The US is nearing the
end of the rate hike cycle after the Fed chair Powell uttered that it is close
to the neutral rate since prices are stable with full employment, the real
interest rate consistent with full employment and price stability, after
keeping it negative and zero for near a decade that lifted all, emerging markets
(EMs), too, including the US, especially the bonds and equity markets, across
the globe, nonetheless, the markets remained jittery on the account of rate
hikes and expectations and quantitative tightening coupled with tariffs war and
standoff between the US and China and rising uncertainty in the oil market and
strong dollar, all have inflation and inflations expectations, also due to
depreciation and capital outflows and depreciation expectations in the EMs.
Higher inflation and
inflation expectations due to higher oil prices and strong dollar and
depreciation and expectations have given rise to rate hikes and expectations in
the emerging markets alongwith the US, also a strong dollar and expectations,
have made finance costly and have made businesses postpone spending due to
higher interest rate and lower demand and price and expectations, however as
the Fed delays rate hikes and posit a more stable stance on interest rate that
would give the emerging markets a breather from outflows insearch of higher
bond yields and lower bond prices and stronger dollar and expectations as the
right signals for investment in safe heaven US on higher return expectations,
the Fed is equally responsible for stability in the emerging markets as so to
the stability in the US, a strong dollar and higher oil prices are also
problems for the US trade deficit and stock and bond markets as to the EMs.
Notwithstanding, lower
prices increase demand and investment, but lower price expectations might delay
spending, since people would postpone spending in expectations of lower prices,
ahead, that could delay recovery in demand and supply and prices, however, if
people expect higher prices as a result of higher demand, recovery in demand
and supply and prices could be fast or prompt, but in the real world prices and
expectations might change depending upon demand and supply and expectations and
intervention through prices and expectations, themselves, demand and supply and
expectations affect prices and expectations and prices and expectations also
affect demand and supply and expectations.
Nevertheless, lower
prices are good for demand and investment, but not lower price expectations, since
that would delay demand, and, similarly, higher prices are bad for demand, but
good for supply, however, higher price expectations from a low demand and price
base could increase demand and investment, but not lower price expectations,
which delays or slows demand, consumption and investment.
Therefore, lower prices
are good for demand and spending, but not lower price expectations for recovery
from a slowdown and higher prices are bad for demand and good for supply, but
higher price expectations could increase demand and delay supply further
increasing prices.
However, lower prices
could increase demand, which increase price and supply expectations and excess
supply and lower prices could increase demand and price expectations, again,
the economy moves between excess demand and excess supply in the absence of
data, that’s a cycle, the economy moves between lower prices and lower demand
and low supply and higher prices, higher demand and higher supply, however
stability in demand and supply and prices at full employment is good for
stability in growth and expectations, therefore, the economists have visualized
the neutral real interest rate for stability in the economic system, which aims
to neither boost nor discourage demand, supply and prices and expectations at
full employment.
Nonetheless, during
excess demand and inflation the central banks increase real interest rate which
could further reduce supply and increase price and expectations due to higher
unemployment and lower production and higher borrowing cost, on the other hand,
excess supply and deflation makes the central bank to reduce the borrowing cost,
which could further lower price and expectations upto full employment because
of higher production, therefore, deviations from the neutral interest rate are
self reinforcing through the demand, supply, prices and expectations channels
and the effects on inflation and unemployment are often cumulative.
The central banks might
try to avoid the trap by limiting rate cuts and rate hikes to a very few around
the neutral real interest rate; however, rate cuts and rate hike expectations
could increase uncertainty for demand and supply and prices and investment and
employment and growth and expectations…..
