumption, savings and investment - and growth and higher inflation expectations also because of higher demand and expectations...      

Productivity, Competitiveness and Lower Prices....

The distribution of labour or the efficient distribution of labour according to skill or specialization has taken a back seat in the discussion circles with the issue of in/equality which means that labour could move from unproductive to productive uses or sectors of the economy, the sectors that have a capacity or excess capacity to increase supply and lower the general price level...

The objective of trade could not be different, to increase productivity and competitiveness by increasing allocation of the excess capacity in the labour market to the sectors that are overheating or protected due to lower lower domestic production and supply and high demand, but only if there is unemployment in the economy and there is scope of efficient distribution of labour in the economy to contain demand and the general price level, but after full employment international trade would help increase domestic competitiveness and increase productivity by lowering the prices in the economy by increasing international supply...

The WTO supports tariffs to protect employment...

Nonetheless, there is another dimension to the argument that trade or import at a higher cost when we could produce at a lower cost also improves competitiveness of the economy...

Generally, importing is costlier than domestic supply due to higher transport costs....

Trade that increases real wages and incomes or domestic demand by lowering the prices would also lower borrowing cost and increase internal depreciation or devaluation (means lower domestic prices relative to the exchange rate or constant exchange rate) and expectations would also increase exports....

Incentives to increase exports and employment must not be confused with dumping and currency depreciation... Lower taxes too increase competitiveness... and lower tariffs after full employment would also increase domestic and international competitiveness and demand...

The lower prices would increase real effective wages incomes and demand and consumption, increase real effective interest rate and savings and lower nominal interest rate would increase investment and supply and real effective exchange rate which means more savings of exchange and demand of the exports which would also increase imports due to higher real effective wages.... and, EXPECTATIONS, too...

Lower prices are expansionary.... it increases demand and also increases supply which help contain demand supply and prices... In the market you can sell more at lower prices in a day and could also earn interest income... lower prices increases savings through higher real interest rate and increases investment.... export demand too....

Unemployment means we have excess capacity....

The price level or the general price level and expectations affect real interest rate and real wages and incomes and expectations which decide the level of all spending – consumption and savings and investment or debt fuelled spending.

Nonetheless, the central banks job is to target a real interest rate and expectations (too) to increase investment to full employment and full growth through the general price level and expectations.

During deflation and low growth it adopts an expansionary policy or lower real interest rate to increase investment employment income demand prices supply and growth and during high inflation and high growth it controls prices to keep real rates and savings and again investment stable.

We see that investment again increases investment until full employment is reached in the expectation of higher prices and if the agents believe that a particular rate of inflation is consistent with full employment or the nairu rate they would not invest more in the expectation of higher nominal interest rate and the spending and growth would be stable.

Clearly there is a role of communication in the whole process to increase the credibility of the reserve bank in forming rational expectations by achieving price stability and full employment.

Nonetheless, the unemployment or jobless data are too late in INDIA compared to the US.

The data on unemployment is a crucial part of the policy making at the central bank because its objective of the full employment, the RBI rarely talks about the unemployment rate while deciding the nominal interest rate.

And, a higher unemployment rate means that there is excess capacity in the economy to increase productions supply and lower prices.

The RBI actually works with a late data on unemployment and a month old data on inflation.

The monetary policy would be more consistent and credible when we have updated information on both unemployment and inflation.

If there unemployment and inflation in the economy it means we have an excess capacity which could be used to lower the general price level increase demand employment and growth.

Why the economy wants to pay more....?

Keynes and Milton Friedman were aware that a zero nominal interest rate, but a positive real interest rate due to full supply and little deflation would help increase (wages and incomes; Pigou's theory of real balances and Keynes theory of effective demand) and savings and investment demand employment and growth in the economy... Keynes hypothesis of the euthanasia of rent on capital is similar to that concept of the optimal monetary policy... We also have a Neo Classical Synthesis (NCS) theory, a mix of Keynes and Classicals....

When the Fed increases interest rate or interest tax on the economy it affects everybody in the same way, lower demand, but it also reduces supply and lower production which increase price and price expectations which means further rate hikes and hike expectations... which could aggravate the problem of trade cycles and the knife edge problem as put by Solow... Any deviation from the long run a higher real interest rate and savings and zero nominal interest rate and higher supply and lower prices would be self fulfilling and would produce trade cycles and would result in booms and busts...

