Gold, Short-Note...

The main worry about Gold is that we have a large import-bill and demand for more foreign exchange would increase current account deficit. Gold is only one of the investment asset class and is safer and liquid than others, it is a safe-haven asset, it competes with other investment class in the market that yield a return. When you invest you commit to hold the amount off consumption and the market offers a return, but gold gives you the opportunity to sell whenever you think it is profitable, similarly like bonds, but other investments such as fixed-deposits offer returns only after a time-period is lapsed. However, historically gold supply was matched with the money-supply and higher money-supply would increase inflation and therefore would reduce the purchasing-power of gold, but it may increase the nominal returns as a result of inflation. However, if people suddenly start hoarding gold the price of gold would shoot-up when there would be more money-supply in circulation and prices of other Goods & Services increase, which is just a different transfer of money owner ship. The CAD point and the exodus of money from the economy while importing gold seem justifiable while arguing that it is unproductive for the economy and therefore the government wants to lower demand of gold. Indians have a taste for gold also because it is a status symbol, but the investment demand is high too and increases when other investment assets like equities and debt do not perform well during slowdowns, however people think that gold is also a protection against inflation, but they fail to take into account that other prices have gone up too and real-price or purchasing power of gold is actually down. The gold monetization or deposit scheme might help circulation of gold within the economy without dependence on imports, in other words it helps manage demand, supply and price of gold within the economy. Notwithstanding, the gold bond scheme, offering the market-price of gold might also help reduce demand for imports and save foreign exchange.           

Lower Prices Are Good For Equality...

Equality or inequality has had been the underlying objective of the redistribution of natural-resources or endowments within the society or economy, has had been the subject-matter for Political-Economy or Economics since inception which endorses returns or incomes according to the productivity or marginal-product i.e. contribution to produce another unit of a good or a service. Economists presuppose that any activity should increase supply and demand, both, in order to justify investment or spending to keep the economy going or to achieve higher economic-growth keeping the price-level or inflation and unemployment stable since higher inflation or too much lower unemployment would increase scarcity and the cost of factors of production, like labour and capital i.e. wages and interest-rate, and would make the economy uncompetitive. However, there is also a parallel or counter view that inflation also reduces real-wages and real interest-rate; therefore it lowers cost of production and increases competitiveness of firms and the economy. However, if take a close look we might derive that lower real-wages and interest-rate would lower demand and savings in the economy which might diverge the economy from its long-run-equilibrium-path. On the other hand lower inflation or disinflation or slow or controlled deflation might increase real-wages and demand, and, real-interest rate and savings and lower nominal interest rate on investment. Higher real returns on savings or capital is likely to induce further investment by lowering nominal interest rate, probably zero, lower inflation may increase real interest rate if nominal interest rate is constant or reduce nominal interest rate when real-rate is constant, it is expansionary both ways, higher real rate would increase savings and lower nominal rates could increase investment, lower prices would help real interest rate and savings and lower nominal  interest rate would help increase investment. On the contrary, higher inflation could reduce real interest rate and savings and investment and the economic-growth rate. To conclude we may say that higher prices though increase nominal variables like GDP or interest rate or wages, but also reduce real GDP or interest rate or wages or economic growth and is contractionary in terms or demand and supply, but lower prices might lower nominal variables, but increase real variables and economic growth and is thus expansionary. Moreover, higher inflation could stoke bubble fears which might add to instability because the gap between nominal and real prices of assets increase with inflation only to find later that there has been an oversupply due to higher prices without matching demand which might result in price correction, lower economic activity and higher unemployment. Lower-prices or stability is important to avoid wild swings in the economy and achieve full-employment. Notwithstanding, when the price-level is biased lower it increases real-wages, incomes and profits too and when it is inclined higher the society or economy loses their values, lower prices are important to increase spending, consumption and investment, both, and increase government spending, too, when there is scope to increase productivity while containing or lowering cost and prices and increase competitiveness, and, increase supply and demand and per-capita-income to reduce inequality and increase the standard of living of the less privileged. When we try to cut costs by inflation we unconsciously cut demand and supply by cutting real-wages and increasing nominal interest-rate, respectively. Therefore, we might say that the economic-policies that increase inflation and inflation expectations are the second best to the ones which lower inflation and inflation expectations because it increases demand when the population rate of growth is slowing in many parts of the World and might also lower interest rate and interest rate expectations thereby increasing supply, too… Probably, the statement that lower prices are more expansionary… is right…                

Spend To Increase Productivity, Not Just Demand...

The discussion among the analysts and economists on the rationale of the Universal-Basic-Income (UBI) in INDIA has yielded momentum as the present government’s revenue has shot-up after demonetization and there is a demand to transfer a minimum amount in poor people’s account in order to re-distribute the society’s resources which could spook public-debt resulting in higher taxes and interest rate, later, for future-generation. However, the economists deter too much borrowing, but someone with a liberal perspective would tell you that more money in poor-pockets would increase their welfare when there is no restriction of the gold-standard and the central banks can print more money keeping prices and unemployment stable. Nonetheless, money from monetary-policy and money from fiscal policy might work differently because higher money supply by the central-bank would lower interest-rate and increase employment or demand and supply or investment up to full-employment, but more money from fiscal-policy would diverge capital and labour from their optimum uses as per the market allocation than to increase public-goods and services, that has been the bone of contention among the economists of different schools, especially between the neo-Classicals or freshwater economists and neo-Keynesians or saltwater economists. The former camp favors the market-mechanism to restore deviations from full-employment, but Keynesians support government intervention during high-unemployment, they advocate use of fiscal-policy during slowdown. The idea of UBI gained higher clamor after the recession 2008 when the western or developed economies were stuck in higher unemployment and low demand. The unemployment benefits or jobless claims and social-security in countries like the US supported consumption from slumping too low, they acted as cushions to the falling demand due to sub-prime crisis, housing-bubble-burst and unemployment. Unemployment-benefits and UBI are more or less same as far as their effect on demand and the use of fiscal-policy is concerned, they increase effective-demand in the economy, nevertheless, economists like Barro oppose high-public-debt and Keynes also advised fiscal-policy during slowdowns because higher public-debt might constrain the economy’s budget during high unemployment. Notwithstanding, public-spending on increasing productivity might have a positive effect on the economy than merely increasing demand because higher productivity could reduce prices by increasing supply and higher wages would also increase demand, but higher demand after  full-employment and limited supply would increase inflation or prices and interest rate. INDIA is still recovering from the previous slowdown and effects post-demonetization, read lower demand, which might require government spending to increase productivity and wages when inflation and growth projections or expectations are biased lower.  

In the Process of Budget...

We are expecting the first budget after demonetization on Feb 1 which rendered the economy with supply and demand disruptions imposed by note-exchange and limits on cash withdrawls with a lower inflation and inflation-expectations than targeted by the central-bank for 2017 at 5%, which has left the policy-makers with little choice but to re-monetize the economy with lose money-supply and spending by the monetary and fiscal tools to restore the economic-growth, lower interest rate expectations have further strengthened the case for boosting growth and growth expectations.   The Reserve-Bank-of-INDIA (RBI) has signaled an accommodative stance in the face of lower inflation and inflation expectations and a rate-cut is expected in the next monetary-policy review after Bidget-2017 even when the commercial-banks have already cut rates close to 1% after the note-ban and surge in deposits which would help increase demand for investment by improving the rate-cut transmission by the RBI. Nonetheless, higher tax collections followed by the demonetization would help to infuse spending on increasing the productivity and wages; an educated and skilled workforce would increase the economy’s productive capacity and increase competitiveness which is likely to increase demand and growth. The government has announced a slew of measures to give a fillip to the affordable housing for the poor and middle-class through lower interest-rates and exemption in taxes which would increase demand for labour and lower unemployment; it has the potential to increase consumption-and investment demand in the economy and foster the growth-rate. The spending on infrastructure would help improve supply-chain and logistics that would help growth of other sectors; however irrigation is still a negative when the agricultural is so heavily dependent on rains for growth, our former Finance-Minister Yashwant Sinha accede to this problem. The RBI might help the government to finance dams and irrigation facilities in the economy to diffuse floods and conserve water for agricultural purposes, probably by printing money. INDIA has done well in terms of reducing poverty in the last decade but education and skills gap are still there at higher-levels which are mired by low government-spending compared to many developed and emerging economies. China is still ahead in terms of number of patents registered a year and innovation in INDIA is also low which need spending on research and experiment, innovation should be incentivized by the government.            

Bells for More-Spending...

