Multiplier & Accelerator Effect

Today there is a very good article in The Hindu about how NREGA is helping in terms Multiplier & Accelerator effect in this crisis to Indian Economy.

RBI's Annual Policy Review

As expected today RBI reduced the repo rate [rate at which RBI lends to banks] & reverse repo rate [rate at which banks lends/deposit to/with RBI] by 25 basis points to 4.75% from 5% & 3.25% from 3.5% respectively.

Apart from these few other important things from RBI policy reviews are as follows...

After clocking annual growth of 8.9 per cent on an average over the last five years (2003-08), India was headed for a cyclical downturn in 2008-09. But the growth moderation has been much sharper because of the negative impact of the crisis. In fact, in the first two quarters of 2008-09, the growth slowdown was quite modest; the full impact of the crisis began to be felt post-Lehman in the third quarter, which recorded a sharp downturn in growth. The services sector, which has been our prime growth engine for the last five years, is slowing, mainly in construction, transport and communication, trade, hotels and restaurants sub-sectors. For the first time in seven years, exports have declined in absolute terms for five months in a row during October 2008-February 2009. Recent data indicate that the demand for bank credit is slackening despite comfortable liquidity in the system. Dampened demand has dented corporate margins while the uncertainty surrounding the crisis has affected business confidence. The index of industrial production (IIP) has been nearly stagnant in the last five months (October 2008 to February 2009), of which two months registered negative growth. Investment demand has also decelerated. All these indicators suggest that growth will moderate more than what had been expected earlier.

You can see how the 3rd quarter has become disaster due to NEGATIVE growth in Agriculture & heavy slowdown in the industry sectors. You can click on the image for enlargement.




Business Confidence:

The Industrial Outlook Survey of the Reserve Bank for January-March 2009 indicates a further worsening of perception for the Indian manufacturing sector. The overall business and financial sentiment, which touched a seven-year low in the preceding quarter, slid below the neutral 100 mark, for the first time since the compilation of the index began in 2002. According to the survey, the demand for working capital finance during January-March 2009 from external sources dropped due to slowdown in business, even as the availability of finance eased. The business confidence surveys conducted by other agencies are also consistent with these findings.

Inflation



The analysis of the last four years suggests that WPI inflation and CPI inflation moved, by and large, in tandem till April 2007. Thereafter, inflation measured in WPI and CPI tended to diverge. However, the divergence in the recent period has been unusually high reflecting the volatilities in commodity prices which have a higher weight in WPI. With the decline in WPI inflation, CPI inflation is expected to moderate in the coming months. For its overall assessment of inflation outlook for policy purposes, the Reserve Bank continuously monitors the full array of price indicators.

Monetary Conditions

Growth in key monetary aggregates – reserve money (RM) and money supply (M3) – in 2008-09 reflected the changing liquidity positions arising from domestic and global financial conditions and the monetary policy response.

Reduction in the CRR has three inter-related effects on reserve money. First, it reduces reserve money as bankers’ required cash deposits with the Reserve Bank fall. Second, the money multiplier rises. Third, with the increase in the money multiplier, M3 expands with a lag. While the initial expansionary effect is strong, the full effect is felt in 4-6 months.

Bottom line:

Growth Projection

The India Meteorological Department in its forecast of South-West monsoon expects a normal rainfall at 96 per cent of its long period average for the current year. The fiscal and monetary stimulus measures initiated during 2008-09 coupled with lower commodity prices could cushion the downturn in the growth momentum during 2009-10 by stabilising domestic economic activity to some extent. However, any upturn in the growth momentum is unlikely in view of the projected contraction in global demand during 2009, particularly decline in trade. While domestic financing conditions have improved, external financing conditions are expected to remain tight. Private investment demand is, therefore, expected to remain subdued. On balance, with the assumption of normal monsoon, for policy purpose, real GDP growth for 2009-10 is placed at around 6.0 per cent.

Different way of measuring Inflation

As you people may be aware that this week's inflation came down to 0.18% even though basic food article's price is moving north direction due to high base effect. Many times I have written about drawbacks of Our Inflation Measurement System.

In today's mint there is an article by Mr. B Y KAUSHIK DAS about new way of measuring Inflation. I am posting some excerpts from that article.



The Austrians define inflation as the aggregate expansion of total money and credit. This definition has no mention of purchasing power or prices. Mainstream economists define inflation as the rate of increase in the general level of prices of goods and services.

The true cause of inflation is always excess money supply or credit relative to the real pool of savings present in the economy.

Moreover, trying to capture inflation through simple price indices can throw up a completely misleading picture about the financial stability of an economy. For example, if the excess money supply had found its way into stock markets or in the real estate sector, price indices such as CPI and WPI will not reflect such a bubble as asset prices do not form a part of CPI or WPI.

An Austrian economist who considers inflation only as a monetary phenomenon will focus his attention on broad money supply (M3) growth to get a gauge of the true inflation prevailing in the economy. For example, if RBI expects the Real GDP to grow at 7% in fiscal 2009 and expects average WPI inflation to be 9.2% for the whole year, then the M3 growth target should be 19% (7X1.4+9.2) for fiscal 2009.

