Capital...

Capital is another, apart from Labour and others, important factor of production on which investment depends to a large extent which has a cost and price, and, a demand and a supply of money or Capital, Keynes demand for money equation is popular and supply is controlled by the central-banks, there are strings of measures of money-supply (M0, M1, M2,...) which varies with investment and demand, and, inflation and full-employment and growth… Investment could be important for the economic-growth-rate. The central-bank controls the supply of money and demand for money by moving the real interest-rate i.e. by nominal interest –rate and inflation… Across the Globe, to a greater degree, now at this stage, the neutral or natural rate of  real interest-rate is around 1 - 2 %... In INDIA the RBI has said that it would target a neutral-rate of real interest-rate of 1.25 % in case of low and stable inflation, the RBI has set a band for inflation 4 +/- 2 and has committed an accommodative stance… The interest-rate is on a downward trajectory and interest rate expectations are also biased lower and we have a pickup in the investment-cycle, although tepid… The investors track the GDP growth-rate for investment decisions and lower cost and price of Capital would increase investment and growth, this has been a long practice in China, they always project a higher growth-rate… The cost of borrowing might be positively correlated with the rate of economic-growth, a recent study shows that there are evidences of low but positive significance between economic-growth and the real interest-rate, and. income and demand, and, supply and profits, and, lower income and demand expectation would lower the warranted rate of the economic-growth and investment… The supply-side may be positive for employment, income, demand and economic-growth, through the real rates offered to the businesses and investment… The businesses can borrow either from banks, bonds or equities or through personal-borrowings and for all this they pay a real interest rate for the money… All businesses have a degree of risk because of uncertainty of work and income… The economy swings between boom and busts, the trade-cycle-theory… The are several types of hedges the market has to proffer for investment, there are interest-rate derivatives, currency-derivatives, commodity-derivatives, these help to avert the risk to the series of incomes from the investment and the interest-incomes, but it is difficult to demand less money for investment when you want higher interest rate from investment… The demand cuts the supply curve at a point where demand meets supply and decides a level of real-prices or income and demand… A recent study shows that prices decide the level of demand and the economic-growth-rate… when lower prices are more expansionary because of the lower cost of borrowing… The price of Capital, i.e.the real interest-rate is one important determinant of investment and the economic-growth-rate... The supply and demand of/for money bear a real rate of interest which also depends on the rate of inflation… and inflation reduces the value of money and real-returns… Out of all the investment vehicles bonds are largely inflation protected, because for them either yields increase or prices with the general price-level… Recently, the RBI has liberalized foreign-borrowing through Masala-bonds, i.e. bonds denominated in Rupees, plus the RBI too has tried to develop INDIA’s Corporate-bond-market… the RBI has signaled expansion in the balance-sheets… So there is a lot of scope in the borrowing from abroad… moreover, if the investor wants to invest s/he can hedge the interest-rate movements by derivatives… Loans in foreign-currency could increase the foreign-exchange-reserves, meanwhile… The competition from foreign-countries to sell loans would also aggravate the competition in the domestic-market  and would push the real-interest-rate to the real marginal cost… The RBI has increased competition in the market to borrow through bonds… Historically low nominal-interest-rate-levels in the developed countries presented the opportunities to borrow since a long-time now after 2008 and negative interest-rate in a big part of the developed world signal lower interest-rate projection and expectations that would also bolster borrowing in the emerging markets… The real interest rate paid for foreign loans would be low enough, because interest rates are near zero and inflation in INDIA is around 4 %... Now, we have a minus 3-4 % of the real interest rate which should promote investment… Nevertheless, it could be hedged through interest-rate derivatives and/or currency-derivatives… However, in the last interest-rate cut cycle the RBI was also told to control capital-inflows because of overheating…

Shaping Expectations, An Awkward Observation...