Prices or the general-price-level or inflation play an important role in the economic-policy-making and the economic-growth (-rate) via spending, private or public, when lower prices and price-expectations are a signal for expansion or more spending, and, higher-prices or price-expectations are a sign of contraction or lower-spending, all through by the management of money-supply and interest-rate or borrowing cost by the central-bank when lower prices and interest-rate and expectations also increase the scope of public-spending without crowding-out the private-sector expansion and overheating, however the accelerator from public-spending on employment and wages has a higher value than the multiplier because all wages are consumed by the poor, their propensity to consume is higher, demand and economic-growth increases at a faster rate. In the context of the Indian-economy and demonetization and limits on cash-withdrawal, which has hit employment, wages and spending, recently, has set lower prices and growth and expectations in the near-term also promote the expectations of lower interest-rate by the apex-bank and higher public-spending by the government, it presents a case for expansionary monetary and fiscal policies, however the RBI delayed the rate-cut in its last monetary-policy-review in the hindsight of not to violate its inflation-targeting framework, adopted during the last governor tenure,  under the uncertainty and unavailability of the latest inflation numbers, but, now, as the most recent data (December) on inflation show unexpected fall to 3.41%, due to interruption in the economy-wide economic-activity, lower demand, supply, prices and higher unemployment, because of the unprecedented move to demonetize 86% of the currency in circulation, the bank might decide to cut-rate in higher frequency to stall falling economic-growth and expectations and at the same-time improvising the prospects for the economy which is still trying to recover from the past rate hike cycle and slowdown with higher non-performing-assets (NPAs) as the residue which is a major concern of the economist and policy-makers in the country. Higher NPAs are a major drag on the capacity of the commercial-banks to lend- out to businesses to increase employment and growth and they are hesitant to invest due to slow recovery from the past trough, nonetheless the growth-rate of the Indian-economy is the best among the major economies, though lower than its peak or potential depending upon the labour-force participation rate that joins every year, the higher the workforce of an economy the higher are its growth chances because it increases both demand and supply. Notwithstanding, when the private-sector is short of bad- assets and lower borrowing cost, it is upto the government to lead and crowd-in them by more spending on infrastructure and improving productivity of the economy. The RBI recently has prodded the government to be wary of high debt and misallocation of resources, but it is natural to have high debt during slowdown to increase revenue and growth in the future, however it is still low compared to other countries like China. Nevertheless, generally, economists warn of higher foreign-debt because the central-banks cannot print foreign-currency, but debt in domestic-currency could be easier to handle. Higher public-debt in a developing economy is desirable because of higher needs of the economy when the private-sector is limited by higher borrowing-cost and slow recovery in demand. INDIA is still gaining pace from the previous slowdown and rate-hike cycle for which lower interest-rate and public-spending could be panaceas for more private spending, lower unemployment and higher economic-growth-rate. Higher growth and growth-expectation are crucial for investment decisions…           

It is a People's Fight...

Black-money is that part of the society’s untaxed-income which it could not consume, also a loss in indirect-taxes, and is put-off from the banking which reduces savings and investment in the economy, higher savings reduce interest-rate and increase investment, more savings are good for investment, therefore it has direct terms with investment and the per-capita-income which is important for an equitable distribution of income or wealth or equality in the society. It is not difficult to imagine that it affects the economy in a negative sense when the objective of the economy or society is equitable distribution of resources or endowments. Nobody can deny that black-money or untaxed wealth might diverge the economy from it fiscal-consolidation path, too. The whole idea of the black-money is against the government’s plan to eradicate poverty and improve allocation between public-purposes. People amass black-money which they even could not consume through right channels and become a source of further corruption in black-deals or trade with cash. It would not be an exaggeration if we say that black-money too work through multipliers, i.e. black-money-multiplier which is a multiple of the black-money, people try to hide the use of it, there is a whole black-money or parallel or shadow economy of which the public-sector has no data which once brought to the books might increase income, consumption, savings and investment, and taxes and spending, and the economic-growth and expectations. It is true that demonetization could not end all the black-money, but by committing to a less-cash economy it (government) has laid foundation of a larger and more accountable economy which could quell generation of the future black-money. The charm of demonetization further comes from the fact that it would also increase genuine demand by reducing illegitimate demand and prices of important things like shelter or homes, one of the largest spending in once life apart from gold and marriages, though lower interest-rate or borrowing-cost would  also increase supply of almost everything and lower-prices, more over black money is also used for hoarding and speculation. Lower interest-rates are also responsible for higher investment and lower unemployment and higher working days in MNREGS through higher taxes and public-investment. Demonetization would fuel our economy for better-days… The common-man would realize and recognize that the present government has taken an important step to end corruption against society; our patriot country-men would appreciate the fight against illicit-wealth and power same as when they read stories and feel proud of our freedom-fight and freedom-fighters. Freedom from corruption is a fight of the common-man, by the common-man and for the common-man…         

The Political-Economy of INDIA 2016…

Economics or the Political-Economy, one and the same, has a direct link with the standard-of–living of a country which is the product of higher-growth-rate, the barometer to measure the rate of improvement in the productivity and wages, and, demand and growth which may have a correlation with the lives of the country-men for which a low and constant un-employment-rate and price-level are must because of the same and same demand and supply, the former same because, of the key-words in Economics  and the latter same is because the quantity-demanded must match quantity-supplied to fulfil the aforesaid objectives but, in the real-world the match is often absent due to inconsistent monetary and fiscal policies dependent on the data delay and availability for transmission of signals, action and change in the economic variables and higher growth could be related to the higher-investment, though not in case of higher inflation because that would require tightening and higher unemployment and lower-prices to restore value of money and equilibrium between demand and supply by managing interest-rate or natural-real-rates, the money-rate or nominal-rate of interest (minus) the rate of inflation. Lower-natural-real-interest-rate could be linked to higher-investment, higher-supply, lower unemployment, and, higher-demand and spending - consumption and investment - even across economies, international-trade has a role since it may help to lower the price-level in the long-run, beyond five-years, and it would also increase demand in the trading-partners economies and they would demand more exports and could help-us earn foreign-exchange, wealth would increase, in the old-times gold, which would also increase employment and lower-poverty because it would also increase taxes and the government-spending on education and research and, skill-development to increase innovation and productivity, and, real wages and demand, and economic-growth or GVA (the Gross-Value-Added after deducting the deflator), in the domestic-economy  and also externally. All the three - monetary-policy, fiscal-policy, and the foreign-trade-policy are responsible to achieve the NAIRU (Non-Accelerating-Inflation–Rate-of-Unemployment). The NAIRU is that rate of un-employment at which the rate of change in the general-price-level does not reduce the value of money, and, demand and economic growth-rate, in case of lower prices money-supply is loosened and when there is inflation the money-supply is tightened which help maintain full-employment and price-stability to achieve the projected economic-growth.

It is also true for INDIA…

The supply-side in INDIA...

The current wave in economics is the Real-Business-Cycle-Theory which says that more money-supply is likely to reduce interest rate and improve supply and reduce prices in the long-run... however, inflation is expected in the short run due to full-employment and protectionary policies... It concentrates on increasing demand/supply and growth by concentrating on real variables rather than nominal variables... Lower interest rate would decrease prices in the long-run by lowering the borrowing cost... Higher interest rate would make the Indian companies uncompetitive because of the higher borrowing cost, however the US, for example, is capital rich... INDIA has comparative advantage in labour-intensive techniques because labour is abundant and wages are cheap. Exports would only be competitive if the industry uses more cheap labour than expensive capital-intensive techniques which save labour. Interest rates in INDIA are high compared to the developed-world which means INDIA needs to specialize in labour-intensive products...  Indians would benefit from labour intensive production functions, but if the borrowing cost is also low that would be an added advantage... Higher interest rate is not good for domestic investment... High rural-agri interest-rate cost is another big problem because of lack of proper credit facilities... Farmers borrow at higher rates form the local money-lenders... 

INDIA has a tight unemployment rate on which the supply-side rests too much... INDIA''s, both, high demand and low-supply-side are the reasons for higher prices for food... which increases wage-demand and prices depending on productivity (wages equals marginal product of labour) which in turn depends upon training and skills, they might have a correlation... Moreover wages also do depend upon inflation and inflation expectations... productivity also increases supply which may help keeping prices stable and lower interest-rate and increasing the economic-activity and growth... More public investment in training and skills is needed when the private-sector is constrained by higher credit cost... Low inflation and low wage demand would increase the economy competitiveness among peers... Skills and training might also help keeping prices in check by increasing productivity and supply... In order to boost productivity investment in skills development and innovation, through investment in education and research, are equally important.

Foreign-Direct-Investment (FDI) which increases employment in INDIA should be promoted, if the domestic investors are reluctant and cost is high... Agriculture is an employment-intensive sector in the country, it gives employment to close to 50% of the population, it is a major source of income in the economy... FDI in food-processing and retail would increase farmers'' income by cutting the middleman-chain by procuring directly for the farmers... Food-inflation is high in the country, more investment would cut supply-side bottlenecks and reduce inflation... 100% FDI in marketing of food products sourced locally is a major supply-side reform to reduce the prices of food items and improve farmers income. Companies can source directly from the farmer... It is the same FDI in multi-brand retail... 100 %... but, only in the food...  Deregulation and liberalization are not the same and sometimes liberalization might require better regulation...