In the current down cycle, however, aggressive monetary and fiscal stimuli have been administered (and more likely to come) since October to prevent the economic growth from free falling. The stimuli have resulted in M3 growth remaining at high levels of 18-19%, while economic growth has continued on its downward trajectory. The government’s huge borrowing programme on account of the various fiscal stimuli in fiscal 2009 and fiscal 2010 has already led to severe strains on bond market yields, hampering the effective transmission of monetary policy measures adopted so far. In order to relieve the strain on bond markets, some market participants are, therefore, suggesting a direct monetization of the fiscal deficit as the last resort over and above the back-door monetization of defi cits that is already in vogue in the disguise of open market purchases of government bonds. If this were to happen, the money supply growth would continue to remain high or may even increase as monetizing deficits are same as printing money.

Is this crisis worst than THE GREAT DEPRESSION!

There will be multiple opinions if you ask this question. Depending upon the which segment of the economy you are comparing there will be different answer for this question.

But for all the segments like crash of stock markets, industrial production indicator, interest rate response & etc are showing worst indication than the THE GREAT DEPRESSION itself! See this article from Barry Eichengreen & Kevin H. O’Rourke.

The New International Currency

From 2nd world war there is a constant approach towards a new international currency. But every time it was opposed by the MAJOR INDUSTRIALIZED COUNTRIES. Now in this crisis time also there is this talk is going on. And this got substantial boost after the G20 meeting.

Here are the some of the opinions...

Mr. Swaminathan's article in STOI

Mr. Nageswaran's article in mint

Financial Express article

In related to this see what Mr. George Soros thinks about the US economy.

mint COLUMN: WANTED: A KEYNES FOR THE 21ST CENTURY

A s the G-20 summit begins in London, the markets are looking for the magic words “coordinated fiscal stimu lus” in the communiqué. There’ll be a lot of talk of more regulation, some will discuss global imbalances and token obeisance will be paid towards building a new financial architecture, but the big question that will be debated will be the Keynesian one of just how much deficit financing needs to be done to get the world economy out of its hole. The ghost of Keynes will loom large over the meeting.

The ideas of John Maynard Keynes, long dismissed as obsolete, are now back in fashion. That’s because conditions in the West are very similar to the Great Depression that prevailed during Keynes’ time and his advocacy of the need for a fiscal stimulus is appreciated much more keenly now that the economy is deep in a slump. Likewise, Keynes’ notion of a liquidity trap, a situation when lowering the interest rate no longer helps to stimulate the economy, is very much in tune with today’s policy environment. Laymen may find it odd that we could have one economics for good times and a vastly different economics for bad times, but at least the revival of Keynesianism is entirely understandable.

But while we have forsaken our new and shiny monetarist gods and taken refuge in old ones, perhaps it’s not really being recognized just how subversive this particular old god is.

Keynes viewed the money-grubbing culture of capitalism with lofty disdain, although his critique was from the point of view of an aristocrat—he had no love lost for Stalin’s Russia, although he did condescend to label himself a “liberal socialist”. In economic theory, he could scarcely have been more heterodox. Right at the beginning of his magnum opus, The General Theory of Employment, Interest and Money, Keynes makes the extraordinary claim, “I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limiting point of the possible positions of equilibrium. Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.” No wonder orthodox economists were furious. Keynes assumed that less-than-full-employment was the normal state of capitalist economies and it required government action to ensure that all resources were productively employed. As he put it, “a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment”.

It wasn’t just classical economics that came in for criticism. Although he made a lot of money by speculation, Keynes was completely against the kind of financialization of the economy represented by Wall Street, and his quote about economic development becoming the byproduct of a casino is well known. He gleefully looked forward to “the euthanasia of the rentier”.

While we are all Keynesians now, perhaps not enough attention has been paid to the kind of world that Keynes wanted. The world before World War I was in many respects similar to our present one. Capital flowed freely across borders.

Scholars have often compared the current period of globalization with the one that existed at that time. By the middle of the Great Depression, Keynes became sceptical of the benefits of globalization and wrote in the Yale Review in 1933: “The decadent international but individualistic capitalism, in the hands of which we found ourselves after the [first world] war, is not a success. It is not intelligent, it is not beautiful, it is not just, it is not virtuous—and it doesn’t deliver.” Recognizing the havoc that could be wreaked on economies as a result of capital flight, Keynes became an advocate of capital controls, sympathizing “with those who would minimize, rather than with those who would maximize, economic entanglement among nations. Ideas, knowledge, science, hospitality, travel—these are the things which should of their nature be international. But let goods be homespun whenever it is reasonably and conveniently possible, and, above all, let finance be primarily national”.

Small wonder that the world after Bretton Woods was built largely in that image, with capital controls and fixed exchange rates, although Keynes’ idea of a world currency for trade, the bancor, was scuttled by the US, whose leaders were more interested in setting up the dollar as the medium of international exchange. The Chinese central bank governor has recently said that Keynes’ proposal for an international currency unit was the correct approach.

But there are also big differences between now and the world in Keynes’ time. A lot of production, for example, is now international rather than local. International finance is much more complex. Countries such as China and India have been big beneficiaries of neo-liberal globalization and for them the system has clearly delivered.

Most importantly, not enough attention is being paid to the fact that Keynesianism failed during the 1960s and the 1970s and the system that took its place was an attempt to address those failures. Why did the need to replace Keynesianism arise? How do we ensure those weaknesses don’t recur? These questions need to be answered. The resurrection of Keynes is all very well, but the world has moved a long way since his time. What we need is a Keynes for the 21st century.