Shaping expectations is important, though, difficult by the way of targeting variables... It is really an irony that if we target a variable and try to carve expectations it works in the opposite direction... For example, if we target inflation and shape inflation expectations it takes us in the opposite direction, deflation... because inflation would make things costly which means less purchasing power and spending, moreover it increases savings because of higher future inflation-expectations, people would demand less and save more... Nonetheless, if we could try to target lower-prices or inflation people would spend more and save less because of lower prices and price-expectations, they would feel richer, spend more and increase inflation in the future... For further understanding we could take example of targeting higher interest-rate and expectation, it would again lead to lower spending and lower interest-rate... Moreover, if we try to target lower exchange-rate, lower demand for imports and foreign-exchange would make foreign currency cheap and increase imports in future... It looks we should try to target variables other-way if we want them to work better.....

Labor...

Labor is one of the most important factors of production or production-function, apart from capital and organization… Like any firm lower cost of factors of production increases profit, other-things remaining constant. Cost of capital, often than labor, is the core of discussion-circles… but, the labor market has also a more direct link with the long-run movement of the price-level and economic-growth, as the evidences from the developed-countries show that real-wages have gown down in the past decades and interest-rate-trajectory has also shown a downward trend in the neutral rate or the natural-rate or equilibrium exchange-rate in the same period and prices have also gone down. Since, the interest-rates are often discussed; therefore here we would concentrate mainly on the labor cost of the production-function. Like lower cost of interest-rate or borrowing, lowering labor cost of production has been a crucial way to incentivize or stimulate-supply for the same lower cost of production and the same profits… Like lowering real-interest-rate by inflation, increasing inflation would also lower real-wages and cost of production, nonetheless nominal wages may also increase since the economy would try to balance in terms of demand and supply and prices and this process has a cumulative- effect on the same variables… When money supply is increased it also affects the three factors but in a magnified way and the economy goes through credit or trade cycles… During booms real wages and interest rate increase, and during busts they go down, however, the part of the government is to regulate or ride the trade-cycles through counter-cyclical monetary and fiscal policies by manipulating real wages, interest-rate and exchange rate. The price of labor or real-wage is responsible for equilibrium in the labor-market, we have heard of market-clearing prices and higher real-wages would increase labor-supply… But, the economic-models assume subsistence-wage-theory, because of better negotiation-power of the Capitalist and influence on the three rates… Capitalist try to lower the above three rates… but, higher skills increase income or real-wages… INDIA’s unemployment-rate is close to its natural-rate and the economy doesn’t need too much higher stimuli in terms for higher income, demand and supply, and economic-growth, but, it still needs to push since it has a young-population and a higher labor-force participation-rate… The rate of growth of workforce decide the natural-rate-of-–economic-growth and lose money-supply increases it and higher real-wages would improve consumption-demand and economic-growth by lowering the price-level through lower nominal and/or real-interest-rate and higher-supply… In INDIA, labor is cheap therefore it is profitable to invest in labor-intensive production when the borrowing cost is high... However, the investors might hedge them through interest-rate derivatives when the neutral-real-rate assumption is now close to 1.25%, lower than the previous target and nominal-rates are also likely to go down further… Lower borrowing cost would increase the ability to employ and increase wages… In the long-run, 5-years ahead, increase in real-wages is needed to boost demand-supply and economic-growth. The unemployment-benefits and social-security-net during slowdowns may help contain demand. They are important… Moreover, sometimes a little higher unemployment-rate is significant for lower price-level to increase real-wages and demand in case of lower population-growth rate and the economic-growth-rate… 

China and the WORLD (revisited)...

China and the WORLD...