Lower supply would increase prices... And, higher supply would reduce them (prices)... Look at the oil prices behaviour...  The world is going through excess capacity and therefore there is deflation... INDIA is supply constrained and slow trade liberalization has kept prices in a fix... After full-employment imports would help lower prices... It would also help shoot foreign demand... Income in the trading partners’ economy would go up... Imports are important for price-stability, demand, full-employment and growth and jobs... Interest rates are higher due to sticky prices or inflation... It also restricts domestic investment...

Targeting economic-variables has had been popular...

Targeting economic-variables has had been popular though targeting the economic-growth-rate is more common than others like wage-rate, interest-rate and the exchange-rate… These variables do have a significant effect on growth by the way of manipulating supply/demand or in common the economic-activity after accounting for inflation and inflation expectation in the nominal terms… Nominal rates include the real-rates plus inflation… Similarly, we have a corresponding real-rate after subtracting inflation for every nominal-variable… Inflation decides the future expectation about the real-wages, the real-interest-rate and the real-exchange-rate…Like nominal-wages and real-wages, nominal- interest-rate and real-interest-rate and the nominal-exchange-rate and the real-exchange-rate… By targeting these variables we try form an impression or expectations about the health of the economy by managing supply/demand and inflation and the economic-growth-rate… The counter-cycle economic-policy makes the transition between boom and busts, in a controlled way so that that the trade-off between unemployment and inflation during trade-cycles for the underlying objective of growth becomes smooth… Expansionary-policy during slowdowns and tight budgets during inflation to control demand and expectation by the way of targeting variables has been the role of economic-policies for the past three decades… Targeting variables has been a popular practice also through forming expectations… Inflation or the general-price-level and expectations about the same determine the expectations about the real-variables – real-wage-rate, real-interest-rate and real-exchange-rate - and demand/supply/growth… The economic-growth and expectations about it would increase spending and demand in INDIA, if expectations about the economic-growth are bright, people would demand more and it could help achieve the full-employment and full-growth and investment to help the economy innovate could increase productivity and wages and incomes… In the West, the developed-world is cutting real-wages with inflation to make exports competitive, is also not uncommon, too… Every developed-country has a higher weight-age of exports in its trade-account… Depreciation or the efforts to increase exports during slowdown has pulled economies out of depression because when a country compares it’s domestic-demand vis-à-vis the export-sector it is more vast and also because of foreign exchange earnings… In the past three-years the low import of gold due to higher-tariffs has saved INDIA much of its exchange-reserves and foreign-money, too, through higher debt and equity inflows in the form of FPI’s, FII’s, and FDI’s… have all shot-up… Nonetheless, the export sector in INDIA is under-penetrated… The government might try to increase depreciation to give exports a kick in-terms of higher nominal-exchange rate, it is short-term fix, but, in the longer-run lowering the general-price-level or prices would save the domestic demand with the foreign-demand… lower-prices too can make exports competitive and also increase domestic demand because of increase in the real-wages… Expectations about higher real-wages increase spending… Likewise, interest-rate and interest-rate expectations affect investment and spending decisions… An interest-rate cut cycle may increase investment… the RBI has maintained that it would target a neutral or natural-rate of 1.25% which means lower real-rates than in the past which would increase real interest-rate-cut expectations... A lower real-rate would increase risk-taking because investors would move to higher-yielding asset classes… Bonds are safe but equities have higher yield, but more liquid… Lower-interest-rate-expectations could give a push to spending, higher demand through higher real wages and real-wage expectations could also increase spending… INDIA is going through expansion… but, NPA’s and impediments to rate cut-transmission by the commercial-banks is a drag on the economic-growth-rate, but, delay in action could further pull the growth-rate expectations down… Expect our governor to bring innovative ideas to the board to curb bad-loans… It is more a matter for the government because the majority of bad assets are in the Public-Sector banks…. Lowering cash-reserve-requirements during a bad-turn may help banks pass-on the rate-cut by the RBI… In the last rate-cut-cycle the nominal interest-rate was just above the 4%... Committing a higher real-wage, a higher real-interest-rate and a higher real-exchange-rate and expectations would increase consumption and investment and foreign demand, too, in the economy through more spending and higher supply/demand/growth… and, more jobs, too… 

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.

Increase productivity; invest in education and skills...

INDIA’s productivity or productivity per person compared to the peers has been low given the size of the economy or its labour force and the level of innovation or technology. The US’ nominal GDP is four times that of INDIA, even though, labour-force is smaller. INDIA, though, having a larger population and labour-force has been lagging behind due to it low education and skills base compared to the developed countries on which the productivity of the economy is dependent. The Government of INDIA has now realized that competitive markets would help lower the prices by the way of increasing the number of firms or competition or more supply. Therefore, in education and skill-development INDIA too needs to liberalize investment or entry of new firms. More education and skill development firms would lower the prices of education and skills and increase employability. It’s Make in INDIA program, also, could not succeed without the right skills to add to the productivity of the Industry. INDIA has recognized the importance of foreign-capital to finance it goals. The government is trying to woo foreign investment in agriculture and manufacturing, but this time it also needs to increase foreign investment in the world-class education and skills. The Make in INDIA invites the foreign firms to invest in production with cheap wages in order to be competitive, but, without an educated and skilled workforce the firms would find it difficult to investment in INDIA. Foreign firms are provided entry into the economy to increase competition for the domestic producers which was earlier considered against the domestic industry could also help us import new-skills and technology. Moreover, more FDI in education and skills development would also help us spreading domestic skills-base and productivity...

Commercial banks should reduce lending rates to increase demand and credit-growth after today's pause...

The RBI said that it would continue to maintain a liquidity neutral stance from a deficit mode that it would provide the markets much liquidity to pass on the rate cut transmission to lenders to increase investment, but the banks are saying lending rates which are variable could not be decreased till deposit rates, which are fixed, go down. But, the commercial banks are borrowing from the central-bank at 6.5% which is much lower than the current market lending rates. However, deposits are only one source of liquidity or money-supply to the commercial banks, others including the interbank-rate and other financial arms. Therefore, if the cost of fund from the RBI is 6.25 the banks should decide interest rate closer to 6.25-6.75% for sectors which are in the list of strategic or priority lending area such as infrastructure and capital-formation. The commercial-banks do not charge same price for the services they offer. The interest rate for short and long lending differ to a considerable degree. The same is true for the deposits. The banks should recognize that the lending is more important for the bank’s profit because deposits are an outgo. First you earn and then pay for the expenses. Lending represents the income side and deposits the cost side. Your income decide you expenditure. The banks should realize that they are not the government which first decides expenditure and then the sources of revenue, they need to decide the lending rates first and then the deposit-rates which is always a tad lower than the lending rates which increases investment and bank’s profits. Banks profitability is constrained by higher lending rates; moreover high deposit rates are increasing the cost. The banks themselves are responsible for slow recovery by not reducing interest rates and increase demand. Nonetheless, banks are also hurt by NPAs, but higher rates would also lower credit growth and profits by banks. They are waiting for the signal from the RBI when they themselves can increase their business by lowering the price of their products. The commercial banks has held the economy away from recovery by not reducing rates when the controller wants them to so. The banks so far have been saved from competition from foreign banks which has left them with a choice not in favour of the economy when they can use lower prices and increase their own business and start recovery in the economy. Many already know that banks shares enjoy appreciation even when the repo-rate is cut or increased, when the repo-rate is cut and banks lower interest rate it increases business and when it is hiked it increases their profits. Banks are almost always in profits because of the protection of the central-bank. Even-when the RBI is a controller of commercial-banks they are not following its signals and communication for which the RBI might need to become more diplomatic by increasing competition to higher degree by inviting foreign banks to invest in INDIA. Repo-rate cuts are not being translated in to lower lending –rate. Howelse the RBI may help banks to lower lending-rates and increase their business? It is little absurd when the Indian economy needs more investment and growth. Banks are holding the recovery back…

Stressed assets, miles to go...

