Among the lot of alternative careers that I wish for, one that would have ranked up high in the list would have been climate change researcher. I feel very strongly for this subject and I guess everyone should. We have this earth not for ourselves but for posterity. I had wanted to write this post for long, about the vicious cycle and the slow changes that work behind the global warming phenomenon. Everyone knows that carbon dioxide from human activity is causing an increase in greenhouses gases in atmosphere leading to global warming as global temperatures rise due to heat being trapped in the atmosphere. This post highlights little known facts about the global warming process to give you a bigger canvas of the momentous changes happening slowly as we live and as we sleep.
Fact 1 : If you see the amount of CO2 in the atmosphere over a year, the figures tend to vary dramatically due to the fact that northern hemisphere in winters does not absorb any CO2 leading to an increase of CO2 percentage in the atmosphere while the amount goes down in northern hemisphere summers. So the graph of CO2 amount over a year is zig-zag and not constant, but the trend is definitely upward over long term.
Fact 2 : The northern hemisphere warms more than southern because there is much larger land in north which heats more than sea. Besides there is more ice cover in north.This is causing the arctic circle ice shelf to melt dramatically while some sectors in antarctic ice-shelf are gaining ice, but the net-net is negative.
Fact 3 : The warming is forcing ice caps to melt and increasing the global temperature which increases the moisture content in the air causing a feedback loop since water vapour is a mild green house gas. So the more temperature causes more water vapour and hence more temperature and the cycle goes on.
Fact 4 : The increasing temperature will lead to decreasing ice caps and ice cover, which will cause less and less of sunlight to be reflected back and more to be absorbed by ground and water causing another feedback loop.The dark water and land absorbs more heat as compared to ice cover as ice reflects it back. So the more ice melts the more land/sea gets exposed and absorbs even more. Another tragic feedback loop.
Fact 5 : The increasing temperature in the polar and sub polar region will cause the permafrost to melt. Now this permafrost is frozen for probably millions of years and hold vast amount of organic matter. Once the temperate rises, this permafrost will thaw causing the organic matter to decay and releasing the vast amount to methane/CO2 trapped inside causing another feedback loop since methane is many times for greenhouse causing gas then CO2. More temperature means more permafrost melt and hence more greenhouses gases in air and consequently more temperature. Besides permafrost will melt and flow to the sea or lose its rigidity causing vast arctic and siberian plains to be uninhabitable,.
Fact 6 : Colder water absorbs more CO2 than warmer water. As the greenhouses gases increase, the sea temperature will also rises, causing the CO2 in the oceans to decrease and that gets released to the atmosphere. Another feedback loop that will cause an increase in temperature to contribute yet more increase.
Fact 7 : As temperature in Arctic increases, it is causing lakes and rivers over the ice cap and glaciers that barrel through the width of the ice cap and lubricate the surface between ground and ice above causing the whole ice mass to move to the sea. This fresh water flow goes down in crevasse and slowly melt the underlying foundation of the ice-cap making it more prone to flow towards the sea. As temperature rises, more of these lakes and rivers get formed that increases the water that is reaching the continental shelf.
These are just some of the various factors that go into the complex climate science and since these time scales are so large and effects so small and variables so many, it is still and evolving science that is difficult to fathom to many. People find it hard to believe the idea that just cars and factories can affect the whole climate of this vast planet. But the brutal truth is that what if the science is right, what if we really cause. We do not have a luxury of a second home. This Earth is all we have!
The Economy Thread Part II
Couple of weeks back we discussed briefly on some basic economic terms and the way the whole puzzle works out. Today we will discuss, the brief contours of the current monetary system (fiat money) and why it is what it is today. Before we get down to detail, there are couple (actually more) of terms that i would like to be clear about.
Fiat Money - is money that has its value because of government legislation. For e.g. Rupee as its value is because government has said (and guaranteed) that it is a legal tender for money.
