Demand and Supply are linked with Employment...

The capital and labour are the two important factors of production which add to the cost of production and prices, the cost is an important determinant of productivity and competitiveness in the terms of demand and supply, both, and innovation may also increase these two. The demand and supply competitiveness increase when the ability of firms to produce and sell increase and the ability of people to demand also increases, otherthings remaining constant. A lower cost and price increase competitiveness and productivity and a higher cost and price would decrease competitiveness and productivity because it might reduce supply and demand and prices employment and demand further. In short, to increase competitiveness and productivity it is important to reduce cost of production, capital and labour costs are managed by the central bank through interest rate to incentivize or disincentivize businesses while following the objective of full employment and price stability. However, the price of labour or wages are determined by the demand and supply of labour in the economy and are indirectly managed, we do not have any institution to decide wages in the labour market, the central bank indirectly manages demand and employment and wages through the borrowing cost. The central bank manages demand and supply, both, through the borrowing cost, therefore it is important to keep the borrowing cost low to achieve the objective of price stability and full employment, borrowing cost too add to the cost of the economy and prices which could be lowered to increase demand and supply, both, different names of the same economic activity. When the borrowing cost is lowered it increases employment which increases supply by increasing production and also increase demand by increasing employment and wages, therefore it is not plausible to view demand and supply as separate from each other as both are functions of the money supply and the borrowing cost. Employment is important for demand and supply which determines the price level, higher employment or full employment means full demand and supply and stable prices and vice versa. The central bank usually overlooks this aspect when increasing the borrowing cost, it views that it is controlling demand to tame prices, but forgets that it would also reduce supply and employment and demand, both. Moreover, it misses to increase supply which has a positive correlation with lower borrowing cost and prices and demand. Lower borrowing cost and prices could help increase the demand and supply upto full employment after which lower borrowing cost would also help imports and contain the prices. Notwithstanding, if the central bank tries to contain either demand and/or supply through the borrowing cost it would affect businesses negatively with swings in the trade cycles, but if the central banks try to adjust the borrowing cost low and stable it would help sustain demand and supply at full employment. Lower borrowing cost and prices would help increase employment, (real) wages and savings and investment. The central banks are waiting for wage inflation after full employment because relative prices due to the lower borrowing cost compared to wages would go down. By keeping the borrowing cost low the banks might allow real wages and demand to go up which may help contain demand, supply, employment and prices. The lower borrowing cost could help increase competitiveness if wages are increasing. History has seen less periods of wage inflation than commodity inflation. Paul Krugman is largely true when he says that the central banks are confronted with a novel situation when they are expecting wage inflation instead of commodity inflation like oil price inflation in the past. No central banks in the past have tightened explicitly due to wage inflation which could be good for demand and supply. Higher wages could increase the supply of labour and demand, but how fast that is a question. Higher wages could increase the population rate of growth or immigration or just imports which is also favourable for domestic and global growth and demand.  

Lower prices increase competitiveness, demand and supply, both...

Normally, the economists view higher prices and inflation and expectations to cut real interest rate, real wages and real exchange rate and expectations to make the economy competitive domestically and externally or globally in order to incentivize demand and supply, and, investment and employment, and expectations to achieve the equilibrium, or NAIRU – the non accelerating inflation rate of unemployment, of full employment growth rate and expectations. But, they fail to recognize that inflation reduces real spending and savings and investment and employment and expectations while increasing the nominal interest rate, nominal wages and the nominal exchange rate which makes the economy lose competitiveness and demand and supply, however exports may increase through higher exchange rate. They think that higher prices would incentivize the supply side to increase employment and demand, but when prices increase, they negatively affect demand and spending first and then lower savings and investment and employment and expectations which would lower growth and expectations. Generally, people expect that price of everything increase in the long run so they need higher incomes and savings to achieve the desired standard of living. Nonetheless, if people expect higher prices in the future they might rush to buy which could further increase demand and prices, inverse of the expectation that lower prices would delay spending and it would again lower the prices. This has been observed by the Knife Edge Problem due to expectations; lower growth and price expectations are cumulative in effect and also produce trade cycles and vice versa. The higher prices to increase investment and supply first reduce demand which might set the precedent for lower prices because supply would outpace demand due to lower real wages despite employment, higher prices cut real wages and demand as experienced by the developed countries, inflation and lower real wages have reduced demand relative to supply, even though investment and employment has increased which has lowered price and growth expectations.

