Tightening in the US...

Balance-sheet reduction coupled with gradual rate hikes in the US are likely to increase the market rates more than the policy rates... The Fed expanded the balance sheets in order to improve rate cut transmissions, long-run and short-run interest rates, both... Actually it is the money-supply that decides the market rates and the policy rates work as a guidance, therefore market rates are generally higher than the policy rates and, as been said before, money-supply improves interest rate transmissions... Lower money supply with gradual rate hikes and higher market rates are likely to lower spending and growth and expectations... The Fed itself is putting brakes on expansion even when there is scope to achieve a higher potential growth rate... It should tie its decision with higher growth rate and overheating... So far there is no such condition... The Fed is trying to act in the hindsight or trying to be proactive when overheating would itself give it chance to control inflation and build capacity to act when the next recession hits... The Fed by increasing rates is itself bracing for lower demand and growth which is already low given the potential... Why the Fed wants to lower demand and growth when inflation is still contained and there is space to improve upon the growth rate? The Fed should wait for clear signs of overheating before lowering demand, inflation and growth and expectations...




Why the Fed is tightening when inflation is still low and there is less pressure on nominal and real wages (?) in the face of the inflation target, which could amount to lower demand and growth and lower inflation expectations... But, it is not as straight as it seems... The Fed could stabilize when we are close to the inflation-target by neutralizing all of its levers... US' population growth rate is over 9% per ten year which after accounting for the natural or structural employment at 5% gives a potential growth rate of 4% that means the US has to grow 4% on an average or mean basis to achieve full-employment and growth with a neutral stance... Growth rate is still tepid... Fed is expecting inflation when there is no inflation... The Fed itself is creating and uncreating inflation and deflation and expectations which often work in the opposite directions, lower inflation increases demand and inflation expectations... Low and stable inflation means we are close the natural or neutral real rate of interest which should be continued...

There have been two major reasons why prices are not increasing despite full-employment, number one is lower population growth in the developed economies and the second one is lower crude oil prices... Now, the US has become a net producer instead of a net importer in the last decade... Technological progress or innovation or productivity has slowed down except the shale-oil and investment in the renewable energy... But, lower real wages despite increased productivity in the developed economies has also held-off the demand and growth rate low... In a bid to increase exports through inflation and depreciation the economies have cut down on doemstic real wages and demand... Even though the economy achieved full employment and nominal wages increased but that is due to inflation... When inflation increased it increased nominal wages, but kept real wages low which is likely to reduce demand and inflation that is why the developing economies like Japan are going through a period of low inflation... The same might also be true for the US...

Reduce Trade-Deficit to Increase Jobs...

Policy makers often give stress to job creation and lower unemployment with decent wages to claim that growth has been fruitful to justify the long-run course of expansion in the people’s living standard for which jobs are very important. Jobs are the best insurance against poverty, moreover it also generates demand and supply and growth with price-stability at full-employment. Full-employment gives the highest demand and supply to maximize growth while maintaining financial stability, niether inflation nor deflation, the same prices-stability in a sense… Both, the domestic and the external sector of the economy decides the level of employment or full employment in the economy, countries also object trade deficit due to less jobs in the domestic economy… Like the continuous spar between the US and China… INDIA has traditionally relied on the domestic demand to achieve growth; however it is a major exporter of cereals, but fewer jobs in the manufacturing and exports which demand skilled labour force… Skills are very crucial to create employment oppourtunities in manufacturing, economists and analysts many times have underscored low manufacturing and skills base as impediments to job creation. INDIA’s trade-deficit also point to less quality or skilled jobs in the economy…

Lower wages in INDIA provide it a competitive advantage in trade... It is unwise to import articles which INDIA could produce at lower prices also because jobs are important... Economists favour international trade because it increases real wages and not decrease it... Lower domestic prices would also increase domestic real wages by lowering the domestic price level and would also increase exports by lowering the same and imports could increase too, since real wages would increase... INDIA should go for internal devaluation to increase demand, domestic, imports and exports, and growth, local and global... Lower borrowing cost would also make the exports competitive or help lower prices and increase demand...