The Indian-economy is doing well when we see growth in terms of the unemployment rate (4.9%) which is the reason for an overheating economy because low labour supply has made wages rise in a consistent way with the rate of growth i.e. growth has increased demand but strings on investment including slow interest rate cuts by the RBI has made the cycle somewhat downbeat and slow in terms of investment and expenditure by the public-sector is seen as a tool to crowd in private investment. The stress on the commercial banks’ balance sheets due to stressed assets is another factor that has contributed to only half of the interest rate transmission in the market rates. However, the RBI is now using Marginal-Cost-Lending-Rate (MCLR) in deciding the lending rates and expanding the bank licenses to increase competition, but the stress on the banking is now a wholesome around several Lakh Crore Rupees of which the government would be able to contribute in Thousand Crores this year. The loss of banking is a debt gone bad after a boom and is restraining the profitability of the banks by constraining lending during low growth. Liquidity in the domestic economy has also constrained the interest rate transmission because of bad loans and fewer funds for credit creation. Nonetheless our RBI governor has made standout that the RBI wants a liquidity neutral position and has done liquidity improvement through OMOs and other levers. The government and the RBI might try to incentivize the sectors that contribute to low prices and wage demand because that would increase cost and reduce investment by delaying rate cuts and loose competitiveness. But to increase domestic demand the policy makers may try to increase real wages and income to increase demand and growth by reducing the price level by more investment and supply in the economy by improving liquidity. More liquidity in the economy would make the commercial banks lend in large scale by lowering the lending rates. Keynes said that nominal wages and prices are sticky at low levels, but lower price rigidity is not supported by the evidences. In the Western World increased liquidity and lower interest rates have improved the supply and reduced the price-level in the long-run. Lower price expectation and increased real wage and income expectations could increase spending, consumption and investment, both, and, GROWTH… 

Lower interest-rate might be correlated to higher supply and lower prices...

The scarcity of capital depends upon the scarcity of investment goods and services, and, consumption goods and services since a rise in the price-level would prompt the central bank to increase interest-rate and reduce demand, consumption and investment, in order to reduce fall in the value of money and demand when supply cannot be increased in the short-run. The central bank tries to control demand in case of lower supply to keep prices in check. However, if we have space for increasing supply then the central-banks may reduce the interest-rate to improve supply and control the price-level or inflation. Therefore, the first task before a central banks is to determine whether the inflation is supply-side induced or the demand-side because a supply-side solution in case of higher demand and inflation seems more feasible than to control inflation by reducing demand which diverts the economy from a higher growth trajectory. A lower interest-rate regime may also increase supply and lower prices depending upon the actual availability of goods and services in the economy. Therefore, the central-banks must try to control demand when there is no scope of increasing supply of goods and services. Nevertheless, lower interest-rate might be good for the supply-side (investment) and the demand (consumption) side too. Therefore, if lower interest-rate increases supply or productivity to lower inflation instead of just demand and inflation it should be welcomed. Conventionally, higher money-supply and lower interest-rate is supposed to stoke demand and inflation in the event of supply shortage, but, how the central banks can ignore that the same interest-rate which controls demand is also responsible for increasing the supply because lower capital cost might be significant for it. Keynes said that capital is not that scarce as compared to other factors of production since the central banks could resort to printing money when there is a need and its real scarcity depends on the real availability of investment and consumption goods and services in the economy. The capital is scarce because other things are scarce. In a big economy like INDIA how inflation is explained with so much of unutilized resources and excess capacity, its inflation might be attributed to low investment and supply compared to high demand which could be incentivized through lower interest- rate. The central banks try to contain demand and inflation in the short-run when the long-run objective is to keep prices low by lowering the cost of credit and increase supply. Increasing interest-rate and reduce demand and inflation in the short-run is a short term strategy, however improving the supply-side and demand too by lowering the interest-rates might increase inflation in the short-run but would also increase supply. The interest-rate in the developed world has shown a downward bias in the long-run and it is an assumption that interest-rate in the developing and the developed world would converge in the same direction in the long-run. In many of the developed countries with low population growth rates the interest-rates have remained around zero in the past several years with deflation. Japan is now a classic example of economies with zero-lower-bound or liquidity-tarp and deflation for the past two decades. In the developed world the improvement in the supply-side due to lower interest-rate has made the price-level less volatile and less volatility has also kept the interest- rate low. The example of the developed countries shows that in the long-run supply-side has improved much to keep the prices stable when interest-rates are at rock-bottom. 

Lower-prices and demand/supply...

Deflation would not last too long, because demand would go-up, since lower-prices could increase demand. The most relevant example could be understood by depreciation in the exchange rate when the nominal-exchange-rate increases relative to the prices (CP) demand increases, another example is the movement of real-wages since when inflation cuts real-wages labour-demand goes-up, the last example may be cut in real-interest-rate with inflation, it increases demand for investment, and foreign demand increases, too, and growth goes-up, even if wages are more less fixed or sticky because of presence of the downward wages rigidity, but prices might go-down because there is competition in the market to increase market share and demand, and, as more firms enter market the market every-year prices go down in the long-run... Supply is scarce people would rush to buy, investors, too, firms could restrict it in the case of the supply-side weakness and higher-cost  ... After, the inventories are consumed; firms could demand more resources and prices could go-up... Economists partially explain the effect of lower-prices on the unemployment-rate, but lower-prices increase real-wages and supply of the man-power. Rich countries that pay higher-real-wages and incomes for the skills in demand attract foreign labour-force, nonetheless voluntary and frictional-employment may exist, but fail to accept the other-side, the good-side (common-side)... Lower-prices may also help to reap the economies-of scale and sell more in the short-run and earn higher-real-interest-rate and real-profits, more investment would increase the nominal and real interest rates in the future, but assume inflation is constant or low, close to  Milton Freedman’s Optimal-Monetary-Policy, he accepted that deflation rather than inflation helps increase growth. Incentive to invest increases, Capitalists would save, earn interest-income and invest more. At once place the Capitalist income increases and they save more and earn higher real-interest-rate, investor wait for lower-prices to invest and sell at higher-prices. It depends upon the ability to hold money, lower income level would have a higher propensity to consume out of a given income and save less and higher incomes increase the ability to consume, save and invest more.  Lower prices increase the real-wealth of ALL, and increase both, consumption and savings and investment and employment and demand/supply and the economic-growth. The lower borrowing-cost would increase the supply. Investors track the growth projection, lower inflation and interest-rate expectations could increase investment, employment and economic-growth.. In the rich-world prices have gone down in the long-run, as interest-rate response and threshold have varied over-time... In the long-run interest-rate or the real-interest rate have shown a downward bias because of the lower-interest-rate in the past-period, higher-supply and the lower price-level. Cutting the nominal-interest-rate would also lower the real-interest-rate if other-things, including inflation is constant, Ceteris-Paribus (CP). But, the rich world central-banks are trying to lower real-interest-rate by increasing inflation and inflation-expectations which is difficult to achieve below full-employment. And, INDIA’s unemployment rate has gone-up. The central-bank’s new-governor is appointed by the government recently with a loaded monetary-policy committee. The committee has to decide whether lower real-price of capital could stimulate supply and demand and growth to increase investment and employment with stable or low inflation...  Lower borrowing-cost would also increase export-competitiveness... The government has a counter-cyclical role to control too much volatility on the either side... Bring, the both, buyers and sellers in equilibrium by the effect of wages, interest-rate and exchange-rate. Actually, the real wages, interest rate and the exchange rate, by lowering inflation and inflation expectations which means lower cost of borrowing, higher supply and lower –prices.

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 favour 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 in 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”.  

Food inflation is holding us back...

The food-inflation that is rampant in the Indian-economy could be primarily ascribed to the low level of technology, investment and over-dependence on rains for irrigation have made the RBI delay rate cuts in the expectation of a good monsoon and lower prices of food. However, INDIA is also a big exporter of cereals (rice and wheat), in which inflation is close to 6.3% and had been higher in the previous years, could be brought down to a lower level if we try to reduce exports and increase domestic-supply to lower inflation. The men in authority argue that they cannot increase domestic-supply by restricting exports because it would lower domestic-prices of cereals and would hurt farmers. Nonetheless, everybody, the government and the RBI, still expect that a better monsoon would help bring down the inflation in cereals, therefore if we increase domestic-supply by curbing exports it would have the same outcome, lower prices. INDIA could easily lower some of its inflation by curbing export of cereals. Food-inflation has kept the RBI in the delay mode in the expectation that time may itself improve the supply-side without lower interest-rate, however the government has committed interest-rate subvention which might not work with credit-facilities-gap in the village areas where most of the farmers are forced to borrow at very high rates form traditional money-lenders. Agriculture has now become a high cost and risk sector of the economy because of high rural credit cost and hole in irrigation facilities. Lack of the irrigation facilities and agricultural loans has been the main culprits for farmer’s suicide. The policy setters must try to eliminate these repercussions which would also reduce inflation and interest rate and propel economic-growth. Prosperity of agriculture, lower food inflation and lower interest-rates are sine-qua-non for a healthy-high economic growth. Nevertheless, allowing 100% FDI in food retail and processing was a major supply-side reform of this year’s budget which might again help reduce food-inflation and increase farmer’s income by improving the supply chain and storage and by reducing the middle man chain in the agriculture. The government has pledged to increase farmer’s income in five years which would affect demand and growth positively. The government’s vision of the rural and agricultural economy would take time to materialize to bring out their best, but, implementation is the key and the sooner it is, the better it is.