Reserve Currency - is a currency that is held by various governments as part of their foreign exchange reserves and most commonly traded commodities (like gold, oil) are traded in it. Dollar for e.g. is a reserve currency. Oil/Gold are dollar denominated.
Fixed currency regime - where currency is pegged to a reserve currency and can trade within a parity. e.g Chinese Yuan
Managed Float regime - where currency is fluctuates daily but central banks intervene by selling & buying reserve currency. e.g. Indian Rupee
Free Float - where currency openly fluctuates in the foreign currency exchanges. e.g. Japanese Yen
The basis of current monetary system is a fiat money based and has a managed float currency (as is case with India) with the American dollar being the reserve currency. The world initially started with Gold Standard. In gold standard, the monetary unit was a fixed weight of gold. There were lot of variants of this standard, wherein either gold coins were circulated or where silver coins were circulated that had a fixed external value in terms of gold that is independent of the inherent silver value or where authorities have agreed to sell gold bullion on demand at a fixed price in exchange for the circulating currency. A full gold standard, exists when a monetary authority holds sufficient gold to convert all of the money it has issued into gold at the promised exchange rate. This is difficult to implement as the quantity of gold in the world is too small to sustain current worldwide economic activity at current gold prices.
These systems had some inherent problems, first being in bimetallism (a system establishes a fixed rate of exchange for the two metals) where if the market forces of supply and demand for either metal caused its bullion value to exceed its nominal currency value, it tends to disappear from circulation by hoarding or melting down. Besides in the beginning of 19th century due to the imperfections in the trade, silver which was being used to stuck coins began to get drained out of the industrialized world. Over those initial years variations in trade, deficits to fight wars and variations in supply of these metals caused governments to move back and forth between various types of gold standard and silver standard and sometimes entirely off the gold/silver standard. But it was the Great Depression of 1933 that put the final nail in the coffin of the standard. Due to gold backing, the central banks in those times were bound by how much money they could inject in the system by the gold reserves they had in their vault. This hampered their maneuverability to end the crisis. Besides the central had to defend the price of the dollar(by increasing interest rates), which caused deflation and led banks to redeem the gold backing causing further reduction in notes in circulation leading to more slowdown. By 1930's most of the world had abandoned gold standard and moved to fiat money. The basis the gold standard was convertibility.The international value of currency was determined by its fixed relationship to gold; gold was used to settle international accounts. The gold standard maintained fixed exchange rates that were seen as desirable because they reduced the risk of trading with other countries. Imbalances in international trade were theoretically rectified automatically by the gold standard. A country with a deficit would have depleted gold reserves and would thus have to reduce its money supply. The resulting fall in demand would reduce imports and the lowering of prices would boost exports; thus the deficit would be rectified. Any country experiencing inflation would lose gold and therefore would have a decrease in the amount of money available to spend. This decrease in the amount of money would act to reduce the inflationary pressure.
After the WWII, to empower trade between the devastated economies of the world, so that economies could recover it was decided that an international monetary standard would be established for free trade and exchange rate stability. This also ensured that devastated countries do not devalue arbitrarily just to rig exports and set of a chain of devaluation by competing nations. Since the only nation to emerge relatively stronger from WWII was US, it was decided that the value of the U.S. dollar would be fixed to $35 per ounce, and the value of the U.S. dollar was thus anchored to the value of gold. The US Government committed to convert dollars into gold at that price. Also decided in the Bretton Woods system was a system of fixed exchange rates. The rules further sought to encourage an open system by committing members to the convertibility of their respective currencies into other currencies and to free trade. This was also called as a peg currency regime. Nations were required to establish a parity of their national currencies in terms of the reserve currency and to maintain exchange rates by intervening in their foreign exchange markets. The U.S. dollar was the currency with the most purchasing power and it was the only currency that was backed by gold. The Bretton Woods regime also led to the establishment to World Bank & IMF. This regime led to huge transfers of gold to US, massive trade surpluses for US and an appreciated dollar. To reverse this dollar flow, US started the Marshall plan to distribute aid and grant to nations besides improving dollar liquidity.
