Economy: Are we rushing towards Depression with help of Federal Reserve and RBI?

Rejoicing Stock Markets:

On 9th of October 2007, Dow Jones Industrial Index was 14164.53. That was the highest ever. In less than a year on July 15th 2006 it fell to 10962 and eventually hit 6626 on March 2, 2009. Last weekend on 14th September it hit a new recent high of 13593. Rejoicing that fed is keeping the interest rate at near zero and that Govt. will buy out the mistakes of private Corporations.

Zero rate interest:

Japan’s economy is in depression for more than a decade even though it is maintaining the rate of interest at less then 1%. Now the problem of prolonging the near zero (0.25% to be precise) rate of interest:

Record low interest rates risk becoming a “long-term crutch” which hinders the repair of the UK economy, the Bank of England’s chief economist has warned.
Spencer Dale’s comments yesterday underlined the nervousness of the hawkish faction on the Bank’s Monetary Policy Committee, which has held interest rates at 0.5 per cent since March 2009 and pumped £375bn into the recovery through quantitative easing.
Mr Dale argued, in a speech in Dublin, that drastic measures taken by rate-setters – as well as the lenders’ relaxed stance – could be delaying the “re-balancing and restructuring that our economy needs”, for example by allowing failing business to survive. “Monetary policy can and should provide short-term support in times of need, but it must avoid becoming a long-term crutch,” he said.
Mr Dale said that if both supply and demand sides of the economy had been damaged by factors such as tight credit conditions, extra QE risked little more than fueling inflation without boosting growth. “If your car’s handbrake is stuck, putting your foot further down on the accelerator
won’t get you very far before the car starts to overheat,” he added. (Source: http://www.independent.co.uk/news/business/news/lowrate-crutch-can-hinder-economy-8119833.html)

Problems with zero rate of interest

Rate of interest is not a simple matter but causes a whirlpool of chain reaction. First of all the low interest rate is fixed in anticipation that it will boost capital expenditure like new Manufacturing Units or new investments in Farming or something like that so that new units may generate employment. Now in the present scenario no such thing has happened. Actually what happened was that the money was diverted to fixed assets or in speculation or in other trading activities. The proper thing to do was to subsidize the new units and leave rest to open. businesses which are not competitive, must be closed down as eventually they will, but in due course, dragging on the fuel tube provided by Government.

BTW Reserve Bank of India is still clueless and continues with its direction-less policy. The annual budget was a futile exercise and an opportunity wasted. Last year when it raised the interest rates, I had cautioned that it is like pouring oil on to fire. Because at that time the inflation was already high and high interest rate meant higher input cost. But it continue to raise interest rates. Now the inflation is out of hand and yet on Monday the 17th September RBI did not take decision to cut interest rates rather declined. Now within two days, some things happened to Government and rate of interest has been cut down by 25 basis points. What is the logic except that it is flip-flop decision-making and acceptance that its steady instance to control the inflation by raising rate of interest was either wrong or had no effect.
While common man suffers under high prices and stagnant income, RBI and Government seems to have run out of options except to make announcements to please the Stock Markets.

Wall street is not Common Man’s Street

Now which book of economics are these policy makers are relying. No economist of repute is supporting these decisions. Why? To understand, we shall have to understand how the economy of a nation works. Economy of a house hold ordinarily does not go into negative. If it does, a person has to apply for bankruptcy, with the declaration that his liabilities have exceeded assets so he may be helped with liquidating its liabilities.

Until the First World War, it was presumed that the Nation must also govern on above principle and must not exceed its expenditure. John Maynard Keynes was first economist to propose overspending by Government by printing currency notes in excess of the reserve with the Government. But this excess was to be utilized for generating purchasing power in the hands of needy and creation of public assets by construction of assets for society and community. So what are the public expenditure in USA. What the Government of the day has built? New Cities? New Stadiums? What?
What has happened, is that US Fed. is spending money on toxic notional assets and then it is begging the corporations to generate employment. Government coffers are not bottomless. Soon there would be another round of problem when the businesses feeding on low-interest rates’ fuel tube will start to fail. What will happen then? When resources would be further low and employment is not generated as quickly as required? That is the beginning of another Great Depression?

© Sandeep Bhalla

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