Blind faith in the economic policies of the developed-world has landed China in trouble as far as debt and housing-bubble in the economy are in focus. By more and more easing through government bonds purchases China wants to lower interest-rate on public-debt to spend more on infrastructure, but by not lowering interest rate directly it wants to keep housing bubble and private-debt in check. Nonetheless the objective behind easing has been the devaluation of the yuan, everybody knows it. Chinese have relentlessly applied loose monetary-policy and think that it is a panacea for all ailments, but in not a less developed economy with supply-constraints, still, more money supply will always increase overheating and price-bubbles near full-employment. The economy has gone through many currency-re-denominations which is used to avoid too much increase in inflation and loss in the value of money, but, lately, it has also learnt to increase money-supply and depreciate the home-currency, and, give exports, employment and growth a push. The money from easing is flowing out of the economy after quantitative-easing which is responsible for higher interest-rates for the economy. Nevertheless, in the absence of capital-flight to abroad the money would have positively affected the scale of ability of banks to sell credit at lower interest-rate will increase. Higher capital inflows of foreign-investment (dollars and euros) have kept the yuan under pressure to appreciate, but PBOC is buying more and more dollars to keep the yuan depreciated. So at one place domestic capital is flowing out and at the other, in form of foreign-capital is flowing in. Not much difference. There is a considerable trade-off between the gains from domestic monetary-policy and foreign-exchange-rate-policy, however the whole idea is to keep yuan devaluated which means more export competitiveness and growth in the face of slowing domestic-demand because of overheating and high interest rates. Economists are right when they lecture China on concentrating on domestic-demand. China is trying to cash foreign demand at the expense of domestic-demand when its own expansionary monetary-policy and depreciation is inviting overheating in the domestic economy. To avoid this it needs tightening, and, not easing to avoid inflation and bubbles. More money-supply and inflation will hurt domestic value of yuan and demand within the economy.

Chinese will benefit from a strong yuan and not dollar... A weak yuan will pour money out... China decide it wants money in or out... Yuan has more uses in China... multiplier will be bigger in terms of wages and income and demand... good for the global economy... China is also exchanging money out side China... Dollar is strong, which is coming in and weak yuan is going out... Therefore China is exchanging less money for more money...China is too much ambitious, but it does not want yuan to compete dollar... only for the sake of exports and employment which is good... But, it should (now) drop accumulating dollar reserves because it own huge demand for dollar has made the greenback soar too much, and for others too ... Yuan should buy more dollar and not the otherway...

China’s economic expansion of the last three decades has come to a point where employment and productivity could not increase with the pace realized during the boom. An economy swings between boom and busts due to increase in money-supply and inflation and deflation/disinflation. Monetary-policy cycle of expansion and tightening decide the level of employment and trade-cycles. Expansion turns the boom and tightening turns the burst. Every economy goes through booms and bursts. However, the length of trade cycles might vary from time to time and country to country, but it may also affect other countries through trade. Moreover, the economy is also on the knife-edge which means when the policy-makers try to reduce inflation and growth it would lower them more than expected and when they choose to increase both, they increase them more than expected. It is true that the economy goes through boom and bust over a period of time. Booms can go as long as employment increase, but after full-employment inflation increases which reduces domestic demand. Depreciation increases exports, but at the cost of domestic demand. Higher inflation would lower real wages. Full-employment may increase supply to a level, but productivity may be increased through more investment in innovation, but it is a natural process of mind and may or may not happen at once. China is boxed by full-employment but if it manages to increase productivity it might continue expanding at a higher growth-rate. If more money supply increases productivity and wages then the expansion is justified, however if it increases inflation and wages it would reduce competitiveness. China is trying devaluation of currency for competitiveness when full-employment and higher wages are working against it...

Chinese policy-makers are arguing that inflation is not evident so far and that all the easing and rate-cuts are justified because it is not cutting real wages and domestic demand, but as long as inflation does not increase it would not increase nominal exchange-rate and demand for exports, and, buying foreign reserves and devaluing the domestic-currency would also increase inflation and inflation expectation but with a lag, whenever money-supply is increased it increases expected inflation (unless you are in the liquidity-trap) which is observable in the recent data. Higher inflation expectations show that spending is not a problem in China when the labour market is almost cleared; unemployment is close to 5-percent so it is true that the economy is so far stable, but it now needs to change its approach to stimulate the economy. China is moving away from an investment led model to a domestic demand driven economy because external situation is more or less out of an economy’s control and creates uncertainty. It now needs to concentrate on increasing domestic consumption which would also increase external demand by increasing imports; income in the trading partners’ economy would go up. China might stop seeking depreciation and inflation, also the other way, but work on increasing real wages and exchange rate by committing lower prices. Lower prices could also increase export competitiveness. It would increase exports demand by lowering prices and it would also increase imports because real wages would appreciate... and, it may also increase domestic demand by increasing real wages. It probably looks good from all the sides... in depreciation exports go up, but imports and incomes go down, it is contractionary... Lower prices would release domestic demand and also demand for exports. This is based on the argument that lower prices increase demand, domestic and external both and higher prices although help exports via the exchange rate but reduces domestic demand and imports. It is true that lower prices are more expansionary. No one knows better than China that lower prices increase demand; depreciation or external-devaluation also lowers prices relative to the nominal exchange rate. To achieve this China needs to lower inflation and inflation expectation, and the conventional way of doing this is to increase interest-rate by tightening money-supply. More money-supply after full-employment would increase wage cost, because labour is scarce, and inflation thereby lowering demand. China might change its ideology because its domestic demand may help improve external demand which is also good for its exports.