Similarly, tax and tariffs too reduce demand of the whole economy.... and divert resources from the market... Nonetheless, where and when the market is not efficient it needs direction through incentives, inducements and stimuli...

Inflation, similarly, too reduces demand and savings which would drive the system away from the long run higher growth trajectory...

Inflation and inflation expectations theory is not supported by the evidences... The popular one is Japan... and low rates in the US and Europe There has been a consistent downward pressure on the prices, due to lower borrowing cost and higher supply, domestic and foreign....

The situation in INDIA and the US is quite different and the former too has raised import duty on several items, but unemployment in INDIA would let employ more people by the domestic steel producers and increase production and lower the prices, nonetheless the US is close to full employment which could increase wage cost and inflation, too, apart from higher tariff on imported steel which would also be less in quantity compared to the past...

The time is not right for the US....

At this time it is more important to increase productivity and real wages to increase demand supply and growth.... And, higher imports or supply might help reduce domestic price level and increase productivity...

And, competitiveness...

The whole recession passed and the US never tried to contain trade deficit by increasing tariffs, however it tried to achieve depreciation which did not materialize due to low domestic inflation...

Notwithstanding, if Trump really wants to do favour to the US people... he must impart them with good education and skills... The US has been dependent on immigration of skilled labour...

If Trump is trying to increase prices for the Capital and lower real interest rate that is a myth, coz that would reduce real return on money and demand.........

Why Trump fear trade deficits when they are settled in dollars... The only problem with the Trump policies is that they have a bad timing when the economy is close to full employment and money supply through tax cuts and spending would increase inflation and inflation expectations and nominal interest rate hike and expectations, and lower real interest rate and expectations and lower real wages and expectations and more dollars in exchange... The US would have to give more in nominal dollars, but would also increase real domestic goods exchange... unnecessarily...

Simply, import tariff on steel would make the domestic economy expensive and uncompetitive... Higher tariff on imports also means that US would pay more....

Why Trump wants to pay more.........,? 

Protectionism and Competitiveness....

The strong US dollar is one of the main factors affecting current account, 'coz of its demand due to its SDR status.... not many people could afford to buy dollar and dollar denominated goods... Inflation is a popular way to increase depreciation and cuts real interest rate and real wages and real exchange rate and expectations... But, we forget that we also lose domestic demand and savings and investment and increase capital outflows, just to increase demand for exports, and increase possibility of currency and trade wars... Inflation makes the economy expensive and uncompetitive... Nonetheless, nominal (foreign) exchange rate could go up due to inflation and expectations which also increase interest rate hike and expectation which may be contractionary interms of demand and growth and would also increase unemployment... 

A just reverse argument that lower prices could be expansionary could be the right way to increase competitiveness demand and market share of the economy...

  

Since wages are sticky, lower cost of capital could increase competitiveness, demand and growth if prices go down… 

It would increase real wages, real interest rate and real (domestic & foreign) exchange rate and demand and spending and growth........., it would also increase real return on investment....

  

Lower price and price expectations could still increase demand and lower supply and high price expectations leading to higher long run nominal and real wages, nominal interest and real interest rate and nominal foreign currency and and real domestic goods exchange rate and expectations...

  

At least the US quality is far superior than Chinese products... INDIA should welcome the US to produce and increase employment in INDIA... and export to the rest of the WORLD... The US expertise and capital would prove beneficial to reduce unemployment in INDIA...

The Fed does not need to control prices because demand supply in the market would adjust to change in the prices, higher prices would control demand, but would also increase supply to control prices and demand.... 

INDIA may allow raw materials and intermediate goods for lower cost of production and lower unemployment in the country and might also reduce tariff on other goods after full employment to control demand by increasing the supply... Trade that increases competitiveness and productivity might be promoted and that would happen when we would achieve full employment and full production and full supply within the country and outside the country...

  

China is sitting on a lot of dollar denominated debt, especially the local governments in China which have little control over dollars, and foreign exchange reserves that has become risky due to rate tightening cycle and lower supply of dollars... Higher growth in US could make the Chinese worse off in terms of interest payment on debt and could trigger capital outflows... A sudden spike in rate could kick off money out of China... China has invested in the US in bonds which could go down with lower supply of dollars.........,