The real cash balances and competitiveness (rev.)....

The global economy and the stock-markets are reeling under a rough phase which has been a cause of worry for investors throughout the world and stockholdings (and selling) – public or private - have been discouraged due to higher inflation, protectionism and trade (and tariffs), higher oil prices and higher interest rate and expectations that could make the economies lose competitiveness and demand when the population growth rate too is going down, even when the real wages are lagging productivity and competitiveness and is holding demand and growth back, the lower wages have also lowered the population and demand and growth.

Higher interest rate and expectations in the US and higher interest rate and expectations in the emerging markets due to higher tariffs, higher oil prices and capital outflows and depreciation has a direct effect on investors, credit and business, but may increase exports through depreciation, which might further drag down real wages and demand and growth, global growth, too…

Higher borrowing cost could also lower real wages and incomes due to debt repayment and higher other prices and also reduces employment because of less investment, all due to higher borrowing cost which would reduce demand and prices and economic growth rate and expectations.

The bust period would long as long as the rate hike cycle continues and the boom would correspond to rate cut cycle which depends on the inflation or inflation target/band.

But, if we try to increase demand by lowering borrowing cost and prices the economy wide and increase competitiveness, also through increased productivity and supply of capital due to lower borrowing cost, would work same as external devaluation or depreciation and exports, it would increase the real wages which could increase domestic demand as well as the real exchange rate and exports, productivity, competitiveness and demand and economic growth rate would increase.

Moreover, lower borrowing cost is a potent tool to achieve full employment, but also increases supply and lowers prices due to lower borrowing cost, it would increase both demand and supply and trade would further help improve the cost of living, tariffs after full employment would increase inflation and interest rate and expectations, also due to higher nominal wages and wage cost inflation.

Lower prices and price expectations because of lower borrowing cost and inflation may delay spending and stockholding, people wait for the lowest prices to increase spending and stockholding as it increases real cash balances or real wages and incomes with the public when interest rate is cut low which increases demand and price and growth and expectations.

On the contrary if there are higher prices and price expectations because of higher borrowing cost, the real balance effect or real wages and incomes channel would not work since people would lower spending and the stockholding which would lower demand and price and growth expectations…

Therefore, from a policy perspective lower prices and price expectations could increase demand, price and growth and would prove to be expansionary than higher price and price expectations which discourage spending and stockholding *resulting-in lower prices and price expectations which could delay recovery from a slowdown.

Nonetheless, the job of the central bank is to find out for the natural or neutral real interest rate at which the economy is neither expansionary nor contractionary at full employment, also called the non-accelerating inflation rate of unemployment without producing the cycles, but the inability to control volatility in the prices through the borrowing cost or cost of capital either tightens too much or loosens too much resulting in trade cycles.

Nevertheless, lower prices and price expectations due to lower borrowing cost would increase demand and growth expectations through the real cash balance effect than higher price and price expectation which lower spending and stockholding and lower demand and growth expectations….

* correction

...the fresh-wave of protectionism...

The US has again imposed tariff on the Chinese exports which has unleashed a fresh wave of protectionism, also in the form of retaliatory tariffs, and uncertainty in the global trade scene and economic growth which might increase the cost of living in countries by reducing real wages and incomes and increasing real cost to the economy in the case of raw material and intermediate goods and services.

In short, protectionism and tariffs are self defeating when it comes to the cost of the economy and that reduces competitiveness and demand.

Moreover, trade is viewed as an engine to reduce unemployment in the economy which is justifiable to an extent as an excuse for the protectionism, but after full employment tariffs would increase the cost for the economy increasing prices and inflation which reduce real wages and demand and growth and when it is countered by retaliatory tariffs the same happens in the trading partners’ economy, ie higher prices and lower real wages and demand.

By levying tariff we tax domestic demand for imports which increases domestic prices of the same goods too if we are near full employment.

The timing for such a move is not opportune and the trading partners, those are retaliating, are repeating the same mistake if they are around full employment, tariffs would lower domestic real wages and demand and growth.

The question is why Trump wants the economy to lose competitiveness by imposing tariff on the domestic demand.... it would reduce real wages... but, would also increase interest rates...?

He might otherwise try to incentivize exports... the corporate tax cuts if passed on to prices would increase real wages and real exchange rate too and demand, imports, too... it would also add to the trading partners economy... higher real interest rates would also increase savings and investment and stable interest rates....

Trump is losing edge because of lower real wages and incomes, but might gain from tax cuts if passed on to the goods and services the economy produces... it could boost real incomes...

Trump might try to increase (domestic) competitiveness... instead of protection from foreign (competitiveness)…

The neutral real interest rate could be found at full employment....

INDIA has a flexible inflation target of 2-6% than the US’ 2% target which gives it flexibility to maintain interest rate and the financial stability to manage trade cycles to curb exuberance and excess volatility. The central banks use higher borrowing cost to reduce demand by lowering employment, but this reduces supply too because of less employment and production; in short higher rates would reduce the demand for labour to reduce wage inflation and commodity inflation, mainly, and that may lower demand and prices and interest rate expectations which might kick back demand, inflation and interest rate up in the next cycle. We see that when the central bank increases interest rate, the prices move in the opposite direction, which could create demand and increase prices and interest rate in the future, in a sense it makes little sense to deviate from the neutral real interest rate at full employment. The economy experiences trade cycles due to the deviation from neutral rate of interest which are cumulative in nature, but the higher wage inflation is like the higher borrowing interest rate to control demand, higher wages would itself control demand for labor after full employment, business would become uncompetitive by the rising wages, they would fear that higher prices would make them lose market share. Notwithstanding, the problem of knife edge might be attributed to double tightening or loosening, tightening in labour market and tightening in the capital market, it could be the reason for excess tightening and loosening or volatility or swings in the trade cycles. But, finding a neutral rate at full employment is important to abide the objectives of inflation targeting. In a flexible inflation targeting framework, price moves in a band, like INDIA, we might expect inflation to move between 2-6%, and stability in the interest rate for financial stability. However, a strict or inflexible target, like the US at 2% might necessitate frequent changes in interest rate and expectation which would produce cycles and corrections, a flexible inflation target would help manage interest rate and expectations better with stability. The RBI may try to maintain stability by communicating that it would hike when inflation is above 6% and it would cut interest rate when inflation is lower than 2%, it must make its’ objective and signal clear to the people so that it produces the desired outcome, but as has already been pointed that deviations from the neutral interest rate would produce trade cycles and corrections. A neutral interest rate might be found at full employment at which prices may move in a band to clear excess demand and supply in the market or economy which needs flexible inflation targeting. A strict inflation target might not let prices move to clear excess demand and supply in the economy. Moreover, lack of updated data on unemployment in INDIA to determine full employment would make it difficult for the RBI to find the neutral rate of interest except the neutral stance. The RBI is shooting in the dark….    

People think that the rate hike would arrest capital outflows and depreciation, but to increases domestic investment and exports a lower rate could help and higher rate would lower domestic investment exports and growth... A lower interest rate or yield would also increase bond prices which would increase capital inflow in debt... Higher yields would make the debt unattractive... it would also help domestic investment in stocks... Cheap foreign money had been a prime cause of higher investment in the emerging markets therefore cheap domestic investment should replace cheap foreign investment...