By late 1950's the US balance of payment went negative, besides for $35 an ounce convertibility to work, the peg has to be maintained in the open gold market as well to avoid nations from buying gold from US and selling it in open market for profit. Rising US government spending in the 1960s, however, led to doubts about the ability of the US to maintain this convertibility, gold stocks dwindled as banks and international investors began to convert dollars to gold, and as a result the value of the dollar began to decline. Facing an emerging currency crisis and the imminent danger that the US would no longer be able to redeem dollars for gold, gold convertibility was finally terminated in 1971. The gold backing requirements for the US dollar were also repealed. This marked the end of the international gold standard and the fixed currency regime. Within five years, most of the nations moved to a floating currency regime.
One question that maybe in readers mind is since all currencies today are fiat money, what is stopping central bank from printing money and handing everyone 1000 Rupee notes. Yes it is true that there are no gold backing requirements that bars central bank from printing endless money, but increasing money supply will lead to inflation and hyperinflation.
The next part of this series would be on 2008 financial crisis.
Fiat Money - is money that has its value because of government legislation. For e.g. Rupee as its value is because government has said (and guaranteed) that it is a legal tender for money.
Reserve Currency - is a currency that is held by various governments as part of their foreign exchange reserves and most commonly traded commodities (like gold, oil) are traded in it. Dollar for e.g. is a reserve currency. Oil/Gold are dollar denominated.
Fixed currency regime - where currency is pegged to a reserve currency and can trade within a parity. e.g Chinese Yuan
Managed Float regime - where currency is fluctuates daily but central banks intervene by selling & buying reserve currency. e.g. Indian Rupee
Free Float - where currency openly fluctuates in the foreign currency exchanges. e.g. Japanese Yen
The basis of current monetary system is a fiat money based and has a managed float currency (as is case with India) with the American dollar being the reserve currency. The world initially started with Gold Standard. In gold standard, the monetary unit was a fixed weight of gold. There were lot of variants of this standard, wherein either gold coins were circulated or where silver coins were circulated that had a fixed external value in terms of gold that is independent of the inherent silver value or where authorities have agreed to sell gold bullion on demand at a fixed price in exchange for the circulating currency. A full gold standard, exists when a monetary authority holds sufficient gold to convert all of the money it has issued into gold at the promised exchange rate. This is difficult to implement as the quantity of gold in the world is too small to sustain current worldwide economic activity at current gold prices.
These systems had some inherent problems, first being in bimetallism (a system establishes a fixed rate of exchange for the two metals) where if the market forces of supply and demand for either metal caused its bullion value to exceed its nominal currency value, it tends to disappear from circulation by hoarding or melting down. Besides in the beginning of 19th century due to the imperfections in the trade, silver which was being used to stuck coins began to get drained out of the industrialized world. Over those initial years variations in trade, deficits to fight wars and variations in supply of these metals caused governments to move back and forth between various types of gold standard and silver standard and sometimes entirely off the gold/silver standard. But it was the Great Depression of 1933 that put the final nail in the coffin of the standard. Due to gold backing, the central banks in those times were bound by how much money they could inject in the system by the gold reserves they had in their vault. This hampered their maneuverability to end the crisis. Besides the central had to defend the price of the dollar(by increasing interest rates), which caused deflation and led banks to redeem the gold backing causing further reduction in notes in circulation leading to more slowdown. By 1930's most of the world had abandoned gold standard and moved to fiat money. The basis the gold standard was convertibility.The international value of currency was determined by its fixed relationship to gold; gold was used to settle international accounts. The gold standard maintained fixed exchange rates that were seen as desirable because they reduced the risk of trading with other countries. Imbalances in international trade were theoretically rectified automatically by the gold standard. A country with a deficit would have depleted gold reserves and would thus have to reduce its money supply. The resulting fall in demand would reduce imports and the lowering of prices would boost exports; thus the deficit would be rectified. Any country experiencing inflation would lose gold and therefore would have a decrease in the amount of money available to spend. This decrease in the amount of money would act to reduce the inflationary pressure.
