The Fed might delay, again...

The lower growth forecast along with lower inflation and inflation expectations on passive consumer- spending and housing demand in the expectation of higher interest rate by the Fed itself this year would make it delay rate-hikes. The attempt to reinforce higher inflation and interest rate expectations by the Fed despite low public inflation and inflation expectations on the account of lower oil-prices has reduced consumer-spending, economic activity (low industrial production) and housing demand in the expectation of higher interest rates. Moreover, increased labor-force-participation-rate due to improved economic outlook of the US economy in the past has reduced wage and price-inflation pressures which might also push the Fed to delay rate-hikes. In addition, lower housing demand which is responsible for higher growth rate in the economy, a study shows, would also make the Fed holdup interest rates. Higher inflation and interest rate expectations have reduced consumer and investment spending by increasing savings which is evident in the data. The inflation and inflation expectation have made the people save more for the future which goes against more spending during recovery. Nevertheless, inflation targeting makes people expect higher inflation which might drive them save more, but, if people expect lower prices or deflation they would spend more because they would feel themselves richer when nominal income would also increase due to loose monetary-policy, real wages would increase. We have the optimal-monetary-policy by Milton Friedman which says that such a policy would require sufficiently low nominal interest rate and little deflation in the economy in order to maximize welfare. The studies in this area show that deflation and depression have a weak relationship, moreover, many deflation periods are related with satisfactory growth rate. Therefore, lower inflation or little deflation might help increase spending and real-growth-rate. Likewise, higher inflation and interest rate expectations may reduce spending and increase savings, and reduce the real growth rate. The Fed could try to increase spending by delaying the rate hikes when growth forecast is lower than before.

Lower prices might happen...

In Economics the debate usually starts with variables not adjusted for inflation like nominal interest rate, nominal prices of investment assets, nominal wages, nominal exchange rate including others not mentioned here and as the argument deepens, a closer look at the situation shows that the debate always comes to a point where the description cannot be completed without real variables like real interest rate, real wages, real prices of financial assets, real exchange rate i.e. inflation adjusted values of the variables. Sometimes the economists also tend to focus majorly on nominal or market variables rather than real variables because the trajectory of growth of an economy is supported more by increasing prices or inflation rather than deflation. We generally assume higher prices or inflation as result of increase in income, demand and growth-rate; economists very occasionally presume deflation as a consequence of growth unless the economy is going through a down turn. Also, because more money supply always push inflation and expected inflation, because the quantity theory of money says so. Therefore, economists rarely try to increase real variables because they do not assume deflation as an outcome of economic stimuli. One more reason is the downward rigidity of commodity prices and services, as put by Keynes

Economist and layman never think that prices might also go down as a result of expansion. However, a central-bank does not want to favor and communicate deflation because that would stifle supply and employment by increasing the value of money and thereby debt which is expected to incentivize investment, but sometimes the economists forget that increase in the value of money would also increase the real rate of return on investment and may also decrease real cost of investment by lowering the prices of factors of production. The real-investment would be cheap and real returns could also increase. But, the policy makers never commit deflation because they do not believe that prices may fall as a result of more money-supply.

Nonetheless, it is possible to have deflationary price regime because more money-supply would lower interest rate and cost of borrowing thereby increasing supply and lowering the prices.

This is evident is most of the developed countries stuck in deflation and liquidity-trap even with so much of monetary and fiscal easing Japan, Europe, US (still the interest rate is too low to qualify for the liquidity-trap). These economies are showing a deflationary bias in their price-trajectory. Although, productivity has increased with a lower rate but the population growth-rate has also gone down which has made supply outstrip demand aggravated by recessionary and slowdown outlook in many parts of the World.

Lower price and price expectations would make people feel richer, increase real wages and demand, and growth. Lower prices may help boost demand and clear the market. Once Ben Bernake, the former FED-Chief, himself said that” little deflation is not bad”.

INDIA could follow Germany for demand and exports...

