Wages... Interest... Exchange... Rates... and Growth....

Ricardo pointed out that population would increase with higher wages, but when population and labour supply would increase it would, again, push down wages to the subsistence level or minimum wages... But, in the developed world real wages have been held low despite rising productivity which has reduced the population growth rate and the potential growth rate...

Higher nominal and real wages, when inflation is low, would also mean higher demand and growth in the economy... Businesses would sell more which would increase profits... People, who have money, would demand more... It would increase real wages and incomes increasing demand competitiveness of the economy like depreciation in the exchange rate or higher nominal exchange rate and/or devaluation in the real exchange rate or internal devaluation which increase exports... lower prices relative to wages and incomes... When income or wages would go up relative to the prices it means lower prices and higher demand... The demand multiplier would also work, which would increase demand in a multiple of initial increase or spending on wages and incomes... It would be good for the economy....

It would also increase employment.......

The reasons for low long run rates are low inflation and inflation expectations... Sometimes people also attribute higher long run rates to higher risks associated in the long run... Long run rates are also higher because of longer parting time or sacrifice of consumption.... However, lower long run rates are good for bond prices... bonds are safe during slowdown, too, bond prices go up... Lower inflation and inflation expectations might increase real returns on bonds in the long run... Lower price and price expectations due to lower borrowing cost could help achieve full employment and full investment and full demand and full supply and full growth... Lower borrowing cost is a sign that the country is capital rich which could dramatically increase competitiveness...

Creating long run loans out of short term deposits does not look feasible because of uncertainty and peoples' need, which could be a reason for risk in the banking when lower term loans or credit should be created by long run deposits or bonds to keep compliance with the depositors' withdrawal... any business is a lot of risk...

China's huge demand for dollar and dollar denominated assets and demand for dollar denominated oil have all contributed to a strong dollar, apart from the dollar's safe heaven image... China huge exports to the US also increase dollar demand....

Lower price and price expectations due to higher interest rate and expectations may delay recovery in investment, people would wait for the prices to go down, interest rate, too, or wait for lower prices to increase investment... It is not always feasible to invest all the times... Investment has a higher chance of success when investment cost is low... Lower prices increase demand and higher demand further means higher prices and higher supply and growth... The trade cycle moves between higher supply and lower demand (lower prices) and higher demand and lower supply (higher prices)... and low and higher growth...

Higher Rates INDIA, US... the Global Economy...

In the current expansion of the trade cycle in INDIA, mostly the result of foreign investment and only a little far the result of domestic private sector, which has been saddled with NPAs in construction and real estate and banks, the drivers of growth, mainly, which are also the creator of jobs in an economy with skills and productivity gaps, which has depressed demand and investment, even though a slow implementation of pay commission has further delayed recovery in consumption and demand and growth, moreover, higher real interest rate in the past compared to other countries has cut domestic supply investment employment demand and prices and expectations due to inflation targeting, nonetheless oil prices and inflation has cut down the real interest rate, now.  

The global growth is also in doldrums due to trade wars and higher interest rate and expectations in the US that has led to the outflow of investment from the emerging markets because of depreciation and expectations which has further resulted in higher interest rate and expectations in the outer economies and a strong dollar which would also reduce global demand due to costly dollar, which is one of our SDR currencies, when oil prices are again increasing interest rate and expectations and strong dollar and expectations leading to lower countries’ demand and growth and global growth, higher oil prices would also lower investment, stocks too, and increase supply expectations, we have recently witnessed oil stocks gaining on lower prices which increase demand, oil has been a traditional source of inflation. 

Lower interest rate and expectations are as important to the US economy as to the emerging markets and global growth and more when the domestic competitiveness is hurt by higher tariffs and retaliation which increase price and reduce demand and expectations, also because of higher interest rate and expectations, moreover, a cheap dollar would also reduce price of oil relative to the increase nominal exchange rate or depreciation in the dollar which would also help other economies and global growth, which should also stabilize depreciation in the outer world and could also help increase US exports, in addition lower relative oil prices and inflation would increase real wages and domestic demand in the US and globally, since it is a net exporter of oil, now. 

Tightenings...

Both, the US and INDIA are now almost on the path of rate hike as far as inflation targets are concerned, both are trying to bind themselves with the inflation targeting framework objectives, when inflation is near the upside target in the face of higher global oil prices and rising borrowing costs and expectations which is likely to cut down the expansion of business cycles in the two economies and global growth limiting prices and growth and expectations lower than their potentials, which could push the economies back to recessions and slowdown if people do not follow the central bank signals and inflation perks leading to tightening in the neutral real rate of interest and sudden reversal of a neutral stance on the interest rate in a  tightening cycle and expectations of an impending recession, a period of high unemployment and lower prices needing to cut the neutral real interest rate and expectations and increase demand supply investment employment and prices and growth and expectations.