After the WWII, to empower trade between the devastated economies of the world, so that economies could recover it was decided that an international monetary standard would be established for free trade and exchange rate stability. This also ensured that devastated countries do not devalue arbitrarily just to rig exports and set of a chain of devaluation by competing nations. Since the only nation to emerge relatively stronger from WWII was US, it was decided that the value of the U.S. dollar would be fixed to $35 per ounce, and the value of the U.S. dollar was thus anchored to the value of gold. The US Government committed to convert dollars into gold at that price. Also decided in the Bretton Woods system was a system of fixed exchange rates. The rules further sought to encourage an open system by committing members to the convertibility of their respective currencies into other currencies and to free trade. This was also called as a peg currency regime. Nations were required to establish a parity of their national currencies in terms of the reserve currency and to maintain exchange rates by intervening in their foreign exchange markets. The U.S. dollar was the currency with the most purchasing power and it was the only currency that was backed by gold. The Bretton Woods regime also led to the establishment to World Bank & IMF. This regime led to huge transfers of gold to US, massive trade surpluses for US and an appreciated dollar. To reverse this dollar flow, US started the Marshall plan to distribute aid and grant to nations besides improving dollar liquidity.
By late 1950's the US balance of payment went negative, besides for $35 an ounce convertibility to work, the peg has to be maintained in the open gold market as well to avoid nations from buying gold from US and selling it in open market for profit. Rising US government spending in the 1960s, however, led to doubts about the ability of the US to maintain this convertibility, gold stocks dwindled as banks and international investors began to convert dollars to gold, and as a result the value of the dollar began to decline. Facing an emerging currency crisis and the imminent danger that the US would no longer be able to redeem dollars for gold, gold convertibility was finally terminated in 1971. The gold backing requirements for the US dollar were also repealed. This marked the end of the international gold standard and the fixed currency regime. Within five years, most of the nations moved to a floating currency regime.
One question that maybe in readers mind is since all currencies today are fiat money, what is stopping central bank from printing money and handing everyone 1000 Rupee notes. Yes it is true that there are no gold backing requirements that bars central bank from printing endless money, but increasing money supply will lead to inflation and hyperinflation.
The next part of this series would be on 2008 financial crisis.
The Resonableness Deficient
Reasoning is something that is really in short currency these days. Common sense and logical thought is being replaced by hysteria and arm-twisting. Couple of stories that have been playing over and over again in the media shows how the debate is polarizing the societies (in two vastly different countries) leaving the people in the middle squeezed and with no room for rapprochement.
Firstly, the gruesome murder of Pakistani Punjab's Governor. His being killed is not important now. What is of merit is the causes and the after response. The causes as flimsy as they may be shows the (Pakistani) society in general is losing grip with debate and reason, where loud talk gets the better of reasonable talk. Where external conspiracy theory is believed rather then looking at faults inside. Where tolerance is being replaced by mindless bigotry. And where the killer is being showered rose petals by the lawyers who must uphold justice and law of the land. Where the so called educated and facebook generation is opening approving the actions of the killer and the political class is condoning it. The debate over blasphemy has been needlessly played out in the media as if this is the only issue confronting the nation. Any talk of reason is shouted down as being anti-religious and atheist.
Secondly, the fatal shooting in Tucson which has dominated the American media and consciousness. Here the shooting unlike in Pakistan has united the nation in grief. No one is condoning the psychotic shooter's action. But the vast swath of the nation and its political class is an accessory to murder by not limiting access to guns. The whole debate over guns is something that is beyond my logic and reason. Any talk of gun control is met with such derision as if people have been asked to surrender there right to speech or privacy. In fact, it is easier to pass legislation to pry on people's phone than to control society's access to such high powered guns. Why does anyone need a pistol that can shoot 31 rounds without reload? Can any reasonable person answer this. Why would anyone need an AR-15 military assault rifle? Why? Why is there such a fear of government trampling over citizens rights? Aren't innocent law-abiding citizens rights being trampled by senseless killing in schools, churches and malls because some psychotic had access to such high powered gun due to lack of control and verification? Why such concern for people having access to these guns but none for over thousands killed in gun related violence. Here again the debate has not been over logic and reason but instead has been hijacked by rhetoric and name-calling by the 24 hour news media (as is the case in both countries).