The inflation target for the coming five-years is 4% with a band of +/- 2% given the high food-inflation experienced almost every year. The prices of one or more basic food items catch fire each year. Food and fuel are important from the point of view of inflation and volatility, and have a higher weightage in the inflation index. However, low fuel cost in the near past made the inflation target achievable even when food inflation remained high and the government imported pulses on a large scale to cool-down its domestic prices. The two successive droughts in the past years have worsened the food inflation and lowered the rural demand and growth. At one place income has come down and at other inflation has gone up which have kept real incomes lower in the rural areas when the economy is still recovering from a downturn. Inflation too is responsible for lower demand and growth because it reduces demand for other G&S.  Nonetheless, hope of a good monsoon and lower food inflation comfort the economy in terms of lower expected inflation and interest rates on the account of the credibility established by the RBI to check inflation and inflationary expectations in the past. The RBI sacrificed growth to contain inflation and has now an inflation target out of which it is expected to tighten and below which it would lower interest rates. Like rate-cuts, rate-hikes could also be delayed in expectation of lower prices adjustments. The central banks indirectly manipulate interest rates through money-supply and the RBI has committed a liquidity-neutral stance which also means the natural-rate at which there is neither inflation nor deflation, if there would be surplus liquidity there would be inflation or when there is a deficit there would be deflation. INDIA is yet to achieve that rate, but food inflation is a volatile category which requires more supply and that is determined by a number of variables other than interest rates like weather, trade-restrictions and farmer’s welfare. Deflation should be considered different from disinflation. Opposite of the developed-world in deflationary pressure, INDIA is going through disinflation. Deflation occurs when the price-level go below the base year. However, when there is scope for imports to cool down domestic inflation and lower interest-rate, the government could bring out tenders and might provide interest-rate subvention which would help bring the overall inflation and interest-rate down…

The Irrigation-Gap...

In INDIA prices of food-items are largely irresponsive to changes in interest-rate due to monsoon conditions which has had been a major source of worry and concern to the farmers. Although, the government has put interest-rate-subvention in place for the agriculture, but the unexpected weather- circumstances coupled with lack of irrigation facilities have turned the tide against the development and growth efforts through monetary and fiscal policies. Therefore, even if interest-rate is low, it barely corrects the monsoon vagaries and the irrigation gaps. It looks meaningless to tackle the problem of weather and irrigation through higher interest-rates.

The inflation we experienced during the last few years of the UPA government may be ascribed to misdirected expenditure to increase demand and growth with supply-side bottlenecks in food-management. We have come too far with half of the agriculture devoid of irrigation and good weather which we have to take with a pinch of salt. None of the government after the Independence ever showed their full-commitment to this big-problem. We have been too much dependent on rains for irrigation and food. Nonetheless, the current government at the Center has taken the stock of the situation of the agricultural-economy, wages, incomes and demand which rests too much on the rains.

We hope the present government would show its will-power to implement its plans for the rural and agricultural welfare, and, demand and economic-growth.  

 

Capital...

Capital is another, apart from Labour and others, important factor of production on which investment depends to a large extent which has a cost and price, and, a demand and a supply of money or Capital, Keynes demand for money equation is popular and supply is controlled by the central-banks, there are strings of measures of money-supply (M0, M1, M2,...) which varies with investment and demand, and, inflation and full-employment and growth… Investment could be important for the economic-growth-rate. The central-bank controls the supply of money and demand for money by moving the real interest-rate i.e. by nominal interest –rate and inflation… Across the Globe, to a greater degree, now at this stage, the neutral or natural rate of real interest-rate is around 1 - 2 %... In INDIA the RBI has said that it would target a neutral-rate of real interest-rate of 1.25 % in case of low and stable inflation, the RBI has set a band for inflation 4 +/- 2 and has committed an accommodative stance… The interest-rate is on a downward trajectory and interest rate expectations are also biased lower and we have a pickup in the investment-cycle, although tepid… The investors track the GDP growth-rate for investment decisions and lower cost and price of Capital would increase investment and growth, this has been a long practice in China, they always project a higher growth-rate… The cost of borrowing might be positively correlated with the rate of economic-growth, a recent study shows that there are evidences of low but positive significance between economic-growth and the real interest-rate, and. income and demand, and, supply and profits, and, lower income and demand expectation would lower the warranted rate of the economic-growth and investment… The supply-side may be positive for employment, income, demand and economic-growth, through the real rates offered to the businesses and investment… The businesses can borrow either from banks, bonds or equities or through personal-borrowings and for all this they pay a real interest rate for the money… All businesses have a degree of risk because of uncertainty of work and income… The economy swings between boom and busts, the trade-cycle-theory… The are several types of hedges the market has to proffer for investment, there are interest-rate derivatives, currency-derivatives, commodity-derivatives, these help to avert the risk to the series of incomes from the investment and the interest-incomes, but it is difficult to demand less money for investment when you want higher interest rate from investment… The demand cuts the supply curve at a point where demand meets supply and decides a level of real-prices or income and demand… A recent study shows that prices decide the level of demand and the economic-growth-rate… when lower prices are more expansionary because of the lower cost of borrowing… The price of Capital, i.e. the real interest-rate is one important determinant of investment and the economic-growth-rate... The supply and demand of/for money bear a real rate of interest which also depends on the rate of inflation… and inflation reduces the value of money and real-returns… Out of all the investment vehicles bonds are largely inflation protected, because for them either yields increase or prices with the general price-level… Recently, the RBI has liberalized foreign-borrowing through Masala-bonds, i.e. bonds denominated in Rupees, plus the RBI too has tried to develop INDIA’s Corporate-bond-market… the RBI has signalled expansion in the balance-sheets… So there is a lot of scope in the borrowing from abroad… moreover, if the investor wants to invest s/he can hedge the interest-rate movements by derivatives… Loans in foreign-currency could increase the foreign-exchange-reserves, meanwhile… The competition from foreign-countries to sell loans would also aggravate the competition in the domestic-market and would push the real-interest-rate to the real marginal cost… The RBI has increased competition in the market to borrow through bonds… Historically low nominal-interest-rate-levels in the developed countries presented the opportunities to borrow since a long-time now after 2008 and negative interest-rate in a big part of the developed world signal lower interest-rate projection and expectations that would also bolster borrowing in the emerging markets… The real interest rate paid for foreign loans would be low enough, because interest rates are near zero and inflation in INDIA is around 4 %... Now, we have a minus 3-4 % of the real interest rate which should promote investment… Nevertheless, it could be hedged through interest-rate derivatives and/or currency-derivatives… However, in the last interest-rate cut cycle the RBI was also told to control capital-inflows because of overheating…

Inflation reduces the value of capital...

Although the Indian-economy is growing fastest among the major world economies, its current growth rate is lower than its peak performance after the global financial crisis of 2008 when the economy received fiscal and monetary policy stimuli by the policy-makers which kicked-off the growth-rate in the following years. However, the inflation–rate also soared to double-digits which the central banks tamed by tightening money-supply and increasing interest rate and the government also curbed its expenditure in the wake. Nonetheless, the previous UPA government continued the stimulus longer that pushed inflation to intolerable heights when INDIA is still a developing economy with various types of constraints over investment and supply. The last decade of the country’s growth path shows that the economy is responsive to increase in money-supply, either by monetary-policy or fiscal policy, but in a supply-constrained scenario the economy easily starts overheating or inflating.

Inflation is an important determinant of investment and growth. The foreign investors deter investment when they experience and/or expect inflation and depreciation. Then the question arises that “how, then, inflation be good for domestic-investors or investment?” Inflation more than increase in wages or income reduces real wages and demand, and hurts growth. Some economists also argue that inflation reduces the value of debt even when the nominal interest-rates go up and you pay more in money terms. Inflation reduces the value of money thereby reducing demand for other things and increasing demand for money wages that makes the economy uncompetitive. Higher-prices also reduce domestic-demand by increasing nominal-interest-rates and reduce real-interest-rate which also reduces savings which could further be translated into higher interest-rate and low investment, inflation is a signal. The rate of inflation discourages investment, demand and economic growth.

Inflation reduces the value of capital which means less investment.

Prices, Interest-rate and Bonds...