The recent deceleration in the exports has been a source of concern for the Indian economy when the external environment is not conducive amid slowdown in many parts of the globe, now, including China with falling growth forecasts, and, lower current account deficit on account of the falling crude-prices and healthy reserves buoyed by high FDI inflows has shifted the policy-makers attention away. However, INDIA still needs to look at the sector for double digit growth for which it will have to increase its competitiveness through appropriate monetary, fiscal and international-trade policies. Competitiveness in the international trade could be brought up by either internal devaluation or external devaluation. Economists generally advise external devaluation over internal devaluation because the exchange rate is more flexible than changes in the prices of commodities and services. Nonetheless, evidences show that wages are stickier than commodity prices which might increase real wages and demand when inflation is low. But, the external devaluation reduces domestic demand by increasing inflation and cutting real wages (nominal interest rate minus inflation). Nominal exchange rate too depends upon money-supply, inflation and inflation expectation. Foreign exchange is also an instrument for investment for which inflation and expectation of changes in it matter. Nonetheless, internal-devaluation is also not uncommon and Germany is a live and living example. It has used internal-devaluation, except external devaluation to increase its exports competitiveness and has a considerable trade surplus. Germany recovered fast during the past recessions than other countries in Europe. Low inflation and inflation expectations have kept wage-demand low which has made German exports competitive and although productivity has increased slowly but real wages have been increasing which has also maintained the domestic demand. If INDIA is to fulfill its exports and double-digit growth ambitions then internal devaluation looks more suitable because it would increase both, domestic demand and foreign demand by increasing real wages and real exchange rate (nominal exchange rate minus inflation) by adopting and communicating a low price and inflation policy. Replacing inflation and inflation expectation with low inflation and low inflation expectations might be the better way to go around. Many of the developed countries has actually cut down on real-wages by external-devaluation and depreciation during the past few decades with inflation in order to achieve trade competitiveness which has strangulated and stagnated domestic demand in these countries and they are trying higher inflation and inflation expectations through the Quantitative-Easing and loose monetary-policy which have also reduced real exchange rate and foreign demand. Germany’s internal-devaluation might be a good idea and guide to increase demand than China’s external-devaluation. 

The monetary-policy review is pro-economy...

The Reserve Bank of INDIA today unveiled its monetary policy review along the expected lines with a 25 basis points rate cut in the repo-rate, but did not stop at this when he (our governor) proposed a few more measures to improve liquidity thorough cuts in the MSF and daily CRR requirement by 75 basis points and 5%, respectively in a dovish stand. He maintained that the RBI is committed to resolve the problem of liquidity-deficit by adopting a liquidity neutral position, neither deficit nor surplus, in the coming days with various measures including the open-market-operations. Our governor lauded himself for initiating the marginal-cost-lending-rate (MCLR) framework which has forced the banks to reduce the borrowing cost even before the today’s 25 basis points cut which would also be translated into lower lending rates in the days ahead. He hoped that lower repo-rate and the MCLR could lower the lending rates by as much as 50 basis points very shortly. The RBI has continued with its accommodative standpoint to boost economic-activity and growth rate with further rate cut expectations in the current year depending on a good monsoon and lower inflation. It further expressed its concerns on the back of the 7^th Pay Commission that it might stoke demand and inflation in the presence of the supply side bottlenecks. Nonetheless, our governor has fulfilled his promise of rate cuts while the government adhered to its fiscal-deficit target. The RBI has set a target for inflation with the CPI at 5% for Jan, 2017, even when the WPI is expected to remain very low in the case of soften global commodity prices along with the oil. Our governor has upheld an accommodative and dovish stance as long as inflation remains under check, and, overall the language remained pro economy and pro growth-rate.   

Downturns are time for spending...

The fiscal deficit, the gap between expenditure and revenue, and the cumulative borrowings or debt of the government over the years, back, has been a topic of debate between economists over the sustainability of debt that might involve risk because of overheating and bubbles in the economy. Both, spending by the government and the private sector through borrowing might lead to the tightening of the credit and trade cycles. Debt is not a problem till your financials are sound and revenues robust, and your economy is moving, but when things are not going the right way, i.e. during recessions or slowdown when there is high unemployment, low wages and demand then the Public-Debt makes more sense because the private sector is not doing fine. Higher public-spending increases employment, demand and growth during downturns through the multiplier. However, to use it on time you must have low debt to borrow more during the crisis. Too much public-debt in the Western-world made the countries to spend less during the recession when they should spend more to create employment. Therefore, we might point-out that the fiscal-policy should be used in the times or crisis or rainy days during the downturns for which it has to garner revenue during the booms to control inflation and overheating.

Under these perspectives INDIA too might draw a right framework for its fiscal-policy that downturn is a time for spending and booms are a time for revenues and consolidation to control demand and overheating. Overheating and high inflation fail to give the outcome we want higher wages, incomes, demand and growth, actually real wages, incomes, demand and real growth-rate. Inflation lowers the real GDP and lower inflation might increase it.