Money Policy...

The US is nearing the end of the rate hike cycle after the Fed chair Powell uttered that it is close to the neutral rate since prices are stable with full employment, the real interest rate consistent with full employment and price stability, after keeping it negative and zero for near a decade that lifted all, emerging markets (EMs), too, including the US, especially the bonds and equity markets, across the globe, nonetheless, the markets remained jittery on the account of rate hikes and expectations and quantitative tightening coupled with tariffs war and standoff between the US and China and rising uncertainty in the oil market and strong dollar, all have inflation and inflations expectations, also due to depreciation and capital outflows and depreciation expectations in the EMs. 

Higher inflation and inflation expectations due to higher oil prices and strong dollar and depreciation and expectations have given rise to rate hikes and expectations in the emerging markets alongwith the US, also a strong dollar and expectations, have made finance costly and have made businesses postpone spending due to higher interest rate and lower demand and price and expectations, however as the Fed delays rate hikes and posit a more stable stance on interest rate that would give the emerging markets a breather from outflows insearch of higher bond yields and lower bond prices and stronger dollar and expectations as the right signals for investment in safe heaven US on higher return expectations, the Fed is equally responsible for stability in the emerging markets as so to the stability in the US, a strong dollar and higher oil prices are also problems for the US trade deficit and stock and bond markets as to the EMs.

Notwithstanding, lower prices increase demand and investment, but lower price expectations might delay spending, since people would postpone spending in expectations of lower prices, ahead, that could delay recovery in demand and supply and prices, however, if people expect higher prices as a result of higher demand, recovery in demand and supply and prices could be fast or prompt, but in the real world prices and expectations might change depending upon demand and supply and expectations and intervention through prices and expectations, themselves, demand and supply and expectations affect prices and expectations and prices and expectations also affect demand and supply and expectations.

Nevertheless, lower prices are good for demand and investment, but not lower price expectations, since that would delay demand, and, similarly, higher prices are bad for demand, but good for supply, however, higher price expectations from a low demand and price base could increase demand and investment, but not lower price expectations, which delays or slows demand, consumption and investment.   

Therefore, lower prices are good for demand and spending, but not lower price expectations for recovery from a slowdown and higher prices are bad for demand and good for supply, but higher price expectations could increase demand and delay supply further increasing prices.

However, lower prices could increase demand, which increase price and supply expectations and excess supply and lower prices could increase demand and price expectations, again, the economy moves between excess demand and excess supply in the absence of data, that’s a cycle, the economy moves between lower prices and lower demand and low supply and higher prices, higher demand and higher supply, however stability in demand and supply and prices at full employment is good for stability in growth and expectations, therefore, the economists have visualized the neutral real interest rate for stability in the economic system, which aims to neither boost nor discourage demand, supply and prices and expectations at full employment.

Nonetheless, during excess demand and inflation the central banks increase real interest rate which could further reduce supply and increase price and expectations due to higher unemployment and lower production and higher borrowing cost, on the other hand, excess supply and deflation makes the central bank to reduce the borrowing cost, which could further lower price and expectations upto full employment because of higher production, therefore, deviations from the neutral interest rate are self reinforcing through the demand, supply, prices and expectations channels and the effects on inflation and unemployment are often cumulative.

The central banks might try to avoid the trap by limiting rate cuts and rate hikes to a very few around the neutral real interest rate; however, rate cuts and rate hike expectations could increase uncertainty for demand and supply and prices and investment and employment and growth and expectations…..