Notwithstanding, if we assume lower prices it would increase real interest rate, real wages and the exchange rate which would increase demand and spending and savings and investment and supply and expectations.

Economists think that lower real wages, real interest rate and exchange rate incentivize supply, but they reduce domestic demand and imports, but increases exports which also depend on the external demand and global growth and are sometimes uncertain. Nevertheless,  higher real wages, real interest rate and real exchange rate increase domestic demand, imports and exports due to higher spending and savings and investment to achieve full employment, lower prices would also help contain cost and increase competitiveness and supply. 

  

Productivity, lower interest rate and stability...

Higher productivity or production means lower prices which increases competitiveness, demand and market share... Lower prices further lead to lower nominal interest rate and higher real interest rate, lower prices or inflation increases real interest rate and higher savings and investment and expectations... Lower cost of capital increases its productivity or productivity lowers cost of capital... The oppourtunity cost of using capital or capital intensive techniques is low which lowers unemployment upto full employment, after which wage cost and inflation increase... Full employment is the real constraint on productivity, higher wages would limit expansion or higher wage cost also increases price and price expectations and interest rate and expectations, but if cost of capital is kept low it could compensate the wage cost and increase supply, also through (international trade)... In this situation, a higher nominal or lower real interest rate and expectations because of inflation and expectations would set the contractionary forces double when we need stability and not the next slowdown... A higher ratio of cost of capital and labour would make the economy uncompetitive when higher wages would lower the capital and labour cost ratio... A lower cost of capital and higher wage cost would increase demand competitiveness and demand and growth, means more competitiveness and growth...

A stable or lower interest rate and expectations or lower money that goes for interest payment cost/prices could help slow the deleveraging and would also promote demand for loans and spending and growth... It would also contain fiscal debt...

The objective of the monetary policy is to stabilize inflation and inflation expectations at full employment ie the goal of price stability and full employment... And, not to lower demand and prices and expectations, but keep them stable, to increase supply and prices and expectations to keep growth and growth expectations high... The RBI's neutral stance or real interest rate is just right to keep prices and unemployment stable, if not accommodative... and a stable natural real interest rate and expectations could help more to increase investment employment and growth, than rate hike and rate hike expectations... INDIA's woes due to volatile food and fuel prices could be directly attributed to low investment in agricultural and fuel or oil production... and a low borrowing cost would help increase supply...

Fear and Anxiety... Trade Wars...

The current environment of the global economy is of uncertainty and fear and anxiety due to the protectionist waves and trade wars that are likely to hurt competitiveness and productivity and demand due to higher tariffs and retaliatory tariffs and setback to the supply value chain which might increase unemployment due to disruption and would precede or followed by higher prices and price expectations which could lower demand and growth and expectations. In short, trade wars would be costly and contractionary for the global demand and the stock market around the world, we have seen a fair amount of correction in the stock market since the US President announced tariff on the Chinese products and violation of the patents rights on technology.

Moreover, the strong US economy and higher inflation and inflation expectations have increased the interest rate hike and hike expectations, though gradually, but the withdrawal of the quantitative easing accommodation could further drag the already recovering slow global growth. The gradual reversal of the monetary accommodation after the 2008 crisis is yet to play out since it would increase both interest rate and expectations and strong dollar and expectations and would hurt the domestic and external US economy and lower investment would afflict the other economies, and together the global growth.

The job of the Federal Reserve is not only to restore equilibrium, price stability and full employment within the economy, but also the outside world which are attached due to capital flows after the quantitative easing and ultra low interest rates which, now, have an upward bias due to tight labour market and higher wage cost and inflation and would slow the fragile recovery in the investment partners or borrowers economy and growth, globally. A higher interest rate and rate expectations and currency demand could further aggravate the problem, out flow of the dollar would increase inflation and depreciation in the trading and investment partners’ economy which would also increase imports and current account deficit in the US too…

The RBI might try to stabilize expectations when the inflation has an upward bias to the upside target at 4.44% percent within 4 +/- 2% band, lower than 5%, nonetheless, a 25 basis point cut could prove to be a booster for the market, especially when the stock market is reeling under the trade war and uncertainty... but, the expectations that the income and pay push by the government could increase inflation, notwithstanding a lower borrowing cost could also help increase supply and contain prices... Sometimes, the reverse monetary policy also works, when the central bank increases money supply it reduces the borrowing cost and increase supply and lowers the price level before full employment....