In both the case we are not even going into the causes for these tragic events, and in any case there can be no justification for violence however 'aggrieved' the killer is. The real issues in my view is why is it so hard to talk and reason on issues where course of action is clear and logical without being branded Nazis or atheist. Back home, the lesser said the better. We are maybe getting more developed (economically), but in reality our brains are shriveling in same proportion. Last week a person died in Delhi unforgiving roads due to a (now common) case of road rage. This short fuse, this me.. my car.. my road craziness is insane. People are getting killed because nobody wants to reason, or even stop for a moment to ponder. There is no scope for middle ground. It is either my way or the highway.
Firstly, the gruesome murder of Pakistani Punjab's Governor. His being killed is not important now. What is of merit is the causes and the after response. The causes as flimsy as they may be shows the (Pakistani) society in general is losing grip with debate and reason, where loud talk gets the better of reasonable talk. Where external conspiracy theory is believed rather then looking at faults inside. Where tolerance is being replaced by mindless bigotry. And where the killer is being showered rose petals by the lawyers who must uphold justice and law of the land. Where the so called educated and facebook generation is opening approving the actions of the killer and the political class is condoning it. The debate over blasphemy has been needlessly played out in the media as if this is the only issue confronting the nation. Any talk of reason is shouted down as being anti-religious and atheist.
Secondly, the fatal shooting in Tucson which has dominated the American media and consciousness. Here the shooting unlike in Pakistan has united the nation in grief. No one is condoning the psychotic shooter's action. But the vast swath of the nation and its political class is an accessory to murder by not limiting access to guns. The whole debate over guns is something that is beyond my logic and reason. Any talk of gun control is met with such derision as if people have been asked to surrender there right to speech or privacy. In fact, it is easier to pass legislation to pry on people's phone than to control society's access to such high powered guns. Why does anyone need a pistol that can shoot 31 rounds without reload? Can any reasonable person answer this. Why would anyone need an AR-15 military assault rifle? Why? Why is there such a fear of government trampling over citizens rights? Aren't innocent law-abiding citizens rights being trampled by senseless killing in schools, churches and malls because some psychotic had access to such high powered gun due to lack of control and verification? Why such concern for people having access to these guns but none for over thousands killed in gun related violence. Here again the debate has not been over logic and reason but instead has been hijacked by rhetoric and name-calling by the 24 hour news media (as is the case in both countries).
In both the case we are not even going into the causes for these tragic events, and in any case there can be no justification for violence however 'aggrieved' the killer is. The real issues in my view is why is it so hard to talk and reason on issues where course of action is clear and logical without being branded Nazis or atheist. Back home, the lesser said the better. We are maybe getting more developed (economically), but in reality our brains are shriveling in same proportion. Last week a person died in Delhi unforgiving roads due to a (now common) case of road rage. This short fuse, this me.. my car.. my road craziness is insane. People are getting killed because nobody wants to reason, or even stop for a moment to ponder. There is no scope for middle ground. It is either my way or the highway.
