Rajan's smart moves...

Article;
RBI raises repo-rate by 25 bps to 8%.

Comment;

Rajan in his latest monetary policy has again surprised those who forecasted a status quo,… We thought inflation showed a decline in the recent data therefore our Governor would wait for more data to make sure he is not over-tightening as the transmission to demand and prices takes time… the effect of tightening appears with a lag… Rajan’s decision to hike repo-rate was expected, sooner or later, because a just 50 basis-point hike after our new governor took office, apart from previous rate hikes, when inflation is consistently hovering around 10% since a decade now, since 2004, and there is an upward bias in the face of supply side problems, can not be expected to bring inflation to 6% or less (a liberal view)… A meager rise (50 basis-points) in the repo-rate can not bring inflation at 6% or below… If we have an inflation rate 9 % we need to push-up interest rates atleast 3% (Taylor’s-Rule)...  Rajan has took a good turn, a shortcut in terms of time saving… waiting for more data could lengthen the time taken for turning high interest rate into lower demand and prices… Rajan has done a smart thing to cut short prolonged low growth phase due to higher interest rates… As soon as the inflation comes to the target, the sooner we would be able to push demand and growth higher to reduce destitution locally and globally… Lower prices mean more purchasing power for our common-man… And, the CPI is the right anchor for inflation because people do not buy in the wholesale market…  

Unemployment rate indicates overheating...

Article;
Unemployment levels rising in INDIA ILO report.

Comment;

Unemployment rate at 3.6% or 3.7% or 3.8% is lower than the natural rate or NAIRU (non-accelerating-inflation-rate-of-unemployment, 4-6%) in which inflation becomes low and stable. If it is below the natural rate it is a sign of overheating, the RBI should hike key interest rates to control demand and inflation… Moreover inflation (CPI) too is above the RBI’s comfort zone but after two rate hikes the RBI is expecting inflation to come down close to target (4% with a band of 200 basis points). The RBI’s monetary policy is scheduled on Jan 28, 2014 in which economists expect it to maintain status quo and wait for more data… But with unemployment rate low below the natural rate we can not expect prices to go down too much because demand is still there… the market is experiencing scarcity of labor and to attract labor it is offering higher wages which has further put pressure on prices in the face of supply-side problems… The RBI should affect the proper threshold of interest rate to sacrifice some demand for labor, too, which only higher interest, apart from fiscal policy and taxes, can do to control prices… We can easily expect more rate hikes in the following RBI reviews… This can be said even after taking into account the Urjit Patel Committee report, which has recommend the RBI to follow the CPI as anchor for inflation. The RBI should take both, the unemployment rate and inflation rate, into account to decide the course of monetary policy… Unemployment rate is a sign of overheating…

Inflation targeting...

Article;
Retail inflation as new policy benchmark a good-idea.

Comment;

We should thank the central bank that it has not chosen 0% inflation or complete price-stability as the objective. The central bank would target 4% +/- 2% CPI... much liberal... not very hawkish…It (the central bank) has tried to make the monetary policy more predictable... The RBI has made a complete time-table for years to bring inflation close to the target... a very good move... but let us see how it is accomplished... If that is done by increasing interest rates then we will go through a downward spiral, falling demand and prices until inflation comes close to target 2-6%... or it can be done by fostering supply, especially food items... The Indian story is more about inflation and supply side bottlenecks and as far as demand is concerned the government has pumped too much money through loose fiscal policy... which gave wages and income a boost… demand is outpacing supply due to bad policy in retailing even when food and fuel prices globally are much calm... Bad Government policy is responsible for high food inflation…

Japan, against the market-mechanism...

Article;
BOJ stands pat on easing says winning deflation battle.

Comment;

Inflation targeting by monetary easing can further lengthen the recovery because people will expect that one day inflation targeting will go then they will resume spending... Prices can not fall below the lowest denomination of currency. In Japan it may be 1 yen... Prices fall but they can not be negative... If you buy you have to pay something then what could be the lowest price? It must be the lowest denomination of a currency… The higher end tends to infinity… Nevertheless we can increase the purchasing power of money if we let the prices fall and float a lower denomination of yen which will increase the space in which prices can fall… For example, in Japan if we float a 50 ney (hypothetical) a lower denomination of yen then price can fall from 1 yen to 50 ney… value of yen will go up… Nominal wages are very high in Japan, as high as 750 yen per hour, but we need to increase real wages to reduce income inequality and push growth… Without monetary easing there is a persistent pressure on prices to go down which means we have an excess of supply over demand… The unemployment rate is close to 4%, near the natural-rate which means demand is not a problem within the economy, but falling prices mean oversupply… And, prices should continue to fall to clear the market, but the policy-makers want inflation… Japan has chosen external devaluation over internal devaluation via monetary policy to give exports a push. Falling prices and wages too could make exports competitive…

Public v/s Private spending...

Article;
Interest-rates may come down without Raghuram Rajan's help.

Comment;

 If interest rate goes down private demand would kick-in... good for industries... High government borrowing crowds out private borrowing... Both public and private spending can boost growth but the public sector is constrained by deficit target and there is no such binding with the private sector they can spend higher can push growth higher... Just like the Central bank, a lender of last resort... the government should be a spender of last resort... The government should fill the gaps where market becomes inefficient... as in case of public goods... The government spends when it puts tax somewhere, because it is its revenue... This is why private spending is preferred over public spending... Nevertheless inflation remains a problem and restricts higher growth rates...

OMOs, again...

Article;
RBI to infuse Rs 10000 cr liquidity into market on Wed via omo.

Comment;

OMOs at this point of time when inflation is high will increase more money in circulation... Moreover, the central bank is buying securities which will reduce interest rate on the same. Government will borrow more and will spend more which will push inflation up... The government's fiscal situation is worsening, debt will increase... During high inflation financial innovation makes more sense because it will reduce money in circulation and will, thereby reduce demand and inflation... Why the central banks think that there is a problem of liquidity when inflation is high? The government has put enough money in circulation which resulted in demand pressure due to rise in wages and income... The monetary policy, by increasing interest rate, is the first tool to control inflation the other being the fiscal policy, the use of income-tax... If the loose fiscal policy has created demand pressures then use of taxes to control demand is more plausible... More tax means more revenue... Fiscal position would improve...

Inflation, why? The INDIA's case...

Inflation happens due to scarce resources...  we need innovations to save resources... we need to investment more in education and skills... which will result in higher technology... To avoid inflation we need to operate with capacity above demand... no doubt we need more investment... but in the short-run we experience inflation because labor is scarce... full employment is our second objective besides price stability... and when labor becomes scarce then firms start competing for labor, and, wages and income increase which in a developing economy with supply side constraints result in overheating and produce inflation which the central banks tries to control by increasing interest rates. In the short-run the Central-bank needs to restrict demand because supply is almost fixed, especially in the case of agricultural products, the market takes time to respond, supply increases only with a lag. If the farmer expects higher prices he will produce more, but that incentive is missing in INDIA, because prices are fixed by the government because it buys the produce…We need to liberalize the agriculture, too ...  This is INDIA's case itself...