The Long-Term...

 In the long-run, 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... But, now there is also a special quantity theory of money observed in the developed countries that is not expected under the general conditions. In a major part of the developed world loose monetary policy has failed to increase prices as expected because demand might not increase due to excess of labour supply which may put a downward pressure on the wages and prices when interest rate or cost are also close to the zero lower bound. 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. The central banks consciously or unconsciously are favouring the capitalist to reduce unemployment. Nonetheless, when real wages are going down demand too is likely to remain subdued resulting in lower growth rate...  The “long-run” to me exists all the time, which is the truth; it exists always, not subject to short-termism, what everybody does under the similar conditions. The difference between general and partial... 

Japan's higher long-run rates...

It is worth a thought that economic-models assume zero inflation in the long-run. Inflation is a short-run deviation from the equilibrium price-level. Economists think of the long-run as self-correcting. But when deciding long-run rates expected inflation plays an important role because the economy first consumes and then saves for the future; if they expect higher inflation based on the current situation they would also save more for the future too and more savings result in lower spending means lower demand and prices. Interest rate would go down. On the contrary, if they expect deflation based on the current condition they would save less-spend more which might increase demand and prices and interest rate. People expect higher interest rate if there is inflation because the monetary-policy would work to control inflation. Generally, prices and interest rate move in the same direction. Expected inflation would increase the long-run rates, higher than the short-run rates. The long-run rates are higher than the short –run rates which shows that depending on the economic –policy people expect inflation in the long-run which is opposite of what the economic models assume that inflation in the long-run would be lower or zero.  Keynes long ago accepted that labour and other factors of production might not be abundant but capital has no reason to be scarce since the central bank can print money to finance the economy. Gold-Standard off-load was a big move in that direction which was later used to print notes, buy foreign exchange and devalue to gain exports. Keynes foresees capital as not scarce in the long-run. Our zero interest-rate regimes in much of the developed world do support Keynes view that capital is not necessarily scarce. Higher long-run interest rate is against Keynes argument of lower interest rate.  

Higher wages may point overheating in the labour-market...

After increase in the hourly compensation to four-percent the case of a potential rate hike in the US looks close when the Fed meets in Dec. It shows higher wages and cost which may result in higher core inflation, a rise in wage, cost and price of manufactured products which reflect tightening in the labour market that the economy has achieved its potential and further monetary policy stance would be tightening of the capital market too because lose money-supply might increase demand for labour when the economy has reached full-employment and may result in wage cost and inflation which does reflect the reserve bank’s commitment for price-stability and the value of money and demand. The scenario clearly depicts the situation or condition the US economy is going through. The central-bank has had approached the inflation trajectory close to arrive at the hike, but the Fed index of inflation gauge has failed to turn out as expected. The consumer personal expenditure (CPE) with so low fuel prices has failed to increase inflation because of low spending and inflationary expectations have also increased savings. But, higher wages show that there is a competition to attract labour and might also indicate overheating and tightening. Labour is among the scarcest factor of production against the long-held assumption of old models of unlimited supply at a fix price or wage. The supply of labour is the prime cause of low-supply and higher prices in the short-run. Lack of skills too add to the problem of low-supply. Therefore, countries try to update its economy with innovation that increases productivity to overcome labour shortage problem and reduce cost and prices to remain competitive. Full-employment is a major supply side constraint beside food and fuel which may also signal overheating and inflation. However, CPE has been the preferred gauge of inflation for the Fed which shows lower inflation compared to the wage inflation as seen in the hourly compensation. Higher wages and prices indicate higher demand in the labour market but food and fuel prices indicate less demand pressures also due to good supply condition. The US is a developed country, but still constrained by the supply of labour also because of falling population and labour-force participation growth rate...  

RBI's policy...

Almost everybody forecasted a status-quo for the today’s RBI policy review because there were ample reasons to expect RBI to wait and watch the latest data and the outcome is also same. RBI kept repo-rate constant at 6.75 with no liquidity injections. Inflation in the recent data, around more than 5%, after two consecutive months of increase may still indicate food supply problems due to seasonal problems and rains that INDIA face almost every year. Inflation in INDIA mainly emanates from the ineffective supply management of food articles. INDIA suffers from seasonal inflation because it is too much dependent on rains and also excessive rains in some parts which lead to flood and crop damage. Every year drought and floods upset prices of agricultural products. Lack of demand and supply data, and effective action in order to maintain price-stability and demand puts INDIA in a fix and delayed monetary-policy action to increase growth for the past several years. Nevertheless, the situation has improved on account of proper actions to manage food-supply by the government and retail inflation has come down from double digits to below five-percent. However, to avoid seasonal inflation there is alot more to be done to get ontime data and effective actions. Agriculture needs a lot of planning to reduce the lag between demand and supply adjustment. The government has a larger role in the supply-side management rather than tweaking demand by the monetary-policy.