What Tunisia Portends
Last week was one of the rare weeks of change in the middle east or lets say the broader Arab world. After being in power for better part of 25 years, the president of this small Mediterranean country was forced to flee the country. Let me just give you facts as to why this is important. The whole Arab world from Morocco to Iran (Iran & Turkey and not exactly Arab, but we are still branding them for region's entirety.) is filled with despots, monarch and president-for-life types rulers. This is one place where democracy has still to find its feet. Maybe this could be the trigger for broader change. The rulers of Egypt, Algeria and others need to be worried that their local alienated population does not take cues from events unfolding in Tunisia. The problems with this region are unique, especially in the sense that the region as such is not poor. Tunisia has oil wealth as well as tourism, but given the rapid population growth rates that Arab countries are experiencing, jobs are not being created to absorb them. So alienation and frustration is spilling on to streets and since there are no checks & balances in the political system, no safety valves.. it boils over. This problem is same as what is staring in the face of Egypt, Morocco and countless others. Add to this mix, the rising militant Islam, the growth of conservative Muslim influence, Al Queda lurking in the shadows in the vast Sahara and extreme distribution of oil wealth, these events have the power to reshape the entire Arab landscape. Time will tell if a small vegetable vendor's death was the harbinger of change sweeping the vast desert expanse. Time will tell!
The Economy Thread Part 1
I have been thinking of writing this one for a long long time, and yet i have not got it complete yet. This topic is one of the countless that fascinate me, the science behind the economy and factors that influence it. This is the first post in a series on Economy. It is arranged in terms for simple Q and A for easier understanding!
How can the central bank cool the economy?
It does by increasing the bank rate and the CRR rate primarily. Bank rate(discount rate) is the rate of interest at which central bank gives loans to banks. This is used to change the money supply. CRR on the other hand is the minimum reserves that each bank needs to park with the central bank. This is an important instrument in money supply. What is money supply? Suppose bank has Rs. 100 and it lends Rs. 90 as loan(10% being the CRR). The total max money supply is Rs. 1000 (How? - if bank has Rs 100, it loans you Rs 90, you deposit the Rs 90 back in bank, then bank again loans out 90% of it i.e. Rs 81 and this goes on. The total amount would be Rs 1000 like this). If central bank feels that money supply is too much it can raise CRR to 20% and the max money supply now would come down to 100+80+64.. to 500. Hence this reduces money creation and maintains purchasing power. But how can money supply maintain purchasing power??
Suppose there are 100 rupees chasing 10 items in the market, and the increased money supply leads to 110 rupees in the same market for those original 10 products. In short, there are Rs. 11 to buy the same item. Now, the prices will rise. This is a very simple analogy of a complex science, but that is pretty much the way it works.
What about interest rate? Does not that matter? Yes it matters. Lower interest rate means that borrowing is easier for individuals to buy stuff like cars, houses and for companies so they create new capacities and increase employment. The increased spending by individuals also in-turn boosts the economy as it produces demand for goods. On the other hand a runaway growth leads to hardening of interest rates as most of the money is being spent on consumption or creating new capacity leading to bank deposits running low, thereby curbing new loans. In those cases banks increase deposit rates and loan rates to induce people to save and make it harder for companies to borrow. Runaway growth also leads to inflation as wages rise causes more money to chase fewer items in the market, besides the increased money supply in the system is also a factor in increased inflation as there is a higher demand for credit.
How can the central bank induce growth in the economy?
To induce economy, the easiest is to lower the rate of interest so that it is easier to burrow and increase consumption. Also lower the CRR, so that money supply in the system increases that causes more money at bank's disposal.The other form of stimulus is increased government spending like government agreeing to make 8-lane all 4-lane highways in the country. The spin-off of such spending is increased jobs and consumption of goods therefore kick starting the economy. But it has a trade-off, since this government spending is financed by borrowing, this increases debt causing interest rate to rise as borrowing created a higher demand for credit. since most money is put on government debt, less money on consumption so this may negate the effects of the stimulus.
Another way to induce growth is to qualitative easing (which is done when interest rates are near zero, so there is not much scope to reduce rates.) In this the central bank prints money and buys back the government bonds previously issued to the bank so that money supply is increased in the system and this excess liquidity is used to loan money to individuals and companies to induce growth.
What is T-bills?