Liberalizing the bond-market in INDIA would increase competition resulting in lower interest rate... The RBI has also proposed to liberalize foreign borrowing through masala-bonds... We now have competition from abroad to sell debt...Masala-bonds are rupee denominated bonds offered to overseas investors which do not need hedging... however, borrowing in foreign currency must be hedged by currency derivatives... Economists do not favour borrowing in foreign currency because of the lower reserves and also because it cannot be printed by the central bank...If you could borrow from a foreign country at lower interest-rate, domestic-demand for funds would go down and domestic banks would lower interest-rate to increase their demand... Domestic-lenders would face competition from abroad... Moreover, inflow of foreign funds would also likely to lower interest-rate... More investment and more supply could also lower the price-level and interest-rate... It would help transmission of rate cuts by the central-bank...

Lower-price-level and lower bond-yields mean higher bond-prices and returns... A negative-yield would even increase bond-prices more... Bonds are already inflation protected since when yields go down bond-prices increase... The real-value of bonds is protected... More supply of savings would lower bond-yields and increase prices, therefore bonds are safe... Lower prices increase the value of savings if other things remain constant...Low inflation and interest-rate mean savings would be discouraged and spending would be encouraged... Including the dynamics show that in the future inflation and interest-rate would rise because of higher spending... Lower-prices or higher real-interest-rate could make people save more and spend more, while higher-prices or lower real-interest-rate would increase the supply of savings and could decrease spending... According to Wicksell higher real-interest-rate means higher return on capital... We need to explain the relationship between economic-variables in the dynamic sense because expectations are equally important for the outcome... The real-world is dynamic...

Keynes said that money is not scarce when the central-banks can print currency... Supply-side problems and inflation is the main cause for tight money-supply because it reduces the value of capital... If they are not present then the central-banks may continue with lose money to increase employment, demand and economic-growth and in some cases with negative-real-interest-rate... Public-spending, that boost innovation and productivity, on education, skilling or re-skilling and, if necessary, on infrastructure are important for increasing real-wages, with low inflation, and, demand and economic-growth when population-growth-rate and demand is going down in the most of the developed-world - Japan, the US and Europe..

Labour...

Labour is one of the most important factors of production or production-function, apart from capital and organization… Like any firm lower cost of factors of production increases profit, other-things remaining constant. Cost of capital, often than labour, is the core of discussion-circles… but, the labour market has also a more direct link with the long-run movement of the price-level and economic-growth, as the evidences from the developed-countries show that real-wages have gown down in the past decades and interest-rate-trajectory has also shown a downward trend in the neutral rate or the natural-rate or equilibrium exchange-rate in the same period and prices have also gone down. Since, the interest-rates are often discussed; therefore here we would concentrate mainly on the labour cost of the production-function. Like lower cost of interest-rate or borrowing, lowering labour cost of production has been a crucial way to incentivize or stimulate supply for the same lower cost of production and the same profits… Like lowering real-interest-rate by inflation, increasing inflation would also lower real-wages and cost of production, nonetheless nominal wages may also increase since the economy would try to balance in terms of demand and supply and prices and this process has a cumulative- effect on the same variables… When money supply is increased it also affects the three factors but in a magnified way and the economy goes through credit or trade cycles… During booms real wages and interest rate increase, and during busts they go down, however, the part of the government is to regulate or ride the trade-cycles through counter-cyclical monetary and fiscal policies by manipulating real wages, interest-rate and exchange rate. The price of labour or real-wage is responsible for equilibrium in the labour-market, we have heard of market-clearing prices and higher real-wages would increase labour-supply… But, the economic-models assume subsistence-wage-theory, because of better negotiation-power of the Capitalist and influence on the three rates… Capitalist try to lower the above three rates… but, higher skills increase income or real-wages… INDIA’s unemployment-rate is close to its natural-rate and the economy doesn’t need too much higher stimuli in terms for higher income, demand and supply, and economic-growth, but, it still needs to push since it has a young-population and a higher labour-force participation-rate… The rate of growth of workforce decide the natural-rate-of-–economic-growth and lose money-supply increases it and higher real-wages would improve consumption-demand and economic-growth by lowering the price-level through lower nominal and/or real-interest-rate and higher-supply… In INDIA, labour is cheap therefore it is profitable to invest in labour-intensive production when the borrowing cost is high... However, the investors might hedge them through interest-rate derivatives when the neutral-real-rate assumption is now close to 1.25%, lower than the previous target and nominal-rates are also likely to go down further… Lower borrowing cost would increase the ability to employ and increase wages… In the long-run, 5-years ahead, increase in real-wages is needed to boost demand-supply and economic-growth. The unemployment-benefits and social-security-net during slowdowns may help contain demand. They are important… Moreover, sometimes a little higher unemployment-rate is significant for lower price-level to increase real-wages and demand in case of lower population-growth rate and the economic-growth-rate…

Lower real-wages lead to lower demand and growth...

All the countries are trying to increase their per capita income and living-standard according to the increase in productivity while maintaining their competitiveness with innovations because labour is relatively scarcer which might restrict the economy’s capacity absorb capital without increasing wages and the general price-level, as found in the general quantity theory of money.

Productivity is measured by output per labour (Y/L) and output per capital (Y/K). If these increase over time, we can say that productivity has increased and vice-versa. Productivity can be measured. We need productivity growth-rate to decide growth of returns to factors of production. We are here talking about productivity that increases supply capacity to sell more at lower prices. In the market there is a competition to sell at low price. A direct factor that drives productivity is knowledge or innovation.

More money-supply has reduced the cost of capital with low wages increasing supply despite of low demand which has lowered the general price-level and interest rates pushing the economy at the zero lower bound or liquidity-trap for a longer period. At the zero lower bound cash hoarding increases, not necessarily in banks, because the value of money goes up in the face of lower prices, moreover everybody expects higher inflation in the future because it is the our basic observation that prices increase with time and the will to hold unlimited money also increase savings.

The zero lower bound also trims the possibility of increasing investment and employment by reducing the borrowing cost or nominal interest rate, but the central banks are trying to reduce real interest rate and wages with inflation to incentivize the supply-side and profits which would also increase the relative international competitiveness to survive in the market-place.

A higher current-account-deficit (CAD) in the most of the developed -world means you have to devalue, either by cutting on nominal wages, interest-rate and prices (internal-devaluation) or by cutting real wages, interest-rate and prices (external-devaluation) by increasing inflation. In internal devaluation money-supply is tightened to lower inflation, to cut down nominal wages and interest rate. In external, money-supply is loosened to increase inflation and cut down real wages and interest-rate. But, we have evidences of downward-nominal-wage-and-price-rigidity after a point. In most of the developed world there has been a cut on real-wages despite increasing productivity. There has been a real-wages and productivity gap since few decades.

Nonetheless, when real wages are going down demand too is likely to remain subdued resulting in lower growth rate. But, if, we pay equal to the marginal-product or productivity, there would be no inequality-issue. Economists favour reward to factors of production according to their product which is the purpose of Economics (explaining income-distribution). It is among the stylized-facts that share of labour and capital should be equal in GDP and real-wages would rise in the long-run. Labour-saving technological progress and higher productivity may be the reason for higher capitalists’ profits, but real-wages-productivity-gap is observable in the charts.

Lost Jobs and Unemployment Benefits...

The Bankruptcy-code passed few months back was among the most important legislations of the parliament, besides the GST and the price-control during high inflation, the government has proposed to set prices of some categories during high-prices due to demand and supply mismatch and lower interest rate and unemployment (more jobs). The uncertainty before the Bankruptcy-code on the hiring and firing of employees was a major road-block in the way of starting investment and employ people when the Indian-economy is growing at a high-speed even when the developed world is going through weak demand, which has undermined the Indian-exports and achieve us double-digit growth-rate. Once a company is declared bankrupt it becomes easy to lay-off labour and dilute the assets to pay bank-credit or credit… During slowdowns unemployment or lay-off increases which lowers demand and growth and investment and lowers the price-level whereas due to boom employment or hiring and demand, growth, investment and prices increase. The bankruptcy-code deters firms to fire labour because of loss or low demand. The market that has a weak labour bargaining-power, employ more people temporarily than a labour-market which gives importance to permanent-jobs. The temporary labour by contract could be fired when there is a downturn. The bankruptcy-code was positive for firms to decide for solvency; naturally a bankrupt firm could not support workers because of balance-sheet recession. Nonetheless, an economy with more permanent-jobs is likely to recover fast during a slowdown because demand would go down less while an economy with more temporary-jobs would take more time to recover. Lower nominal wages given to the labour could be substituted for lay-offs… lower nominal wages instead of complete lay-off could help the economy to recover fast, however during heavy headwinds it is not possible to continue employment… Lay-offs might be the last option used to tackle unemployment and demand and growth. Notwithstanding, the social-security-net by the government is also a land-mark labour-reform, but INDIA still face void in terms of a comprehensive unemployment-benefits plan because it is true that during recession firms employ temporarily and create low paying jobs or less jobs…  Unemployment-benefits during downturns could replace the demand lost because of joblessness… 

Globalisation Reduces Inequality...