RBI in its monetary-policy stated that banks still need to pass-on the previous rate cuts as the interest-rate transmission has been close to half which leaves room for banks to lower the existing rates. Nonetheless, RBI maintained that the monetary-policy would remain accommodative as long as disinflation continues. The RBI proposed to bring methodology to set banking rate as per the marginal-cost of funds. However, the strategy to set bank rates according to marginal cost might not work without opening the sector for more investment and competition. More banks in the market with good regulation may help set rates according to marginal cost. The competition to increase market share results in price-competition among firms. It would also improve transmission... The RBI might try to increase competition in the banking industry...

Deflation and internal-devaluation might also work...

Paul Krugman is arguing about the desirability and plausibility of external devaluation or depreciation over internal devaluation that the first one is easy and quick to achieve instead of cutting nominal wages and prices through the latter. Both are the ways of cutting wage cost, lower prices relative to the nominal exchange rate and increase demand for exports. In depreciation the economy tries to cut real wages with inflation, and, lower cost of production and prices relative to the nominal exchange rate. Inflation also increases the nominal exchange rate. Such a policy aims two things, lower cost of production and prices, and higher nominal exchange rate too. But to achieve depreciation it is important that inflation increase which might not work in the liquidity trap when people save more in expectation of higher future prices because of expansionary policies. But, when savings go up, inflation fails to materialise and instead turn to disinflation or deflation which increases the problem of liquidity trap by lowering prices and interest rate. Even very large amount of money fails to increase inflation. Lower demand increases the relative supply and put a downward pressure on prices in the liquidity trap. However, if inflation goes up it would lower domestic demand due to lower real wages. Therefore, depreciation in liquidity trap world might not work, and moreover inflation and real wage cuts would increase external demand at the cost of domestic demand. In internal devaluation also the economy tries to reduce nominal wages and prices relative to the nominal exchange rate to increase export demand which would also hurt domestic demand, but wages are mostly sticky in the short-run which economists consider responsible for adjustment to store demand. The wage rigidity points to adjustment in other cost, profits and prices to increase external demand which might not be as rigid as wages because all wages are consumed, like low interest rates. But, in the liquidity trap or at the zero lower bound the adjustment cannot be continued without increasing expected inflation which aggravates savings and liquidity-trap by reducing domestic demand and growth. Much of the developed world is going through the liquidity trap and expansionary policies are unable to increase inflation and depreciation. Lose policies have failed to increase inflation and depreciation, but expected inflation and savings have worsened the spending, demand and growth. Therefore, lack of depreciation has not increased external demand and expected inflation has also lowered domestic demand. However, if the policy-makers commit deflation with lose money-supply because lower interest-rate would increase investment and supply, and lower the prices, they might be able to increase both domestic and external demand without increasing inflation, inflationary-expectations, depreciation and nominal exchange rate. It would work same like depreciation by lowering prices and increase the real exchange rate to increase export demand. Krugman should think about the difficulty the Western-world is facing to increase inflation when deflation is more imminent and more money-supply is not pushing inflation up, but rather increasing supply and lowering prices by lowering the borrowing cost. In such a condition deflation could be used as a strategy to increase real exchange rate and external demand. Lower prices would also increase domestic demand. When deflation could help achieve higher real wages and higher exchange rate and domestic and external demand, both, then “why the policy-makers are trying to increase inflation, which would increase external demand by increasing the nominal exchange-rate, but would decrease real wages and internal-demand, when they might choose to increase both by internal devaluation...? Lower prices or inflation would increase real-wages and domestic-demand and higher real exchange rate due to deflation could also increase external-demand...

Wages in Japan...