Chinese policy makers say that there are no inflationary-pressures in the economy when credible international reputed economists say that the economy has achieved full-employment and requires tightening to avoid overheating to retain competitiveness by controlling inflation and wages, which is not true... Food inflation in China is around 7.5% (high) enough to demand wage-hikes... After full-employment the market competes for labour by offering higher wages... Too much higher wages would erode China's competitiveness by increasing wage-cost and prices... More money-supply with inflation in food would increase wage demand and reduce competitiveness... Tightening might be required to maintain inflation and wage-demand to increase competitiveness...

China wants to avoid capital-outflow and real-estate bubble... No doubt, it has reduced the bubble-fear by a consistent monetary-policy since 2010, which deflated it, but high interest-rates, later, choked demand which is the reason behind falling growth-rate... If China wants to increase its growth-rate it must reduce interest rates, but capital outflow, in search of higher returns would reduce investment in the economy, more in favour of the US dollar, but Chinese have already overinvested in the US and US dollars... More, Chinese money in the US will not reward them because the US is already capital rich... The desire for higher interest-rates in the US (probably) would not materialise because the US interest-rates are already rock-bottom and the economy is going through the liquidity-trap, means interest-rates will remain where they are for an indefinite period... So, Chinese money-flowing in US may not be rewarded as expected anytime soon... Moreover, when Chinese money flows to the US, it means more money-supply, lower interest-rates and a depreciating US dollar... The whole point is that the time is not right for investment in the US economy or Chinese money will have to wait longer for better dollar and interest-rates...  China is falling in to inflation again and again, means it also needs to improve supply-side (like INDIA) so that inflation remains under control and bubbles deflated... INDIA and China are almost on the same page as far inflation is concerned...

Just like loose monetary-policy, loose fiscal-Policy too is responsible for currency de-debasing... If we are going to follow China then we will have to go through currency re-denomination every-time inflation is too high... Too much inflation debases the currency and people start carrying large volumes of money which is unnecessary, therefore, countries apply currency-re-denomination which reduces the volumes of notes and makes the new currency re-denomination stronger, the new currency will be stronger. Higher re-denomination indicates loss in the value of money… But, the logic is, if everything’s’ value grows as time passes and investments we make also grow, then why the value of money decreases as the time passes… The trend across the developed countries is that their population rate of growth are contracting which means less demand for their products and they are now too much dependent on exports for growth, therefore, we can conclude that as the time will pass supply will eventually outstrip demand and prices will start falling, in one word- deflation, as we have experienced in Japan, the US and many parts of Europe… Therefore, the pattern we are observing is that prices will fall as the economy will grow and supply improves… But, prices can not fall below the lowest denomination of any currency and in this situation if we want more demand we can choose to increase the real value of money, a rise in real wages, incomes and profits… by applying a lower re-denomination of the currency... But, in lower re-denomination the old currency becomes stronger and the value of money increases…

The highest denomination is rmb 100 which is near to the $100 highest denomination in the US but people hold five-times more cash in China than in the US. It means money supply is higher in China than the US. High money-supply means a weaker currency. It (China) has kept money-supply high in order to gain from  cheap currency and cheap exports. This is what the US objects "an artificially low exchange rate and low value of money to gain advantage from cheap exports." China is expected to overtake the US in 2018, so by that standard we can expect the rmb-dollar exchange to equalize near that period. Meanwhile we are going to witness an appreciation in rmb during this period and a debate to include rmb as a reserve currency like dollar. Chinese interest rate are lower than the Indian rates it means it is opting for a loose monetary policy to gain advantage in exports even when its main trading partners are facing recession and weak demand. If China wants rmb to get the status of reserve currency it needs to let its currency float near to the value of dollar.