The INDIAn rupee has appreciated in the past… A strong rupee would lower domestic inflation since imports would be cheap... Domestic inflation would go down... INDIA is a net importer therefore strong inflows and strong rupee are likely to help reduce demand for foreign reserves and inflation and depreciation... However, cheap imports, lower domestic inflation could also increase demand for exports... It increases demand through internal devaluation because domestic price level might go down too due to cheap imports... Cheap imports could also make the domestic economy competitive in terms of low inflation and wage demand...

Price-Stability and Price-Stability Expectations and (or at) Full-Employment...

The Fed (US) rate hikes are likely to slowdown inflation and growth rate which it would itself correct by lowering the interest rates in the future… In a way the Fed itself is creating booms and busts, but inflation and inflation expectations has changed the model a lot, now, instead of higher inflation and inflation expectations we have lower inflation and inflation expectations which has changed the interest rate and interest rate expectations i.e. lower interest rate and interest rate expectations, both long-run and short-run interest rate expectations, whenever money-supply is increased it increases expected inflation that decides the interest rates. But, the Fed is reinforcing inflation and inflation expectation to increase spending, consumption and investment which has not worked as was supposed to and has also increased savings due to higher inflation expectations, higher inflation and inflation expectations have actually reduced spending due to low real wages and wage expectations and lower real interest rate and real interest rate expectations have also delayed investment. However, lower oil prices have increased real wages and spending evident in the months low oil prices, it increased savings of the average household and spending too. Lower and controlled price and price expectations would increase real wages and real interest rate and expectations, and lower nominal interest rates and expectations would help increase spending, consumption and investment and savings, all… Lower nominal interest rate or borrowing cost due to lower inflation would help achieve full employment and PRICE-STABILITY and at full employment the Fed may try to stabilize the price-level and price-level expectations, and increase real wage and wage expectation and demand, exports, too, and growth and expectations and higher real interest rate and real interest rate expectations because of lower  prices would also help increase investment because it would be cheap to invest now and it would not be delayed with the help of the neutral monetary-policy… It would help the economy to achieve the potential growth rate at 3% sustainable over a period of time with price stability and price stability expectations and (/or at) full-employment…

Other problems facing the INDIAn Economy...

Few days back the Chief-Economic-Advisor Arvind Subramanian presented the Second Volume of the Economic Survey which presented an overview of the economy against the context of demonetisation and tax-reforms such as GST which painted a picture of negative expectations about growth in the short run and calls for achieving the potential in the medium to the long-run through using all the levers the RBI and the Government have.The broadening of the tax base and the greater formalization of the INDIAn economy are likely to keep fiscal deficit under the target and improve the quality of spending. Tax is a power-full tool of redistribution, it is often taken from the rich and is spent on public works and wages which means given to the poor, therefore it is important that everybody pays its due taxes, however redistribution of income and wealth according to the productivity has had been the objectives of the economic-policies so that it increases genuine demand and supply and growth.  If the Narendra Modi government has to end up fight against black money and corruption it should make transactions with the bank accounts compulsory... For children and spouses too... He might try a deadline of eight months to induce or incentivize transaction from the banks accounts... It should try to end cash completely... Not a single rupee should be transacted out of the banking system... It would do a great favour for the poor public who are dependent on the state revenue... It would increase the tax collection... It would also help in 2019 elections... This time we would not need demonetisation... but the will to reduce cash transactions with proper incentives in 8 months... Why people would like to carry cash when it is possible with JAM (Jandhan-Adhar-Mobile)... Money would be more secure while transacting direct from the bank accounts... It might try no pin code for transaction below a certain amount like 100 Rs... which might reduce time consumed in digital transactions... It should try to make bank transactions simpler...

