Demand and Supply...

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.