Globalisation increases choice which could be a step towards a more free-society. The options to the society increases. It increases the choice of work and living, you can choose to live in country of your choice and choose the work according to your specialisation. Globalization leads to specialisation. Even the Foreign-Trade-Theory is based on the specialization point; they say we need to specialize in the line in which we have comparative advantage. It says to exports that product which it could produce at cheaper cost and prices; it says to specialize along those lines. Lower-prices are the foremost argument in favour of Free-Trade and globalisation which would increase real-wages and the standard of living. However, economists are conscious, that higher imports may reduce domestic employment and production and profits. Notwithstanding, globalisation as has been said before is good for real-wages and equality. Capital is moving from the rich-world to the poor-countries which have set the process of sharing prosperity, through immigration, too. Countries tend to allow immigration of low-skilled workers in order to provide the domestic-people with skills and higher-standard of living; nonetheless skills can be acquired to improve wages. Globalisation increases choice and prosperity, but there should be full-employment in the domestic-economy. Protection is often sought for protecting the full-employment objective of the economic-policies with lower general-price-level...

International-trade increases employment and real-wages and demand in the global-economy which further means higher production and growth-rate and more taxes to help eradicate poverty. The presence of more companies in the economy would increase revenue and public-spending on necessities. Presence of domestic-firms in foreign countries would further increase profits and taxes. It generates employment and income and demand in the global-economy.

Foreign-investment which increases employment to achieve full-employment must be given access to domestic-markets. Trade that destroy domestic jobs are not feasible. More companies in the country would lower prices and increase wages, too.

Immigration might also help increase labour-force-participation-rate and increase the economic-growth rate. It would reduce overheating in the domestic-economy after full-employment.

It is good for lower-wages and price-stability and could increase growth-rate and demand within the economy.

INDIA Must Try The New-Model...

The goal of economic-policies is to achieve low-inflation and low unemployment with highest possible potential for the economic-growth... The first two are the primary objects while the economic-growth is the underlying objective... Probably, market stabilization might entail these with clear and present situation... However, we do not need MSS (Market Stabilization (Securities) Scheme), today it has been proposed to bring those with the help of the RBI, right- away, because inflation and inflation expectations are committed lower in INDIA with bias for more expansion in the money-supply and the expected growth-rate which has a direct effect on investment, unemployment and (wages and) incomes and the demand and the economic-growth-real-GDP... Higher expected economic-growth-rate or the real-GDP (expectations) incentivizes investment... In the Harrod-Domar sense it is the warranted growth... we have two other growth-rates... The actual-growth-rate - the current-growth-rate-and the natural-growth-rate or the potential-growth-rate - the rate of growth of the labour-force...

The convergence of all the growth–rates is in the same direction in the long-run. When the actual-growth-rate diverges from the warranted growth-rate or the expected growth-rate or the natural-growth-rate or the pace of increase in the labour-force or the economy produces less jobs or there is unemployment or when demand and inflation are low, we require loose money-supply, otherwise we need tightening in case of high-demand and inflation… A higher actual growth rate might also increase real GDP growth-rate expectations in the next-period…

Shaping expectation is one important task of the economic-policies… But, shaping expectation sometimes may take time… It works with a lag or when people actually feel the outcome or based on current situation, when they know which policy suits then better and create a positive response… For a very long-period in the history inflation and inflation expectation were more common than deflation… However, countries, like Japan, are reeling under deflation for the past two-decades and have tried a lot to increase inflation and inflation expectation to cut real-wages and for competitive exports…

Withstanding, lower real-wages-than productivity has crippled domestic-demand and also the external-demand (for imports) which has set the process of evaporating wages gains and demand… However, international-trade is more expansionary, but at the cost of the domestic demand… But, why a country would increase exports at the loss of the domestic demand…? Domestically, lower prices and higher consumption would increase Welfare…

Therefore, it is fairly possible to have disinflation or deflation and expectations based on the historical evidences as in Europe and Japan where nominal interest-rates are negative to ward-off deflation.

Economists’ fear that deflation would make people delay purchases in the expectation of lower prices are ahead, but everybody knows that supply is limited… People would rush to buy the inventories… Moreover, lower prices would help lower-interest-rate and may also likely to increase internal-devaluation and increase the exports…

INDIA needs not to emulate the old model for inflation, depreciation and exports… However, occasional depreciation of the Indian currency could increase exports, too…

INDIA might also help to increase exports by increasing demand for imports and higher real-wages in the trading-partners economy… Higher real-wages abroad could also increase demand for Indian exports, whereas higher real wages would also boost domestic-demand… 

Lower-prices would increase real-wages – at home and abroad too…

INDIA has committed to a disinflationary-path, also through demonetization which is likely to increase higher real-wages and expectations, but would take time to adjust to the right money-supply when 86% of the notes are being recycled…

The RBI has set to maintain the liquidity with Rs 2000 notes… Probably, it would limit the circulation to match the money-quantity as before the ban… The sooner the policy makers help mitigate the cash crisis, either by cashless-transactions or other means, the sooner we would achieve the stability in the market…  

Demonetization could help lower inflation and inflation expectations which would increase spending provided the cash-gap recovers soon…

Lower-prices and higher real-wages and incomes expectation would increase demand and spending and the economic growth-rate, globally, including the domestic…

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 fulfil 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

Problems with the GST...

The GST is an issue i used to avoid writing on because i think all types of taxes have the same demand and supply effect on the economic-growth, have discussed taxes before that lower taxes would boost private spending when the public pays a higher part of their income as taxes. Both, income and indirect-taxes are levied in a big-part of the world when there should a choice to pay in indirect taxes or direct-tax over a year. This should be a choice of the public to pay either income-tax or indirect taxes. Both would have a dampening effect of demand and growth… Since taxing twice, direct-income-tax and indirect-taxes do not look rational, a developing economy is likely to have higher taxes because higher fiscal deficit and the fear of debasing money… Nonetheless, higher debt-GDP-ratio in much of the developed-world, the rolled over fiscal-deficit over the years has resulted in a heavy debt which does not allow the government to commit a stimulus the size the problem warrants… Thus, lower taxes are expansionary and higher taxes reduce demand and inflation… Higher government spending is often the cause of higher inflation… However, the economy-policy must be there to increase demand/supply and economic-growth to the potential… Nevertheless, the GST is the indirect tax part of the economy, but it would also affect demand, growth and investment in the next-period… However, I was always conscious of the problems the GST would have to be through… and a same rate of tax for every good and services would not be feasible because different goods and services have different utility and dependent on the needs of the society which is important for growth and development… which turned out to be the same as thought… we have four slabs for goods and services… Higher GST would be demand-negative which would regress both, consumption and investment… Notwithstanding a proper VAT could be the best for the economy… A single VAT –Value-Added-Tax because we also measure the GVA, i.e. Gross Value-added… According to the Laffer-curve taxes are revenue increasing only upto a point, but after then it decreases revenue… A tax on value, for both direct and indirect taxes could be the way to simplify the tax-structure for a better understanding of our tax-system. Taxes are also an effective tool to incentivize investment in case of higher social-utility or somewhat important for controlling inflation… 

Demonetisation (Tuesday, November 8, 2016)...

Modi government (today) has banned the exchange of Rs 500 and 1000 notes to curb the black money or the shadow economy and counterfeit currency menace the Indian-economy is facing, which is expected to have a long-run effect on the demand and supply as well as the prices and unemployment within the economy. The step is likely to reduce the amount of money that has entered the economy through wrong channels like tax-avoidance and fake currency by the neighbours to sponsor terrorism. This is the undesirable-money that is coming into the economy for destabilizing it and not good for the country in terms of demand/supply and prices or inflation. The black-money is often turned into other investments and is often hoarded under the mattresses. This is already known that the magnitude of black-money within the the economy is far greater than the black-money that has been kept in the foreign-economies to evade tax. The decision by the government would rule out the possibility to trade in other investment asset-classes like gold, land and property and their demand would go down… In another way it would reduce the demand for everything that could be purchased with the black money which means overall demand in the economy could go down with the decision to remove the old 500 and 1000 rupee notes from circulation. The measure could increase the real value of money in the economy because now money is less which means demand and prices would go down. The relative quantity of money would go down compared to the goods which would push down demand and prices. However, the government has reduced the number of notes in big cash transaction. Nonetheless, the more use of debit or credit cards in the transactions would too help to account for the source of money and verify whether the money is not unaccounted and prior taxes have been paid… The decision to cut back on the black-money should benefit everybody in the same way in terms of the value of money which could go up with lower demand and prices, except black-money would go out of the market… It would increase real wages and income and wealth… Lower prices increase demand and spending – consumption and investment – and the economic-growth-rate…   

Demonetisation and the Monetary-Policy...