We know that rising wages will be detrimental for Chinese competitiveness but good for domestic consumption. China has absorbed all the surplus labour and has reached its limits of expansion and cannot expand without raising wages. I think China will continue to use depreciation as a tool to retain its competitiveness. There are two things to achieve competitiveness either devaluation or depreciation. The former is materialized when the market cut wages to achieve competitiveness in foreign trade and the latter is done with a view to achieve cheap currency and generate demand. I think we will see the Chinese economy slowly turning to domestic demand after cashing three decades of foreign demand…

Any currency should appreciate in the long run and moreover its domestic value must also increase because marginal utility starts declining after reaching a height therefore prices start falling. So in the long-run we have increasing returns from money supply because prices start falling as every economy falls in deflation after a boom period. And, it makes sense why prices start falling in the long run because demand equals supply and after a point supply exceeds demand and prices start falling. We call it deflation and as an example we have Japan and the US… They are trying to avoid a deflation but it is natural for prices to fall in the log-run, as have been said before, and we can make use of deflation too to increase real wages and income (any type of wealth) by floating a lower denomination of a currency. So far China has used higher denomination means Yuan to Renmibi but now it has to move from Renmibi to Yuan. Money-supply wise more Yuan and less Renmibi in circulation. That would increase real value of the Chinese Currency. It seems logical that the domestic value of a currency should also appreciate in the long-run and not like the way it is executed in the real life. We choose higher redenomination when we should go down, I mean lower denomination. We are progressing therefore value of money must also increase…

IMF is backing China for devaluing the yuan when it aspires to be a SDR currency. A currency the IMF and others will use to forward loans for countries in need. IMF is saying that devaluing yuan is a step in that direction. But, a reserve currency status is likely to increase yuan’s demand; therefore it should appreciate, and not depreciate. Dollar’s reserve currency status makes it strong. Actually, China wants to stop sagging growth rate by increasing export-competitiveness, but at the cost of domestic-demand by cutting real-wages with inflation. Does it sound good or any way better (?) when you are favouring foreign-demand against the domestic demand. This does not sound (too) good to go about it. In a way the Chinese are taking money from domestic-consumers and giving it to foreigners. The downward-nominal-rigidity makes wages hard to cut, but it is always easier to cut on real wages by increasing inflation in order to make the economy competitive. The economy is experiencing deflation which means low relative demand or high supply. To overcome this situation Chinese might try to increase demand by increasing real-wages by lowering the price-level which is also likely to increase export-competitiveness. Using lose money-supply in a low unemployment country, and higher wages and inflation will make you globally uncompetitive. Economists know that a reserve-currency status and strong yuan will depreciate dollar and help US’ exports...

I do not know why we are giving so much importance to China’s illegitimate moves on the currency front. Economics and any other stream of knowledge do not talk about absolute actions because they are not simply of any use. For instance, if there would be only one country in this world its decisions would not affect the others, simply because there is no other country. It is the relative significance of actions that matters in any realm of knowledge and Economics is no exception. No single country in this World can dictate the terms to others and exploit Economics to feed its ambitions, without their consent. And, the author is sure it is not possible. I can not believe an economy like States that has almost ruled the modern World, most of its part, is so frightened by China. China’s history is full is currency redenomination to balance inflation and there is no doubt that it has resorted heavily to it, throughout its history. The Chinese currency manipulation can be, simply, offset by retaliatory adjustments in exchange–rates, and affecting money supply and inflation is not just the single way of doing it. It can easily be done on the paper; means America can deliberately depreciate its currency without affecting its credibility, too much. It will certainly augment it productivity and competitiveness, and the ones that are holding its currency in the expectations of profit, may not profit from a stronger currency, but the quantity they will be getting will be sufficient, at least we can expect that. But, i’am nearly sure it will emerge as a stronger currency, later too, if we rely on economic fundamentals, that follow a process. But, if not controlled another 2008 is not too far. This time i expect a food-grain market kind of control for the money-market.