Japan under Shinzo Abe is still trying to target inflation when unemployment has reached a very low level and the economy is waiting to see rise in wages and inflation in the core or manufactured goods segment when food and fuel inflation failed to respond due to low population growth rate and good supply-side. Japan is now targeting core-inflation with food since oil-prices have come down to half and are not a problem. But low unemployment-rate may signal a labour supply shortage which would increase demand for wages, and, could increase wage cost and inflation. Nonetheless, if Japan increases the borrowing cost it would be able to increase inflation in a proportion of increase in interest-rates. Too low interest rates for more than two decades have removed the constraint imposed by higher interest rates on the supply-side.  Food and fuel prices that generally result in inflation in a country are very low in Japan and supply is not a problem, therefore they do not show demand pressures and inflation. Japan has invested heavily in food and fuel supply.  But, low population growth rate might constrain labour-supply and may poke wages and inflation in the retail price of manufactured products because then the market would compete for labour. Japan’s open economy is too responsible for low inflation. Foreign supply of goods and services has also kept prices and inflation low. In short Japan’s supply side is too good that the economy failed to generate inflation, but very low unemployment would help increase wages which Abe wants to increase inflation. Abe is pleading to the Capitalists that they should increase wages to increase demand and inflation, but they are ignoring because that would increase cost and reduce profits when there is a downward pressure on the price-level and inflation due to low demand. It would reduce their pricing-power during slowdown. Japan is actually doing the same the other countries do in a slowdown... It is trying to cut real interest rate and wages by increasing inflation in order to increase investment spending, but due to inflation-targeting people are reluctant to spend because they are expecting inflation ahead and are saving more for the future which has actually put the economy in the liquidity-trap. Low spending (consumption and investment) has depressed prices and interest-rate pushing the economy in the liquidity-trap. To overcome liquidity-trap inflation targeting is a bad strategy because it would increase savings. Liquidity-trap is mainly an expectation problem; if people expect inflation they would save more for future, but if they expect deflation and higher real wages they would consume more because lower prices would increase demand. And in this situation if lower prices increase demand relative to supply then the economy might also be able to push inflation up in the future. So far the country has tried to increase investment spending and inflation, but low demand due to low real wages has failed to attract supply. Abe wants to increase inflation for the Capitalist and investment spending, but he may also try to increase consumption spending which might also increase demand and inflation. But, this time the economy must commit deflation and not inflation which could increase real-wages and demand. Japan might commit zero interest rate and more fiscal spending as long as deflation persists.  Abe can increase wages or real wages without the Capitalists’ help using the monetary and fiscal policies by committing deflation... He should commit that lose money-supply might also be deflationary when supply increases relative to demand against the long held opinion that more money-supply would only increase demand relative to supply and would stoke inflation. Lose money-supply might also increase supply and lower the price-level. More money-supply may also increase supply by lowering interest rate cost which may also decrease the price-level, and, increase real-wages, demand and growth...

Lower inflation and inflationary-expectations in the US...

Interest-rate depends upon the money-supply, the price level and expectation of changes in it, because of the price-stability objective of the monetary-policy or the central-banks. They manage money-supply to adjust interest-rate and demand/supply which jointly determines the price-level or inflation. But, interest-rate in turn is also determined by inflation and inflationary expectations, both short-run and long-run. Higher inflation and inflationary expectations also make the central-banks fine-tune money-supply and interest-rate. Normally central-banks job is to ensure price-stability, but when growth-rate is tumbling it might set higher-inflation-targets, because it is a sign of higher demand/supply and economic-activity. Generally, booms and high growth-rates coincide with higher prices and interest-rate. Nonetheless, busts and slow-downs in the economic-activity and growth-rate calls for lower interest-rates, but to cut interest-rates during down-turn it is important to tighten during higher inflation otherwise it would feed bubbles by increasing the gap between nominal and real prices of assets because of inflation. The fear that lose money-supply and interest-rate might create asset-price-bubbles in the US is baseless since inflation is too low. Moreover, the fear of risky investment because of too low rates is again overdone since banks lend only after assuring feasibility of the project. Nevertheless, low interest-rate on retirement-funds also depends on inflation and inflationary expectation, and, low interest-rate would also mean that inflation in future could remain low which means higher real-interest rates, and the argument that pension funds might lose because of low rates may also be overblown because it would also signal that inflation could remain low in the future so that less savings would be needed. In the US economy low inflation is responsible for low interest-rates which may push the case for more money-supply since it has been a year now when the Fed ended its QE program and inflation is still below the official target of 2%. The effect of QE is fading since inflationary expectations are still low with oil from the Shale-revolution, which had put the expansion of the US economy in shambles many times before. Lower oil-price expectations in the economy has kept inflationary expectations and interest rate low,  which is likely to stay because the US is now a big oil producing country. Most of the prior recessions in the US economy were associated with oil-price booms and inflation. Lower oil-prices are a major contributor to low inflation and inflationary expectations after Shale. Higher oil-prices in the future would also make high-cost shale-exploration more viable, and, thereby more production and supply leading to further low oil prices, inflation expectations and interest-rate.