The real effective interest rate and foreign-competition...

Many among us are now claiming that the Reserve Bank of INDIA has reached the limit of rate-cuts following the institution’s communication that inflation and inflation expectations are biased higher in the hindsight of higher expected inflation in food and fuel that it expects inflation to be tilted to upside even when the current CPI inflation is lower than our short-run target of 4% by 2018 at 3.5%, which gives a real interest rate above than the past and that might signal that RBI must cut real interest rate in a world of negative rates. The real interest rates in a major part of the World are around negative in order to keep capital cheap to boost investment with positive inflation and nominal rates close to zero and i.e. negative real rates, nonetheless INDIA has a much higher real rate compared to the rest of the world which has a lot to do with INDIA’s competitiveness in terms of the cost of investment compared to the rest of the world, which is the ratio of nominal interest rate of the domestic economy and the foreign economy divided by the ratio of prices in the domestic economy and the foreign economy, we may call it the real effective interest rate. In other words, lower nominal interest rate and lower prices would increase competitiveness of the Indian economy and would increase demand, internal and external, lower borrowing cost would increase investment demand which is likely to increase growth. The competitiveness may come from lower input costs and prices; however there is nominal downward wage rigidity, but capital has no such rigidity which might help lower borrowing cost and prices. The lower prices would again help contain wages which would further help maintain competitiveness. In a world of free-trade and Globalization, international access of cheap inputs would help increase investment and demand, moreover lower prices would also increase consumption demand. Lower borrowing cost and higher supply in the long-run would help lower prices and as has been observed in much of the developed world, the lower real or natural interest rate as a result of lower population and demand and higher investment and supply have also helped achieve price stability and in some cases deflation, but they have also reduced demand and inflation by lowering the real wages with inflation in the past, which has negatively stroked the economic-growth in much of the developed world. Inflation is an important determinant of interest–rate and investors assume inflation against the economic-theories that inflation would go down in the long-run which is the same that has happened in the Western countries. INDIA has liberalized foreign debt by allowing credit in domestic currency with the help of bonds, but has refrained from lowering nominal interest rate and real interest rate even when globally interest rate are negative in many cases which is likely to depress the banking sector when they are reluctant to pass on previous rate cut transmissions which might push the commercial banks to lower real effective interest rate and increase demand. Competition from foreign might nudge banks to pass on the rate cuts and the RBI might further help by reducing key rates and increase money-supply. It is the relative nominal interest rate and price-level in the respective countries which decides demand, spending and the economic growth rate in a globalised world…  

Innovation Would Help Increase Growth After Full-Employment and Lower Inflation...

The Indian-economy has retained the status of fastest growing country when the US is gaining momentum and China has started to rein in bubbles by controlling some of its demand for credit and debt-building by increasing interest rate. However, the rest of the World has been going through an anemic phase marked by a lower global-economic-growth except the US and INDIA. The slowdown in China after three decades long expansion also lower growth-expectation for the world-trade and growth when it is losing competitiveness by absorbing beyond full-employment and the rising wages might present reallocation of production to INDIA and other low wage countries. China has been a major supply-chain in assembling imports and turns them into finished products and exports which INDIA might emulate to increase competitiveness of its products and claim its share of world trade, lower wages would help if the country produces at lower cost and increases supply to foreign countries. INDIA’s low manufacturing base, though the government has liberalized and improved on the ease of doing business, is responsible for low paying jobs and demand and spending and the economic-growth when it mainly concentrates on domestic-demand. During the Great-Recession INDIA achieved double-digit growth rate only on the back of domestic demand, but it also increased inflation when lower exchange reserves and imports also restricted supply and growth. INDIA had a problem of twin-deficits and inflation has been tamed by targeting inflation and higher interest rates. But, the situation has improved a lot in the last few years, by en-cashing lower wages and lower interest rate and by improvising on productivity and removing restrictions on supply INDIA may think of increasing the pace of manufacturing, employment generation and reducing poverty by increasing education and skills. Nonetheless, inviting the FDI in education, skills, employment and productivity creation should be incentivized; higher productivity and lower inflation would also increase competitiveness and demand. Inflation in INDIA is because it is big country and has a huge demand, but also because it has a low investment and higher borrowing cost and also low exports. The economy easily starts overheating because of full-employment, but is still supply constrained because of low productivity, education and skills base and to excel INDIA now also needs more investment in innovation, i.e. better technology. INDIA these years has also soaked up its labour-force, unemployment is not a problem, but now it must invest in enhancing productivity of its labour-force through right skills and innovation and those come from investment in education and research which needs inducement through proper facilities. Investment in education is probably the most strategic requirement that the government should ensure to make life easy, productive and world-class in the long-run.  

Target Higher Growth-Rate by Low Borrowing Cost and Prices/Inflation (US)...