    

Prices, Savings and Interest Rate....

Probably, money demand and money supply are not directly responsible for changes in the price level or inflation, but the availability of goods and services in the economy which is determined by the demand and supply in the goods and services in the market, though the demand and supply of money decide the level of interest rate or borrowing cost in the economy, which has a significant effect on the demand and supply in the economy and the demand and supply of labour in the economy. But, the borrowing cost or the natural real interest and the wage cost or the natural real wage rate after full employment start falling due to the evidence of inflation put by the Phillips curve which could affect savings in the economy, nonetheless, the demand for money as put by Keynes has three functions - consumption, precautionary and speculative demand for money. But, here we are talking about just the speculative demand for money or the savings that go for investment and a rise in the general price level after full employment would affect the savings or supply of money which could further lower real interest rate and savings. We see that any deviation from the natural real rate would magnify itself, either inflation or deflation. In this situation higher borrowing cost would further increase inflation by restricting the supply of the economy. But, it is true that the price level could fall before the full employment because supply could be increased by lowering the borrowing cost and use the excess labour supply or international trade, after it higher nominal wage cost could increase due to tight labour market, labour would demand higher wages to relocate which itself would put a lid on labour demand and wage cost inflation. Higher wage cost would help increase population and demand, but only slowly which could help increase supply and growth in the long run. Higher wages are important at this stage because our population growth is going down and higher supply has depressed the prices globally. Higher inflation, higher wages and higher borrowing cost, at the same time, would make the economy uncompetitive and lose demand supply and growth; still lower borrowing cost would help contain the cost and prices. The evidence from Japan, the US and Europe has shown that prices are not increasing due to the falling population growth rate.

Though, not very clear why there is a difference between price level targeting and inflation targeting since both are the same, probably, inflation is the price level or general price level in the economy... Nonetheless, a higher price level or inflation target could help increase demand, because prices rise when demand increase or higher demand means higher prices, therefore if the Fed targets higher demand it may also increase the price level or inflation target. Similarly, if we have to target higher supply we must again target higher prices, but due to irrational expectations or exuberance the market supplies more which increases price corrections and prices may start falling. But, due to utility or profit making function people still would buy at lower prices which means lower prices increase demand and prices which increase demand and profits, but, again due to irrational expectations or exuberance people also often demand more than supply and prices overshoot... This has been taken from the stock market which is often prone to irrational exuberance and risks, the market skids due to, both domestic and external factors which is very common, even in this age of internet and information, long term investment in a good and cheap stock with higher price target are safe compared to others. Any economy or stock is not fully insulated from external shocks, too, when cheap dollar denominated money has boosted investment and asset prices, not even backed inflation in the emerging markets... Nonetheless, higher prices expectations not supported by demand and supply and fundamentals could force correction in the market or the economy.... Moreover, a 2% price target is too low to increase investment demand, for example the Fed has let only .02 dollar inflation in a dollar which is too low to increase investment employment supply and demand and prices and growth...

26/07/18....

The outflow of dollar from the outer economies would increase local money supply and inflation and depreciation and expectations... The dollar would become stronger also b'coz of tighter borrowing cost in the US... In developing countries price would increase and the nominal exchange rate too due to inflation and in the US they would fall due to higher borrowing cost... making the US competitive in real terms and the developing countries in nominal terms... Economist use both techniques to increase competitiveness reduce real wages by inflation, and increase value of money in the inflation adjusted terms, lower inflation would increase savings and demand... The former is called external devaluation or depreciation and the latter, the internal devaluation... depreciation means cheaper products in the relative terms... In the internal devaluation domestic prices fall due to lower borrowing cost relative to the nominal money or exchange to increase demand for labour and productivity upto full employment and in external devaluation nominal money increases relative to prices due to higher money supply and inflation and expectations... But, in external devaluation or depreciation domestic savings and demand go down, but demand for exports increase due to higher nominal exchange rate... But, both would depend on the excess capacity or excess labour supply because if demand would increase and supply not it increases prices and price expectations and lose market share.... At full employment the central bank might commit to leave the interest rate unchanged which could help stabilize the demand and supply and growth and expectations, if the economy is close to the inflation target and the exchange rate, too.... which would also help stabilize real wages and interest rate and expectations leading to a stable domestic demand and external demand and growth and expectations...