Analysts used to say that market was bit expensive therefore the current crash might be an opportunity to invest more in equities. The market today in INDIA has shown a similar trend by recovering 400 points, the next-day of the crash. The rout in China might make INDIA a beneficiary in terms of receiving capital because it is the fastest growing economy with sound fiscal and monetary conditions. Capital flight from one country to the other also takes time. Capital will flow in. The same trend also supports the above point that INDIA will be at the capital receiving end. In the same line the expected delay in increase in US rates due to below target inflation and the slowdown in China will also save INDIA from capital flight. We might expect it to be the major recipient of capital of the current global slowdown US, Europe, Japan and now China. INDIA’s story is based on the domestic consumption, insulated from slowdown in exports; therefore we can expect it to be relatively stable.  The whole argument between Keynes and Pigou was about the self-correction feature of the market-mechanism. Keynes said deviation from full-employment might be corrected by government expenditure. However, Pigou said lower prices will help the economy achieve demand and full-employment, again. In China both monetary and fiscal policy is under the communist regime. Attempt to restore growth might work against the market-mechanism. More money and wage inflation may erode economy’s competitiveness...

Shadow-banking in China reminds me of the US... Shadow banking showed a lot of potential to boost credit used for inflating housing prices in the US... We (in China) are expecting more inflation down the line which means nominal prices will diverge from real prices and would inflate bubble. Recently economists have started to think of bubbles as normal during boom... they have become common... We can not conceive a boom without a bubble... It means it has to happen… If the economy will grow it will produce bubbles… Brakes on credit, especially through shadow banking because they are loosely regulated, away from normal-banks, are difficult and not easy to apply. Shadow-banks are out of regulation. We can not control them too much. But the system in China is a bit different from the US. It is not a market economy… a communist regime… which can directly control prices by directly fixing them… different from demand-supply adjustments in a market-economy… they are very serious in controlling prices to tame inflation… However, China historically has seen a few currency-redenominations due to too high inflation. Which means historically they have relied on a loose monetary policy. But during the communist system China has become more serious for price-stability to contain real wages for the proletariat…

The stock-market crash in China in January was the second-time since the tremors in August (2015) are felt across the globe and there is a disagreement among the analysts over some fundamental problem in the economy and that is it signalling a longer correction (?) which might put the World in a low demand and growth spiral and INDIA is not an exception. Mainly it is a disagreement about the unemployment in the economy which determines the level of the problem. But from that point of view the economy is doing well because the policy-makers have kept pouring money-supply to achieve full-employment but rising wages are making the economy lose competitiveness which is a bigger headache. Chinese economy is largely an exports oriented economy and much of its growth rate is attributed to its high current account surplus. China is worried about its competitiveness which it is trying to gain by depreciation or devaluation which would trigger depreciation and out flow from emerging markets, including China. Falling exports and devaluation through easing and higher interest rate in the US has resulted in the outflows from emerging markets which has created shocks over the globe when the chain is, my exports are your imports and my imports are your exports. Income in one country is also decided by the income in the other country. China is mingled so well with other countries through trade that a recession in China would slow down everyone. China’s share in world trade is huge. A disturbance in the Chinese exports would affect Chinese people income and imports. China mainly assembles imports into exports and it might slowdown when Chinese exports become uncompetitive because of full-employment and higher wages. Moreover slowing in the working age population is pointed as the economy’s long-run problem. And, more money-supply after full-employment would worsen the situation because the market would compete to attract labour offering higher wages. However, debt situation and over-supply in the housing market also need to be controlled for which tightening is the remedy and not easing. More and more money-supply after full-employment may continue to increase debt and over-supply stoking fears of reinforcing bubble and perpetuate a correction. People may default on their obligations when debt goes over and start selling assets because of fear of loss. Speculation should be checked. The correction would entail falling prices but that would be uncontrolled. Nonetheless, if the fall in the price level has to be controlled then the monetary-policy may tighten in a controlled way. Chinese unemployment is lower than 5-percent and it may increase its competitiveness by tolerating a little higher unemployment and lowering the prices. Higher unemployment might help reduce wage-pressure by reducing some demand but it must be controlled and data dependent. The economy must try to avoid extremes, excessive inflation or excessive deflation. Lower prices also make the exchange rate favourable and would help demand. The central-banks choose between inflation and unemployment as required. Economies in recession are targeting higher inflation delaying the objective of price-stability and over-heating economies with bubble fear might try to tolerate higher unemployment by increasing credit cost, and diffuse the bubbles delaying the full-employment objective. Both lower demand in the economy by increasing inflation and by reducing employment. Unemployment benefits might help contain the necessities.  Trade-cycles are imminent, but the central banks job is to regulate the cycles with consistent interest-rate movements, a credible monetary-policy with control.