A complete cashless economy where transactions from bank account is mandatory could dis-incentivize cash transactions by attracting investigation and law-suit on big transactions with unaccounted money on which taxes have not been paid...To dramatically reduce the circulation of black-money the government might had made the use of debit or credit cards with a pan number in 30 days with the help of some software in smart phones to verify finger-prints and the bank account number... we already have Adhar-card and Jan-Dhan bank accounts... the bump would have been narrowed... for this too we would need bank-deposits for future transactions... money had come to the banks in the form of deposits... Modi has still left room for future black-money by not abolishing cash transactions altogether... Still notes could be hoarded...

A thought over this move on its effect on the economy is crucial to convey the idea behind the government decision to unearth black-money to the public... The whole concept is to ban use of unaccounted money and fake or counterfeit money in the everyday transactions which may affect the demand within the economy in the short-run. To remove fake currency from the circulation the government measure is also to curb terrorist activities in the short-run is the most important argument in favour of ban of high denomination notes for which little-pain in the public life comes worthwhile, besides black-money... Security of human-life is more important...

However, lower consumer-spending with only white-money due to disruption in the supply of notes is hurt, the consumption is being delayed till the crunch is over and we are back to the normal-life in terms of money supply and demand... Nonetheless, the rate of price-rise or expectation about it would decide the sames in future, too, including the prices...   The ban on high denomination notes may negatively affect demand and the invalid-demand, both, is the short-run, but in the long-run it is likely to curb invalid demand or black-money-demand to a greater-degree...

The total demand less the demand dependent on the black-money might help reduce prices to a significant-level which would increase real-incomes in the medium-term... All those things that could be purchased with the black-money would see price-reductions and increase in demand as the life gathers momentum with the right money-supply... The reserve bank has committed a liquidity-neutral-stance to lower inflation and inflation expectation and employment and production and the economic-growth-rate...

The monetary-policy should try to match demand and supply of notes and quantity of money with the pre-ban levels... More deposits in banks could lower the rate of interest and increase investment... Lower prices may help increase savings and investment in the long-run... The RBI must try to keep demand intact by lowering the key-interest-rates. We may expect a rate-cut in the upcoming monetary-policy reviews...

Lower prices and lower interest-rate in the near-term would prove to be expansionary and beneficial for demand and growth.

The retail inflation in October has come lower to 4.2 % which also fosters rate cut expectations when we have set an inflation-target of 4% with a band of +/- 2% in the medium-term...

The real-interest-rate-cut expectation is also lower when inflation has scored lower and the RBI has set a neutral rate target of 1.25%...

Expansionary Policies after Demonetization...

Amid the arguments the debate on the demonetization has come close to the point that it has hit the money-supply in the pockets of the public since a large part of it is banned with the move to demonetize (old) Rs 500 and Rs 1000 notes… Almost 80% of the money-supply… Having noticed the changes in the key economic-variables like demand, supply, prices and un-employment in the market over two-weeks, we may find that there are many slips between the cup and the lips… The move has struck the demand in the economy by the way of demonetization of the high value notes to curb black and the counterfeit monies and in the same way it has also restricted the supply-side by reducing money to finance business, even exports have been down. Almost everybody feels that the bold measure to curb black-money and fake-currency, though even with good intentions has slowed down trade and employment in the economy… That, the decision is likely to be a pain in the short-run, but the economy would gain by reducing unjust demand and prices in the economy in the long-run, it would increase real wages and wealth… However, matching money-supply to the pre-crisis period is of utter importance… Previously, the RBI had an accommodative-stance to liquidity… The RBI is responsible for doing the job, nonetheless by increasing investment and employment, and productivity or production the government is equally responsible for keeping demand and growth high to tide over the wave of note-ban. The step could hurt the economic-growth-rate of the economy with slowdown in the demand and supply and inflation and possibly unemployment, but lower price and interest-rate expectations might help increase investment, growth and employment in the future if income does not decrease... Lower-prices and interest-rate could increase spending in the economy in the long-run… Keeping real-wages expectations high the policy-makers might target higher real-GDP. Lower prices would increase real-wages, real-interest-rate, and real-exchange rate and expectations which are likely to increase demand and supply, in the external-sector, too… Both, the RBI and the government are responsible for maintaining employment and wages and incomes and demand within the economy… They might work to keep demand and supply high by manipulating the money-supply and fiscal-expenditure to increase productivity, through innovation, and the economic growth-rate… Notwithstanding, the will to curb cash-transactions would decide the generation of black-money in the future…

Demonetization Would Increase Value of Money, Demand and Growth...

The commentators on the demonetization are often heard advocating the positive long-run effects of it and that it might also cause disruption in the everyday exchanges with cash for some-time since a large part it has been replaced by new currency and digital transactions, which seems to be right. The long-run effects would play-out through the effect of money-supply on inflation and interest-rate and the value of money, however disinflation and lower interest-rate observed after the demonetization due to lower cash, although unemployment has increased temporarily with the shortage of cash to finance economic-activity, are likely to increase demand and growth-rate in the future. Inflation in INDIA has come down in the data following demonetization, moreover the expectations about jobs and incomes is not so grim because investors have only delayed investment and the improvement in the supply of cash day by day would soon help to revive investment and employment. When income is more or less fixed and inflation and inflation expectations are biased lower would increase spending as soon as the economy adjusts to the money-supply and demand. We generally assume higher inflation while increasing money-supply, but when it is reduced we may also expect inflation to go down too because some of the demand and spending would go down. The black-economy which could be as big as a third of the white economy might be an important source of demand in the economy, especially for a home. Prior, real-estate was a cash and black-money oriented market which is now going to see a price-correction because of demonetization which is likely to increase demand of the common people, it would make homes affordable for the poor section of the country, however lower demand and prices would also lower the EMI and increase demand. When demand for construction would go up employment would go up too. The real-estate sector is an employment intensive sector which mostly uses unskilled labour; more employment would increase demand and the economic-growth. Demonetization would help the government in its mission of house for all by 2022. Lower prices signal more spending if employment and income do not go down, it is more expansionary because real-wages, real interest rate or real return on capital and real exchange rate increase domestic and external demand, lower prices could make the economy competitive. In INDIA’s case spending is only being delayed which is likely to come-back except the black-money demand and that people would find the market cheap after the pain-period is over. Demonetization could lower money-supply and increase the value of money, because it would make money scarce relative to goods and services by the way of lowering inflation and inflation expectation by reducing black-money dependent illegal demand.

INDIA Is Not Demand-Deficient, Spending Would Recover Fast...

As the demonetization story is slowly unfolding in terms of the effects on the demand, supply, and prices and growth, expectations… about the future that how long we have been in the trail of facts would signal the agents to do the best in their budgets, investors included, during this short-period of crisis of cash, matter. If people would feel that demonetization has benefitted them apart from the hardships they have faced they would support it since it is a big social-reform that is worth a short-run-pain since black-money is a form of social injustice and add up to illegitimate demand in the economy. The common-man is the agent to bring this big social-transformation, from corruption to a clean system, since his welfare is dependent on good public-services and state support in the form of direct benefit transfer and social-security net. Higher taxes are spent on the important things in life which are difficult to provide by a small vendor and the money from demonetization would be spent on the welfare of the poor, the Pradhan-Mantri-Garib-Kalyan-Yojna (PMGKY) has been started to show the government’s commitment to improve the condition of the poor of INDIA. Good infrastructure and employment-skills are sine-qua-non to a good standard of living and would help reduce poverty. Employment is best insurance against poverty and exploitation and the curb on black-money would improve the distribution of income and reduce inequality. Black-money in cash is saved after evading taxes that has a direct bearing on the spending on public-purposes to increase the quality of life and social-progress. Tax-evasion is a crime against the society, it holds-back development and growth, and higher spending by government may increase demand and supply. Apart from this a sweeping change could be expected when the banks are flushed with deposits and would be able to finance the loan demand at lower-rates when we say that INDIA is not demand deficient and the RBI has kept levers tight due to inflation and inflation expectations which would lower growth-expectation. However it is expected to cut rates when it has maintained an accommodative stance in case of lower inflation. Demonetization has improved on expectations about loose fiscal-policy and monetary policy in the next few quarters. The economy would definitely gain beyond demonetization because of better expectations for the key economic-variables like low-inflation, lower interest-rate and higher-spending, consumption and investment, and lower unemployment, too… The economy meanwhile is getting its math right… Higher savings due to limit on cash withdrawal would also be spent… Demonetization has increased expectations about the growth-rate in the following quarters. The economic-growth rate could touch 9% in the next few quarters on the back of rebound in demand till the cash-cripple is over because spending would recover at a faster rate …