There is a glitch in the people’s understanding of the
economy at full-employment. Prices will start falling after full employment but
that is when supply conditions are good. Supply will outpace demand. In an
economy where supply conditions are not good prices will start rising because
demand is still increasing and supply is not catching up with demand. Any
economy in the short-run is constrained by its labor force.
We see that prices are rising in the US, falling
in the Europe and Japan, and, again, rising in India, much. But, unemployment
rate in the US is 7%, in the troubled Europe it is over 10%, in Japan it is 4%
and in India it is 3.8%. A country’s supply structure is the main determinant
of prices besides international trade. Out of the four countries, here, three
have no supply side bottle-necks or what is required for growth. But India has a serious supply side problem, mainly associated
with agricultural products, so prices are rising faster than demand. India is
going through over-employment.
All the four economies are going through a slowdown, to keep
it precise. But, a slowdown could come from several reasons, like for our four
counties. There is a famous saying that “you can turn a parrot in a learned
economist all you have to do is make him learn just two words, demand and supply”. And, following deduction-ism
I have reduced it to “demand” or more
precise effective demand as Keynes. Both, monetary policy and fiscal policy can
boost demand or effective demand. I’m talking this because during a slowdown
the thing we first need to find and stimulate is demand because only it can
create profits and growth rates, to showcase.
Economies at full employment need not to worry too much
about growth. What they need to worry about is per-capita income and, that is,
real per-capita income, which also necessitates the role of central bank to
keep the value of money intact, atleast, if it can not grow it. But, economies
when their unemployment rate is above five percent use monetary and
fiscal policies to unemployment, and, achieve growth and reduce poverty. They
should first use monetary policy and when interest rates are zero it requires
role of fiscal policy. The US and Europe both relied on fiscal policy even when
market was already at work to pump growth and lessen poverty. They are now run
out of their ammunition when it is the real time to use fiscal policy (a slowdown
and high unemployment rates). This is the time. When we use it, it puts more
resources at work most importantly poor people, who have lost their jobs, to
reduce poverty and inequality. Effective demand lies here (with the poor) and
employment will increase and with it prices as the economy will approach full
employment and will start falling after full employment because supply will now
exceed demand. But, in an economy with supply-side bottlenecks the pressure on
prices, after full employment, will be tremendous and they will start exploding
because prices will rise to control demand and that’s a market reaction and the
central banks reaction would be to increase interest rates. And economy will deteriorate. Like India.
The Problem with Developed Countries is not Supply, it is Demand...
Not talking about oil, it is really scarce. The problem with
the US is that it is falling in recessions every decade and they are associated
with oil price booms. Oil prices are adding too much to other prices in the US.
This situation it also shares with India, but subsidies have saved India so far,
but, not any more, because the government has decided to do away with subsidies.
As far as subsidies are concerned they can play an important role in
controlling prices through transport prices. Transport prices are important in
determining prices, especially foreign goods. We can say that it affects all
the prices. Easily. We should
subsidize the transport, if not oil. Both the
countries need it; actually every country should do it if it has to control
prices and bubbles in their economies. Because when the bubbles burst, no
doubt, prices come down but at the same time it reduces employment and income,
and, most importantly demand, the driver. The pressure on prices is to go up
because we have committed for it. Unless unemployment is at 5-6%. The US can not
use monetary policy except quantitative easing. But, it may not work because the
economy is in liquidity trap and people are accumulating currency notes as
reserves at home because the Fed cut interest rates so low that it discouraged
people from saving in the banks. But why the Fed would discourage people? The Fed
wanted them to spend more and save less which created a bubble between what the
economy can provide and what everybody wants. I mean everybody. There is a
famous “baby-sitting coupons story,” the problem with the story is that
everybody started wanting same thing at the same time. Like our housing bubble.
Everybody wanted a house at the same time. But, why? Because, interest rates are
record low. There was no incentive to save and moreover there is more incentive
to borrow. No saving only borrowing. How this model would work? The economy was
running only in one direction when it actually needed to apply save more, borrow
more. Anyways… Now it time for fiscal policy, we need it in liquidity trap. But
we have already spent the reserves except a trillion dollar coin. We have, 16
birds and one stone. External demand is externally determined over which you
have no control. But, to generate demand and employment, locally, you just need
to put more money where it is not, with poor. You just need to tell them, look,
we are imperfect human beings and this outer world is more imperfect. We need
to make it perfect, what can you help us with and we will pay you, may be wages.
Demand will be created, what the economy is looking for...