It is just a coincidence that China may slowdown at a time when INDIA is expanding which might affect its trade ambitions and growth rate. Recessions are the time for spending and boom is a time to consolidate, might be a good-rule to go forward...

Chinese economy is run for the Commune pride not people... Its not a democracy... Loss in happiness...

Today's Monetary-Policy-Review...

Both, the RBI governor and the half of the monetary-policy-committee are the government appointees, therefore it was obvious to expect rate-cut in the monetary-policy-review today amid government’s demand for rate-cut to boost growth. The government even before the new governor was in favour of rate-cut to boost demand, rural, urban and industry. Nonetheless, a lower CPI than in the past months was the prime cause of economists’ and analyst’s interest-rate-cut expectations in today’s review. The governor did not forget to mention the government’s measure to correct supply-side problems and ease inflationary-pressures. A good monsoon this year in a major-part of the country was also important for rate-cut and lower inflation expectations. Lower price of crude due to over-supply, and, also because of shale-oil production in the US and investment in renewable energy, in the future are also likely to keep CAD and fuel-subsidies contained, and lower inflation-expectations.

Many analysts say that the CPI as the RBI’s most favoured index for inflation might be flawed due to volatile food and fuel prices which have a little effect of monetary-policy and interest-rate movements, therefore Core-CPI which excludes food and fuel prices might be the right gauge for inflation. Many countries do use Core-CPI as the right-guide for interest-rate decisions. The RBI too might apply Core-CPI for interest-rate decisions.

A marked shift in the RBI stance than the past has been the change in the neutral or natural real-interest-rate to 1.25 from 1.5-2% in the Rajan’s regime... A lower neutral rate would increase investment demand; however there has been a weak relationship between real-interest-rate and investment globally due to weak global-demand... But, INDIA is not demand deficient and let us be hopeful that lower neutral-rate would increase spending... A lower neutral-rate would give more room to the RBI for interest-rate-cuts in the future.

Competition and liquidity are important for interest-rate-cut-transmission, not only in terms of more banks, but also along the lines of our last governor’s wishful thinking in terms of deepening the debt or bond-market - g-secs and corporate-bonds - by clearing way for foreign-borrowing through masala-bonds... Our new governor must continue liberalising the banking-sector and the loans by the foreign-countries...

Our government looked concerned over the banking sector saddled with bad-loans or NPAs for which the RBI might lower CRR for banks with high NPAs; it would help them to create loans... Lower reserve requirement could be used in troubled-times without impeding credit-creation and economic-growth...

Lower-prices and demand/supply...