Nonetheless, the RBI has maintained a neutral stance, despite a rate hike, depending on the incoming data, mainly on the effects of higher oil prices and higher MSP effects which is likely to increase rural demand and industry demand and growth. The insufficient level of private investment and production and ineffective distribution of labour to sectors like oil, which has been an unequivocal source of inflation in the economy, have caused higher interest rate and expectations, apart from food that faced ineffective supply mechanism and higher costs. Had INDIA created an excess reserve of oil during low prices, it could have handled higher oil prices and inflation much better. 

Moreover, higher interest rate and interest rate expectations, due tightening in the US and capital outflows and depreciation and expectations have increased uncertainty for private investment that is still trying to recover from the last slowdown and is also marred by the NPAs of the PSBs and the private sector (businesses), the twin balance sheet problem has held back investment in the economy, even though the government has allowed foreign investments and employment creation in the economy. 

Since, INDIA has not been much dependent on exports for growth, the trade wars would have a little effect on the economy, but to create employment and achieve the double digit growth rate INDIA needs to find its right place in the global supply chain and value addition by increasing economy’s competitiveness and productivity to lower prices and increase demand through innovation. 

The US too has maintained a tightening approach through a series of gradual rate hikes due to a stable outlook on the growth and unemployment in the expectation that tightening in the labour market would also increase wage inflation and inflation or general price level in the economy and the Fed would hike to achieve the neutral real interest rate and avoid inverted yield curve that signal looming recession.

But, with a credible monetary policy communication to control spending, both, consumption and investment through rate hikes and expectations could help to control inflation and inflation expectations only to an extent after which it increases unemployment. 

Nonetheless, a sudden or too much tightening to reduce unemployment could significantly lower price and growth expectations, which nobody wants, but lower prices might help increase demand if real wages and wage expectations increase through tight labour market, higher interest rates would make spending costly thereby reducing it.

Systems and Signals...

Trade cycles – booms and busts - have been imminent while adjusting money supply, interest rate and prices or inflation and unemployment in the economy through the monetary policy, in short, if we say that the monetary policy also gives birth to the trade cycles, apart from the market mechanism which also helps clear excess demand and supply or exuberance through price adjustments as in the stock market, would not be far from reality. 

Using it the central bank controls investment unemployment and prices in the economy to keep the value of money and demand intact, but as the time rolls we have seen the value of money going down due to rising prices and interest rate, cost of investment going up which might also restrict the ability to employ and increase supply. 

The central bank during inflation increases interest rate to reduce demand and prices, but this also reduces investment employment and  supply and growth, which further increases prices and could be misleading while attempting to contain demand which also reduces supply and growth, when it might lower cost of investment to increase supply, imports too. 

During higher inflation and wage cost, higher cost of capital could further drag down supply which would accentuate the problem of inflation and loss in the value to money. 

Moreover, higher prices (and lower borrowing cost) could increase supply and lower the price level, but by intervening through higher interest cost the central bank restricts the supply or market mechanism to work to lower the price level, which would increase demand and prices in the future giving rise to trade cycles, swing between high demand and high supply or between higher prices and lower prices. 

Nonetheless, the job of the central bank is not to control all the price movements, but to control excess volatility beyond the targets in a time frame, a stock market has limits for price on a daily basis which moves up and down depending on demand and supply and sometimes unexpectedly. 

Expecting prices movements is a bit tardy and difficult for the central bank too as we can see the inflation target set by the Fed has been consistently undershot years despite ultra accommodative conditions. 

Notwithstanding, the Fed has let the stock market prices to go unregulated and market dependent, but has set a limit for inflation in the economy which has reduced price adjustments based on the demand and supply in the economy, a two percent inflation target or profit or price limit could be too low for to incentivize demand and supply and investment and employment and growth to reach the potential.

It would give rise to frequent and small trade cycles requiring frequent adjustments in money supply and interest rate meaning more and frequent intervention by the monetary policy.

The inflation targeting has cut down the length of the expansion of the trade cycles and increased worry about an inverted yield curve, when short run interest rate exceed long run rate which has always been followed by recession. 

Nonetheless, a clear and loud signal about the neutral real interest rate and price or inflation limits – upper limit or lower limit - could help manage spending and demand and supply and growth by managing interest rate and expectations.

Prices near the lower target would mean lower interest rate and expectations and spending and near high would signal higher interest rate and expectations and lower spending or increase deleveraging.

Lack of proper communication or knowledge about its actions on the part of the central is the main reason for bad outcomes and uncertainty or exuberance in the economy or the stock market, people know not much how the system works and signals of monetary policy, stock market too……