The current global scene is one of uncertainty since there has been tightening and strong dollar and expectations in the US due to full employment and a strong economy amid the debate that how far we are from the neutral real rates, however prices are stable.
But, this has increased instability in the emerging economies coupled with the ongoing trade war between the US and China and few others, but depreciation b’coz of strong dollar might further aggravate the problem of exports to the US from other countries and the outflow of capital from the emerging markets would increase the problem of depreciation and trade deficit in the US.
Nonetheless, the Fed could avert a global slowdown in the US and emerging markets by delaying the rate hikes that would keep the dollar cheap and would help increase the US’ exports and would reduce outflow from the emerging markets and depreciation because of higher trade deficit and dollar demand also in the face of higher oil prices which could help balance deficit for economies overboard.
But, an atonce too much increase in interest rates and inflation and expectations could increase the effects of tightening and strong dollar that could push the economies back to turmoil and adjustments which is by far improbable and only if the yield curve inverts too much or short run rates increase too much and choke investment and reduce stock holding or increase selling and trigger a recession.
Tighter money supply and increase in interest rate, both short run rates and long run rates, to achieve price stability and full employment and vice versa... to achieve the equilibrium or neutral rates... is the goal of the monetary policy… In the aftermath of the recession 2008 the Fed increased money supply and lowered long run and short run rates to stop default on home loans, higher inflation and higher interest rates increased defaults and chances of default...
Housing industry is very employment intensive and when the bubble burst it increased unemployment to over 10% and lowered demand alot which kept the inflation low, biased lower, for a long period resulting in lower interest rate... A too much higher interest rate would again increase cost and cost of living and the risk of default....
Not every business or household has the ability to cope with higher inflation cost, wages or incomes and interest rate which also reduce demand along with supply... A lower borrowing cost is important to avoid defaults and maintain price stability and employment... and, increase growth and growth expectations...
INDIA during the Apr-Jun quarter increased the growth to 8.2% on the back of higher manufacturing and agricultural activities, but depreciation has been a worry in the short run for fiscal spending and current account deficit due to higher inflation and expectations owing to higher oil prices, a cheaper dollar by the increasing supply of dollar could also help control inflation and inflation expectations, otherwise the long run story of INDIA remains intact given the demographic dividend and higher domestic demand.
This could be the right time to reduce some revenue and spending and inflation and interest rate and expectations and increase spending and growth expectations through lower oil prices and revenue... The Government earns 50% in tax on oil prices... and must bring it under GST....
Lower prices and interest rate and expectations could also reduce interest rate payment on public debt and help contain deficit and debt... If the government lowers taxes it also means that spending has been passed on to the agents... it is also a kind of spending... during an election year...
A degrading external environment due to trade wars and protectionism might help the Indian economy through lower commodity prices like oil due to lower external or global demand since it is a more domestic demand driven economy and a net importer...
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