Is India
on the verge of 2008 Crunch ?
Some
TRANSMISSION MECHANISM FAILURE Indicators in regard to that :-
1. Bond Market Vigilance:- If
supply of money growth is
considered as inflationary, LONG TERM BONDS will be relatively less attractive
because of HIGHER EXPECTED FTURE ASSET PRICES & will increase Long-Term Rates.
( Increasing Money Supply to stimulate economic
activity could lead to an increase in expected inflation rates & long-term
bond yields even when short term rates are falling).
This scenario
is less relevant in the current context of the Indian Economy in my opinion.
2.
Liquidity Trap :- Demand for money is very much
elastic & Individuals hold more money even without a decrease in Short Term
rates.
( Money Supply Growth is increasing but short-term
rates are still not decreasing because High Cash Balances by the Individuals
instead of some investment in the securities)
This
scenario is most relevant in the current context of the Indian Economy in my
opinion & that’s what Indian economy is going through.
3.
Quantitative Easing (QE):-Banks with excess reserves because of Purchase of Securities by APEX
BANK
but banks are not willing to lend & hence economic growth still poor.
( Money supply increased by the Apex Bank &
also decreased short term rates almost to zero but still Banks are not ready to
take the lending risk).
This
scenario is also most relevant in the current context of the Indian Economy in
my opinion.
Was
one of the reasons for credit bubble that collapsed in 2008.
In UK, DURING 2008-2009, British Govt. made a
BIG BLOCK purchase of government Bonds which were having the maturity due of
3-5 years & the government intent was quite clear to everyone i.e. to
reduce Interest rates to encourage the Industrialist, individuals to borrow
& to generate excess reserves for banks but because of uncertainty about
the future, banks behaved conservatively & thus transmission mechanism
failed here.
Also, In the US DURING 2008-2009 Fed bought a
Handsome amount of Assets (except Short-Term Treasury securities ) were
purchased like Mortgage Securities from banks to reduce Interest rates to
encourage the Industrialist, individuals to borrow & to generate excess
reserves for banks in an attempt to revive the housing markets specially, but
because of about the future, banks
behaved conservatively & thus transmission mechanism failed here as well.
But when the above transmission mechanism
failed, then US introduced another fresh round of QE2 by
purchasing by making another big purchases bigger than QE1 & even bought the
securities with credit risk they got some stimulus to economy but in this also
it is just that Bank’s balance sheets
got improved & it’s a kind of risk shifting from private to Public ( This method won’t
be very viable in the Indian Economy as per my opinion).
DEFLATION IS VERY DIFFICULT TO REVERSE in comparison
to INFLATION.
(JAPAN is a best example from the history).
Steps that Indian Government should considered
to overcome this SLOWDOWN :- NEXT BLOG