Businesses should start production and accumulating inventories during low inflation slowly... Everything would be cheap except borrowing, as the case in INDIA... Interest rate cut expectations might not materialize as expected due to uncertainty... Lower cost of production might help increase margins... Lower borrowing cost would reduce average cost of production... However, lower inflation and inflation expectations might increase rate cut and rate cut expectations, but exactly how much nobody knows...If investors could form same expectations on the basis of data it would profitable and less risky... You must think what others think... The expectations that form around a stock increase its demand and price... Investor should try to gauge demand... It is more profitable when you buy low and sell high... Corrections are time to buy more...If there is discrepancy in public expectations and Monetary-Policy-Committee (MPC) expectations due to lack of communication, signals might be misread... Expectations are formed by the right communication... Monetary policy signals must be loud and clear to achieve the outcome, for example more investment... Gap in expectations might increase uncertainty... Like happened before, investors are holding back when the RBI is signaling more investment... The RBI has tried no rate cut and expectations, but lower inflation and interest rate and expectations might delay spending decisions... There is a big difference in the RBI''s expectations and people expectations... Differences in information might lead to different expectations... Unemployment benefits or insurance would help flexible labour laws, easing hiring and lay-offs would also give business flexibility ... However, jobs and wages must be attractive enough to reduce voluntary unemployment...

Chinese would never engage in a full-fledged war with INDIA because war is expensive, ofcourse for the both sides... INDIA should not attack first and if China does it INDIA should give a full blow to teach China a lesson... INDIA should utilize the time to find Chinese weakness... and get prepared for any contingency... The problems would be the same on both of the sides... It would also disrupt China and would increase unproductive spending on war just for the Chinese show-off... However, import substitution is a better strategy to create more employment and deal with Chinese hooliganism... INDIA shouldn’t allow imports that it can produce at lower prices... Tariffs might incentivize local production too... It is upto to INDIA what it chooses to do... It is just how you will achieve full-employment and full growth...It is important to protect domestic employment against undue depreciation which is a short term measure to increase export demand... It is unjust because the competitiveness is gained by devaluing domestic currency instead of increasing productivity and lowering the prices which might stoke retaliation and increase domestic unemployment... It is also not good for the devaluing country because inflation and expected inflation increases nominal exchange rate but reduces domestic real wages and imports which means reduced overall demand... In a way devaluing country is giving money to consumers to buy its product which is an awkward way of increasing price competition and increase market share... People would always object depreciation... Depreciation is a form of undue price competition which might force some out of the market which also forces others too to follow suit or fail... It results in currency wars and inflation and higher interest rate which may put break on demand and growth and global growth...

Lower rate cuts and NPAs...

Yesterday the RBI reduced repo rates, by 25 basis points, as expected by the economists and analysts and maintained a neutral stance as before, i.e. data determined calls for further rate adjustments, if inflation remains benign while highlighting a 4% inflation target for the medium term which still releases a lot of scope of further rate cuts if growth and growth expectations remain low. However, the government and the public demanded significant rate cut to push stalled investment, partly due to higher borrowing cost and partly due to high debt and NPAs which has reduced demand and growth, of companies and banks, borrowers are unable to borrow and banks are reluctant to lend due to less capital and reserves. Nevertheless, a rate cut might be important to lower the borrowing cost and adjust margins, for both, but reviving investment demand is equally important to increase profits and margins. However, under the problem of NPAs and low demand, the RBI might reduce CRR for the troubled banks or could buy bonds from banks, banks have a better credibility than corporate, and some private banks have already used external borrowing through masala bonds to recapitalize themselves. Higher NPAs may be a reason for the banks to not feel money-supply and increase monetary policy transmission, the RBI might finance them with new money or using the dividend it has earned for the government of INDIA. The government must also utilize this money purpose fully… hope it has not been used yet… Or the government of INDIA too can borrow from the central bank using bonds which would safe because the government may pass resolution to dilute its debt in extreme cases by mint. The NPAs are a big drag on growth which public spending would increase it indirectly. Reviving demand directly by bailing out banks directly is also not out of question, because it has all happened under tight regulation of the RBI and the government. There could be a wide range of solutions to increase demand, but increasing investment demand is above all to increase employment. The commercial banks too could try to borrow and recapitalize themselves because they are hit by bad loans and deficit in balance sheet which could be increased by increasing demand for loans. There is little doubt that the ability to lend more at lower cost would increase banks’ profits. However, lower demand and lower inflation and higher unemployment has increased real interest rate by 4.5 % which is also likely to increase savings and excess capacity. The lower real interest rate would also help reduce excess capacity and increase investment employment and demand and supply and growth. Higher real interest rate would increase savings at the cost of consumption and investment demand and growth; people are saving more due to lower prices and also due to remonetization and compulsion to deposit money in banks and less spending which were also responsible for excess capacity and more savings. The regulation on deposits by the RBI during remonetization has also resulted lower rate transmission by the commercial banks… Notwithstanding, banks reduced home loan rate once by 1%, but, it had little effect on the investment demand because of lower real estate prices and the same NPAs have reduced the economic activity in the labour intensive sector…. NPAs remain a major cutback on the demand and growth and infusing more liquidity or recapitalization are likely to smoothen or sustain the growth path and path expectations … 