Higher interest rate and rate expectations when the economy is highly leveraged makes the situation more risky... in this condition a stable interest rate and rate expectations might contain the risk of default and recession or slowdown...

The Fed itself is creating trade cycles, but if it chooses only the forward way to increase demand then prices then supply and lower prices and again increase demand and the growth.... it may target lower borrowing cost and lower prices which could increase demand investment employment supply and would contain price and the growth for further demand... and growth....

If Corporate tax cuts are just passed on to lower prices of the Corporations products instead of increase in wages it would help increase demand... This had increased real wages by lowering the general price level... it would also lower interest rate and expectations... it would increase domestic depreciation, the real exchange rate would go up... and increase exports... all due to lower price level... in this situation there is an oppourtunity to increase the market share and profits... .

INDIA…

For farmers costs, including the living cost and wage cost have increased, but profit margins have been low due to government intervention and chain of the middle man who have a better capacity to hold... Storage and brokerage have further increased agri-costs... Credit, too... Marginal farmers might be provided basic income... Irrigation is absent and again costly...The middle man chain has also increased the cost to the market... Higher prices for farm products would not increase inflation much if volatility is curbed through proper supply side management, through imports and price stabilization fund, too... It would generate demand in the rural economy for the industries.... It is important to connect farmers directly to the food and food processing industry or market...

The Precedents....

The lower r* or natural or neutral real rate of interest or borrowing cost because of lower historical inflation and inflation expectations would further reinforce lower inflation expectations due to higher supply as experienced by the US, but after full employment and higher w* or natural or neutral real wage rate could increase wage cost inflation and prices and expectations which could result in higher demand and higher price and price expectations... Still the Fed needs to decide whether it wants to increase demand and supply, both, upto full employment. Nonetheless, if the Fed goes for higher demand, supply and prices and inflation and expectations it would reinforce demand and supply negatively… When prices would go up it would be a precedent for lower prices in the future or lower price expectations because of higher interest rate and expectations, the reverse would set a precedent for higher price expectations which results in boom and busts and trade cycles as put by the Knife-edge problem... Nonetheless, attempts to contain prices at full employment has been the goal for economic policies, but when intervention is made it produces cycle in the opposite and the economy moves from booms to bust to boom within the accepted price or inflation targets or bands set by the central bank in the time frame, same as in the stock market... The stock prices (too) are free to move within the price bands due to changes in demand and supply and normally prices may move 10% up and down in a day, but in some cases they may change 20%... It is true that prices help increase or lower demand or supply to clear the market which is also true for the labour market and other markets, as well. Higher supply lowers prices which increases demand and prices and higher demand increases prices and then supply... The market moves between higher supply and higher demand and between lower prices and higher prices... Lower and higher prices help clear excess supply and demand, since at lower prices people demand more and at higher prices people supply more which are the precedent for each other... Notwithstanding, if the Fed tries to stabilize or prices at the full employment by effective rate guidance people would stop investment and demand because of higher interest rate and interest rate expectations following its price band... The prices at lower end would increase rate cut and rate cut expectations and at higher end it would increase interest rate and interest rate expectations to curb volatility and maintain price stability at full employment… A too narrow price band would imply frequent changes in the monetary policy stance… and could deter demand and supply adjustments and growth…

The Fed has consistently underscored that rate hikes would be gradual under the argument that savings needs to be encouraged with higher nominal interest rates and expectations due to higher inflation and inflation expectations which increases savings and lowers spending due to inflation and expectations that would also lower interest rate and interest rate expectations that is against the expectations... the Fed wants to carve... higher inflation and inflation expectations and lower real interest rate and expectations, but that would lower savings and investment and increase unemployment and lower growth.... If the Fed creates lower nominal interest rate and expectations, but higher real interest rate and expectations due to higher supply and lower prices it would increase demand - employment, consumption, savings and investment - and growth and higher inflation expectations also because of higher demand and expectations...