Rajan cuts repo-rate...

Raghuram Rajan, our RBI Governor, keeps-up with his surprise element in the decision making process. Rajan said he is expecting inflation to remain benign, close to 5.8% in the September, even without the favourable base- year effect, lower than the target (6%) set by the government and the RBI... Nonetheless, the government’s commitment to stick to fiscal-deficit target would keep inflation low giving more room to easing... Low global commodity prices have given Rajan confidence of lower domestic and imported inflation... Lower crude-oil prices would keep the current account deficit in check by lowering demand for foreign-exchange and inflation... However, rate cut might increase depreciation and export-competitiveness in an adverse demand situation globally which the governor tried to supplement with increase in domestic demand when he cut-rates... Lower global and domestic demand has probably made Rajan to try to increase both... Interest- rate movements do affect exchange rates, too...  Exports have also tumbled recently... Lower growth projections in a subdued global scenario resulted in a near aggressive rate-cut by the RBI... Rajan has cut double than the expectations... According to the Taylor-Rule a 50 basis points cut in rate by the central-bank may increase growth by 1% which could improve ahead... INDIA is in a rate-cut cycle but that would continue to depend upon inflation... Rate-cut cycle ends when inflation starts growing more than wages, and, hurt demand and growth... If both inflation and wage increase equally then its effect on demand will be negligible... Growth depends upon demand and supply which are interdependent and should be incentivized to gain more growth with price-stability... Both, price-stability and full-employment is important for domestic- demand because price-stability affects the value of money and therefore demand, and, full-employment signifies that everybody is employed and has an income... Price-stability lowers demand for wages and interest-rates hike which also help to contain cost and price, and ultimately demand, domestic and external... Lower-prices are imminent for economic-expansion and growth; otherwise it will increase cost and price, and, hurt competitiveness... Lower interest-rate today could reduce prices by lowering capital-cost and increasing supply... 

Case for rate-cut, INDIA...

After delay in hike by the US’ Fed, analysts, now, are trying to figure-out what might happen to the Indian scene where inflation and inflationary expectations are on a downside with fiscal- rectitude commitment by the government because it directly increases demand in the market by increasing employment and wages/incomes and inflation under all supply-constraints, higher interest-rates too...

The government was responsible for too much demand creation in the economy... Public-spending mainly aims at the poor which increase their consumption who almost spend all of their wages which increases the value of multiplier... Public-spending on the poor directly adds to demand and therefore to inflation and higher interest-rate which crowds out private-investment... However, the crowd-in effect of infrastructure can not be ruled-out which also needs lower interest-rate so the government could borrow more and spend... Therefore, low interest-rate is a pre-requisite for more investment and supply... Lower interest-rate also reduces cost of investment and inflation, also by increasing the supply...

Nonetheless, monetary-policy manages supply and demand, and, inflation and unemployment by changing money-supply and interest-rate which depends upon inflationary expectations... Interest-rate depends on inflation and inflationary-expectations... In INDIA the RBI is also trying to mould these two by adopting inflation-targeting recommended by the Urjit Patel committee-report... The RBI has set an inflation glide-path to shape expectations about inflation and interest rate... The central-bank has committed itself to lower inflation... And, low interest-rate is also helpful in taming inflation because it would increase supply... Low cost of capital is positive for supply which is also important for low prices... Cost of capital and inflation might go down...

 It is still upto the Governor to decide for a rate-cut, since the monetary-policy-committee is yet to arrive which might strip the chief’s veto over the committee... The governor is still independent to deliver a rate-cut out of the policy date... However. September inflation data might be expected by the RBI on which the base-year-effect is yet to resolve...  Nonetheless, base year effects off will increase inflation which may deter RBI from cutting rates aggressively... Moreover low inflation is a sin-e-qua-non for low interest rates, RBI has cleared repeatedly...

We are in a rate-cut cycle because we are expecting prices to go down... Interest-rate is set according to inflation expectation, both long-run and short-run... Nevertheless, we are expecting lower inflation ahead therefore everybody is expecting a rate cut... And as the cost of investment will go down supply may improve...  

Wait till the potential-rate is achieved (US)...

There is still unanimity among the economists, even the Fed officials, about rate-hike possibility. Price-stability and full-employment are the two main objective of the monetary-policy and the underlying objective of the above two is economic-growth-(rate). The Fed’s point is that the present rate of growth shows that the economy is on a sustainable-path and the rate hike would showcase confidence in the present and future growth. But, that might diverge the economy to a lower growth-rate because demand and supply will go down due to increase in the borrowing-cost. Higher interest-rate, actually real-interest-rate because of low inflation, may result in higher savings and less spending. By increasing the borrowing-cost the Fed could create some inflation, but, again higher prices will result in lower demand. Low demand will further result in lower inflation and possibly deflation. Economists are arguing that inflation and inflationary expectations are biased lower so there is no need for a hike which could be right strategy under the present-case because demand is yet to pick because the country’s growth potential is above 5%. The Fed should wait the economy to get that pace. Why the Fed would like to hike rates when the economy is growing much below the long-run potential, inflation is too low and the external environment is deteriorating. The Fed might wait till the economy achieves price-stability, full-employment and full-growth... The first two have been achieved...