Now, some inflation has become important to contain the inflation target...

RBI must include unemployment rate in its model... Lower growth could also mean higher unemployment... 11% growth in 2011 reduced unemployment to 6%... which is still above the natural rate of 5%... Potential rate is decided by the rate of population growth rate (17% per ten year) minus frictional unemployment (5%), which is present all the time. That means INDIA can grow to achieve 12% on average... INDIA achieved 11% growth rate which is less 1% than its potential 12%... and unemployment could go more 1% down to touch the 5% threshold... Therefore, if the current growth rate is 6.1% we could expect that unemployment might have gone up 11%... which might need substantial rate cuts ahead... NPAs too have reduced confidence...

We have lower price level and price level expectations upto full employment because supply would increase with lower unemployment or higher employment and lower borrowing cost and higher price and price expectations after full employment due to low scope of increasing supply due to scarce labour and higher borrowing cost, however the purpose is to stabilize or constant the price level and price level expectations at full employment and neutral or constant unemployment and constant supply and neutral borrowing cost….

Lower inflation and lower inflation expectation have also increased the rate cut and expectations. However, inflation in 2011 was close to 8% with all the supply side constraints and mismanagement, but CPI at 1.5% in June has revitalized rate cut expectations and higher unemployment and low growth also point rate cuts and expectations. However, if we use the reasoning or logic in the above paragraph that would also indicate rate cut and rate cut expectations… The inflation in INDIA is often ascribed to the supply side weakness and higher demand, too, but this time it is a different situation, INDIA has improved a lot on the supply side and inflation has gone down, also due to higher unemployment and higher borrowing cost which are further likely to reduce the price level through lower borrowing cost, higher investment and higher employment, higher demand and higher supply. In INDIA there is enough scope to increase supply, demand and growth by lowering the borrowing cost and the unemployment rate. Lower borrowing cost might help to sustain inflation around the target 4%. This time by not lowering the interest rate the RBI is expected to ditch its inflation targeting itself… Now, some inflation has become important to contain the inflation target. Lower borrowing cost would increase investment, employment and growth to hit the inflation target… Lower borrowing cost may also help the commercial banks and businesses to reduce NPAs by adjusting margins…

Risky to gauge prices...