In Europe complete price-stability is a stated objective and
sometimes at the cost of employment, there fore the pressure on prices is to go
down. But since unemployment is too high in some regions, they have set higher inflation
target to boost demand and economic activity, because prices are a constraint
to growth and if we choose higher prices we can choose to grow higher. There is
a trade-off between inflation and unemployment for growth, and, we choose high
inflation when employment is low which will results in higher growth, and, when we are at full-employment we choose low inflation which will lower growth and will
contain prices. Europe is a big manufacturer and exporter, it needs to find demand/markets
for their products and sometimes beyond the union, in the US, may be in Asia or
Africa. But they can not devalue their currency because that would mean surplus
for some and for many deficits and for some, just high and low CAD.
Countries with deficit need a weaker currency and countries with surplus need a
stronger currency to maintain the desired level of employment and inflation because the goal is price stability and full-employment. But, both,
appreciation and depreciation can not be achieved at the same time with a
single currency in a currency union when some are better than others in the
same terms, inflation and unemployment. Poverty is very low in Europe but it
can drive the economy 4% (guess), but, we will need more government spending.
The latter option is very limited for European countries because they have already
spent too much on Welfare, almost addicted to spending, like the US, in the
pre-crisis period. As far as sovereign debt is considered the US and Europe is
on the same boat…
Japan is an aged economy, demand is very low and there is no
unemployment, the pressure on prices is to go down and is trying to inflate its
economy. But that is not possible because unemployment is at 4% and the economy
is not adding more people to its work-force. No new demand can be generated
within the economy. The only hope is either poverty alleviation or
international trade. Same like others. Wars are over but not over. The option
of foreign trade through depreciation is well known but the real depreciation
is so low that others are not impressed. Yen is depreciated in term of dollar
but dollar is again depreciating, the affect, as we know, will cancel out each
other.
But, poverty at 16% and needs to
be addressed. And to this end, Japan will have to bring out its people from low
end jobs to high end jobs. They need better jobs. Everybody needs a better job,
according to his skills. Skill up-gradation may work. Japan has created a class
at the bottom of its pyramid, the poverty class…
India’s Problem is
Supply...
But, the main problem with countries like India is supply, oil,
too.
Supply constraints have so severely
plagued the Indian scene that the central bank for almost three years
maintained its hawkish approach. By the way CPI is 10% since 2004, but because
of the 2008 crisis we maintained low interest rates. Our growth dipped after
the crisis, but we bounced back quickly with all the stimulation, fiscal and
monetary polices. But then prices went 20% (CPI). And we needed to increase
interest rates. Past three years almost since 2010. We are suffering from low
supply for a long time now. I favor FDI in retail to end remove supply side
bottle necks and recently i thought that it can also help us to reduce the CAD
and the foreign currency gap. All we have to do is to tell that if we will
supply we will accept dollars. And the advantage of FDI in retail is that we do not need
foreign currency to buy their foreign products as in case of imports. Let them
come in... We will have greater foreign reserves. I’m hopeful for FDI in retail because
of farmers, and, supply and prices. The
condition of our farmers …
When we talk of growth we generally do not talk of a
countries’ potential growth rate, not in news papers, only academics know. However,
our growth rate depends upon our population growth rate and how many people
join the work-force every year. This why the US is so worried, that a lot of
people are dependent on the State for their living. The economy is not
generating enough jobs so that everybody is absorbed and be able to take care
of themselves. But what is the cost of this ‘take care’ engagement, countries
in this distress can tell you. They are completely out of their reserves. Reserves
are really helpful when the economy is going through a trough and unemployment
is the result. Reserves should be used during a crisis and not to create a
crisis. But, it is a fashion now to support your economy through artificial
means but sometimes it is a necessity because the market reaches to money but
not to poor and the State helps poor to reach the market. State spends on their
behalf and therefore it needs reserves and especially during a crisis. The
responsibility doubles. So we need to be extra prepared for this situation and
less during the normal times when the growth rate is convincing. Countries have
depleted their reserves and now the call is to exercise monetization of the
past spending. I do not think the US government could spend more on the revival
during the recession. It was totally broke, except the coin idea. Monetary
policy and the Fed was more effective. Probably it was in a better position.
Europe, not all but many are also entangled in same situation, too much
sovereign debt and they, again, depleted of all their reserves, the individual
countries, not the ECB. Japan too is in a similar situation but the problem in
Japan is prices and deflation, not unemployment. Japan is in a classic over
supply situation, prices are falling. Japan, like India, is too at full
employment and supply is not a problem, there fore, the pressure on prices is
to go down. India too is at full employment but due to supply constraints and
demand the pressure on prices is to go up, labor is fully employed. India’s
unemployment rate was recorded 3.8% in 2012.