The US is going to have its next monetary-policy review on March 14 – 15 and the Fed Chair Ms Yellen has aired in her recent interaction that it is likely that the Fed would increase rates in the sight of higher inflation and inflation expectations and full-employment and higher wages, demand and growth. The latest inflation reading is around 1.9 % after above 2% figures in the preceding two months, the economy is also close to full-employment, the wage pressure is building up and the economic growth-rate has increased to 1.9%, though lower than before, which the Fed says might form the base for future rate hikes following the incoming data. However, the Fed had said that rate hikes would be gradual in the prior communications which was missing in her latest words, but hope hikes would be data dependent in order to be consistent and less confusing. Nevertheless, the Fed is trying to increase wage and wage expectations and interest rate hike and expectations, by increasing inflation and inflation expectations which it at the same time would try to control by increasing the Fed Funds rate in the future, however higher oil-prices are major contributor to higher inflation and inflation expectations which have showed firmness in the recent months. The Fed is trying to increase nominal wages and interest rate and expectations by increasing inflation and inflation expectations, but the economy would lose demand and savings by targeting inflation because real wages and interest rate would go down, by targeting inflation it is cutting on real wages and interest rate and that is likely to reduce demand and savings and the economic-growth. It argues that by normalizing interest rates it would reward savings better, but higher inflation and nominal interest rate in the future would lower demand, consumption, savings and investment spending, and the economic-growth rate. Nonetheless, if the Fed continues with accommodative stance and commits lower interest cost and prices it would lead to the same outcome, higher demand and economic-growth, lower borrowing cost would reduce the overall cost and would increase the economy’s competitiveness and demand, but by increasing nominal interest rates it could increase some inflation by restricting investment and supply. The US economy is trying to generate inflation to increase nominal interest rate, but it would lower real interest rate which might reduce savings and investment, similarly lower real wages would reduce consumption, both resulting in less spending and economic-growth. Higher inflation and nominal interest rate and expectations about them would reduce demand and growth. The US’ rate of population growth rate decides its rate of potential expansion or economic-growth after accounting for natural unemployment and that is around 5%, the population growth rate is 10% and the frictional or natural rate of unemployment is 5%. The economy has barely touched that rate in past after the Great Recession and the Fed might target higher growth rate instead of higher inflation like China and lower borrowing cost and prices or inflation might help increase demand and growth. Though, higher oil prices have helped achieve the inflation-target, but the potential of shale-oil and the US’ joining of the oil market might increase employment and may also help achieve price-stability, when the oil-cartels have cut back on supply which may help increase oil-prices and shale oil production, higher prices would make its production feasible when lower borrowing cost would reduce the cost of investment. The shale-oil production has the capacity to bring back jobs lost in coal mining…  

Growth Dodges Note-Ban...

Yesterday the first real-GDP numbers at 7%, after note replacement, were out which showed little effect of demonetization when it fell from 7.4% that left others puzzled who expected a lower growth rate which shows that spending has been less affected, however it could be attributed to black-money splurge, people have spent their black-money which has resulted in higher spending and growth rate, they have spent (black-) money on luxuries like gold and cars whose sales have shot-up in setting the black-money. Nonetheless, lower inflation or GDP deflator may also result in higher real-GDP, although nominal-GDP and inflation have come down, but it has also increased the real-GDP which is not far from the truth that it has actually been less influenced by hit on the money-supply and demand. The prompt re-monetization as a result of measures taken by the RBI and GoI, flexibility in rules and stress on cashless transactions made the movement effective in terms of its effect on recovery from low demand, spending and lower growth-rate.

Recently Nobel laureate Amartya Sen (though) half-heartedly has admitted that promoting cashless might work, he agrees with the idea of the present government, but counts gaps which may take time to level, however... it could be learned in two days, people would learn because there is no other way to sustain... Payment with Adhar-card would help; its penetration is higher... Black-money is social-injustice because government’s ability to spend on education and health retards... Redistribution and growth might suffer, inequality would go up... Poor people’s living-standard depends on government’s income and social assets...

Demonetization and the cashless drives are to curb money on which taxes has not been paid... It is too increase tax-compliance... The less-cash economy would definitely help to reduce tax evasion... Black-money is a crime against the whole society, it affects redistribution of income by keeping it off from the banking system which lowers interest rate and increase investment and employment and wages... It has lowered inflation and inflation expectations and interest rate cut and lowered interest rate expectations... which would increase spending as soon as the cash or money-supply is restored... Consumption has only been delayed which would return or probably has already returned...

Moreover, black-money hoarders are not poor people... they have mobiles and bank-accounts... Only poor people do not have both which does not attach importance or significance to the infrastructure deficit... Poor people do not have black-money... Rich people have all the infrastructure which is likely to increase tax-collection and government spending on health and education...