Deflation would not last too long, because demand would go-up, since lower-prices could increase demand. The most relevant example could be understood by depreciation in the exchange rate when the nominal-exchange-rate increases relative to the prices (CP) demand increases, another example is the movement of real-wages since when inflation cuts real-wages labour-demand goes-up, the last example may be cut in real-interest-rate with inflation, it increases demand for investment, and foreign demand increases, too, and growth goes-up, even if wages are more less fixed or sticky because of presence of the downward wages rigidity, but prices might go-down because there is competition in the market to increase market share and demand, and, as more firms enter market the market every-year prices go down in the long-run... Supply is scarce people would rush to buy, investors, too, firms could restrict it in the case of the supply-side weakness and higher-cost  ... After, the inventories are consumed; firms could demand more resources and prices could go-up... Economists partially explain the effect of lower-prices on the unemployment-rate, but lower-prices increase real-wages and supply of the man-power. Rich countries that pay higher-real-wages and incomes for the skills in demand attract foreign labour-force, nonetheless voluntary and frictional-employment may exist, but fail to accept the other-side, the good-side (common-side)... Lower-prices may also help to reap the economies-of scale and sell more in the short-run and earn higher-real-interest-rate and real-profits, more investment would increase the nominal and real interest rates in the future, but assume inflation is constant or low, close to  Milton Freedman’s Optimal-Monetary-Policy, he accepted that deflation rather than inflation helps increase growth. Incentive to invest increases, Capitalists would save, earn interest-income and invest more. At once place the Capitalist income increases and they save more and earn higher real-interest-rate, investor wait for lower-prices to invest and sell at higher-prices. It depends upon the ability to hold money, lower income level would have a higher propensity to consume out of a given income and save less and higher incomes increase the ability to consume, save and invest more.  Lower prices increase the real-wealth of ALL, and increase both, consumption and savings and investment and employment and demand/supply and the economic-growth. The lower borrowing-cost would increase the supply. Investors track the growth projection, lower inflation and interest-rate expectations could increase investment, employment and economic-growth.. In the rich-world prices have gone down in the long-run, as interest-rate response and threshold have varied over-time... In the long-run interest-rate or the real-interest rate have shown a downward bias because of the lower-interest-rate in the past-period, higher-supply and the lower price-level. Cutting the nominal-interest-rate would also lower the real-interest-rate if other-things, including inflation is constant, Ceteris-Paribus (CP). But, the rich world central-banks are trying to lower real-interest-rate by increasing inflation and inflation-expectations which is difficult to achieve below full-employment. And, INDIA’s unemployment rate has gone-up. The central-bank’s new-governor is appointed by the government recently with a loaded monetary-policy committee. The committee has to decide whether lower real-price of capital could stimulate supply and demand and growth to increase investment and employment with stable or low inflation...  Lower borrowing-cost would also increase export-competitiveness... The government has a counter-cyclical role to control too much volatility on the either side... Bring, the both, buyers and sellers in equilibrium by the effect of wages, interest-rate and exchange-rate. Actually, the real wages, interest rate and the exchange rate, by lowering inflation and inflation expectations which means lower cost of borrowing, higher supply and lower –prices.    

Prices, Interest-rate and Bonds...

Liberalizing the bond-market in INDIA would increase competition resulting in lower interest rate... The RBI has also proposed to liberalize foreign borrowing through masala-bonds... We now have competition from abroad to sell debt...Masala-bonds are rupee denominated bonds offered to overseas investors which do not need hedging... however, borrowing in foreign currency must be hedged by currency derivatives... Economists do not favour borrowing in foreign currency because of the lower reserves and also because it cannot be printed by the central bank...If you could borrow from a foreign country at lower interest-rate, domestic-demand for funds would go down and domestic banks would lower interest-rate to increase their demand... Domestic-lenders would face competition from abroad... Moreover, inflow of foreign funds would also likely to lower interest-rate... More investment and more supply could also lower the price-level and interest-rate... It would help transmission of rate cuts by the central-bank..

Lower-price-level and lower bond-yields mean higher bond-prices and returns... A negative-yield would even increase bond-prices more... Bonds are already inflation protected since when yields go down bond-prices increase... The real-value of bonds is protected... More supply of savings would lower bond-yields and increase prices, therefore bonds are safe... Lower prices increase the value of savings if other things remain constant...Low inflation and interest-rate mean savings would be discouraged and spending would be encouraged... Including the dynamics show that in the future inflation and interest-rate would rise because of higher spending... Lower-prices or higher real-interest-rate could make people save less and spend more, while higher-prices or lower real-interest-rate would increase the supply of savings and could decrease spending... According to Wicksell higher real-interest-rate means higher return on capital... We need to explain the relationship between economic-variables in the dynamic sense because expectations are equally important for the outcome... The real-world is dynamic...

Keynes said that money is not scarce when the central-banks can print currency... Supply-side problems and inflation is the main cause for tight money-supply because it reduces the value of capital... If they are not present then the central-banks may continue with lose money to increase employment, demand and economic-growth and in some cases with negative-real-interest-rate... Public-spending, that boost innovation and productivity, on education, skilling or re-skilling and, if necessary, on infrastructure is important for increasing real-wages, with low inflation, and, demand and economic-growth when population-growth-rate and demand is going down in the most of the developed-world - Japan, the US and Europe..