Most of the times the economists are seen debating and prescribing demand, supply, price-level and unemployment adjustments or sides in order to achieve the potential growth rate decided by the rate of growth of population, but during the past few decades the population growth rate of the  world has gone down, despite increase in the average life expectancy, which has also reduced the growth rate many economies and has put the onus of creating employment and demand and growth on the export sector of the economy in a world where the policymakers have favoured the Capitalists by cutting the domestic real wages, interest rate and real exchange rate with inflation to achieve full employment and full growth, but they forget that inflation reduces demand and spending because purchasing power goes down, it also reduces savings  and investment, because people would save less and the economy would invest less, and lower exchange rate or depreciation would increase only export demand, but could reduce domestic demand and imports, which reduces both domestic demand due to lower real wages and foreign demand due to less employment and wages and incomes. The lower demand and employment in the trading partners economy would also reduce export demand to a degree therefore the only gain from inflation, external devaluation and depreciation is exports, but the economists misses that in the long-run inflation and a lower value of money would aggravate the problem of low population growth rate and demand and growth of all the countries. Ricardo’s theory of subsistence wages using Malthus assumes that higher wages could lead to higher population growth rate and higher labour supply and wages would again fall to minimum wages. But, as has been observed, population rate of growth has gone down and using the same line of thought we could derive that wages could bounce back from the minimum wages. In other words, wages should increase as a result of lower population growth, but it has not… which could be attributed to lower real wages around the world despite increase in nominal minimum wages only because of higher inflation. Nonetheless, as have already been noticed before inflation is the second best strategy to increase demand, supply and growth, which actually adversely affects demand and growth, because middle and lower classes have a higher propensity consume than the richer and higher classes who have a higher propensity to save, they (poor) spend more than the rich also because they constitute a larger number. However, lower inflation or little deflation is also important for lower borrowing cost and increase supply which might further lower price level and price level expectations which have just the opposite effect on the real wages, real interest rate and real exchange and demand and supply and price level and unemployment. A lower price level and price level expectations and higher real wage and real wage expectations are likely to increase both consumption and savings which might also lower interest rate and interest rate expectations and increase in the real exchange rate and exchange rate expectations could also increase both imports, since real wages would increase, and exports too because of lower price-level and borrowing cost and increase in the real exchange rate. So far, the economists have assumed inflation and inflation expectations as a result of expansion of money and growth which could be right after full employment, but before full employment we might assume the price level to go down and a result of more money or money-supply and lower borrowing cost because supply or production could increase which could only be constrained by full employment, but international trade may also help to keep prices lower and increase real wages, real interest rate and real exchange rate. The technological innovation may further help save labour and increase supply and lower the price level, and increase real wages, real…real…… which could help increase supply, demand and growth and achieve full employment… Notwithstanding, if the economists and policy makers try to stabilize the price level at or around full employment that would also help stabilize real wages, real interest rate and real exchange rate and expectations which might end the demand-supply debate, for the time, and might help maximize or achieve potential growth but might be with lag. Differently, if we could target a constant price level and price level expectations at full employment by a constant money supply we could still have both demand and supply adjustments and a higher growth rate but with time lag. However, improvement in technology and innovation could further increase productivity of labour and capital leading to lower prices to increase real wages and demand, real interest rate and savings and investment and supply and real exchange and exports/imports and growth in the long-run in the event of lower population growth…..  

      

The economists often claim that deflation expectation, and not deflation, is the main problem because people would delay purchases and spending in expectation of lower prices in the future, but price level remains same in the short run to medium term and only changes in the long-run, more than a year, however some prices might be more volatile than others because of faster changes in demand and supply, like food and fuel, which mostly hurt real wages and incomes and are consumed by all. Moreover, it is very difficult to exactly predict price changes, and even more for the general public. However, investors might try to make profit of price and price change expectations, but even they could not rightly predict prices 100% and there might remain glitches even for the central banks. Notwithstanding, it could also be attributed to information asymmetry and difference in methodology, mainly investors and the central banks, but the general public is often not interested in future level of prices a year ahead, public is often short sighted, and even unable, to predict or forecast the future economic variables like prices right in the long-run, they only take in to account the current inflation and think that prices would also rise in the future, but how much exactly they do not know and in some cases the may guess… The whole stock market is a game of predicting the right prices, low buy and high sell, which is risky, amid all the information… People could not delay purchases or spending more than one-or-two weeks, if they have employment and money, because it is difficult to forecast prices beyond and lower prices would also restrict some of the supply, which could change price expectations from deflation to inflation and that might increase supply and lower or stabilize the price and price expectations. We have lower price level and price level expectations upto full employment and higher price and price expectations after full employment, however the purpose is to stabilize or constant the price level and price level expectations at full employment….