The US has a huge budget deficit, so it has more dollars going out, then coming in. It manages this by issuing out T-bills or bonds or notes. All these instruments are different, and have varying yields and maturity time. This is government debt. Why does countries like China buy them? Because it a an ultra-safe investment for there trade surplus dollars besides it buys a certain influence in Washington. What if China one day decides to sell it T-instruments one day. Probably the sky will not fall, as there are other buyers in the market who will chip in.
Why US/Japan is not failing despite this much debt?
The reason US is not going to go under despite the massive deficit, is due to the fact that its currency, the dollar is the world's reserve currency and most of the trade in gold, oil is dollar denominated. In short the buyers for dollar are always there. As for Japan, since about 95 percent of Japan’s debt is held domestically, there’s no risk of capital flight. Japan borrows from its companies and people, an arrangement that’s roughly the mirror image of the U.S.
Next week on stagflation, credit swaps, foreign exchange and bonds.
How can the central bank cool the economy?
It does by increasing the bank rate and the CRR rate primarily. Bank rate(discount rate) is the rate of interest at which central bank gives loans to banks. This is used to change the money supply. CRR on the other hand is the minimum reserves that each bank needs to park with the central bank. This is an important instrument in money supply. What is money supply? Suppose bank has Rs. 100 and it lends Rs. 90 as loan(10% being the CRR). The total max money supply is Rs. 1000 (How? - if bank has Rs 100, it loans you Rs 90, you deposit the Rs 90 back in bank, then bank again loans out 90% of it i.e. Rs 81 and this goes on. The total amount would be Rs 1000 like this). If central bank feels that money supply is too much it can raise CRR to 20% and the max money supply now would come down to 100+80+64.. to 500. Hence this reduces money creation and maintains purchasing power. But how can money supply maintain purchasing power??
Suppose there are 100 rupees chasing 10 items in the market, and the increased money supply leads to 110 rupees in the same market for those original 10 products. In short, there are Rs. 11 to buy the same item. Now, the prices will rise. This is a very simple analogy of a complex science, but that is pretty much the way it works.
What about interest rate? Does not that matter? Yes it matters. Lower interest rate means that borrowing is easier for individuals to buy stuff like cars, houses and for companies so they create new capacities and increase employment. The increased spending by individuals also in-turn boosts the economy as it produces demand for goods. On the other hand a runaway growth leads to hardening of interest rates as most of the money is being spent on consumption or creating new capacity leading to bank deposits running low, thereby curbing new loans. In those cases banks increase deposit rates and loan rates to induce people to save and make it harder for companies to borrow. Runaway growth also leads to inflation as wages rise causes more money to chase fewer items in the market, besides the increased money supply in the system is also a factor in increased inflation as there is a higher demand for credit.
How can the central bank induce growth in the economy?
To induce economy, the easiest is to lower the rate of interest so that it is easier to burrow and increase consumption. Also lower the CRR, so that money supply in the system increases that causes more money at bank's disposal.The other form of stimulus is increased government spending like government agreeing to make 8-lane all 4-lane highways in the country. The spin-off of such spending is increased jobs and consumption of goods therefore kick starting the economy. But it has a trade-off, since this government spending is financed by borrowing, this increases debt causing interest rate to rise as borrowing created a higher demand for credit. since most money is put on government debt, less money on consumption so this may negate the effects of the stimulus.
Another way to induce growth is to qualitative easing (which is done when interest rates are near zero, so there is not much scope to reduce rates.) In this the central bank prints money and buys back the government bonds previously issued to the bank so that money supply is increased in the system and this excess liquidity is used to loan money to individuals and companies to induce growth.
What is T-bills?
The US has a huge budget deficit, so it has more dollars going out, then coming in. It manages this by issuing out T-bills or bonds or notes. All these instruments are different, and have varying yields and maturity time. This is government debt. Why does countries like China buy them? Because it a an ultra-safe investment for there trade surplus dollars besides it buys a certain influence in Washington. What if China one day decides to sell it T-instruments one day. Probably the sky will not fall, as there are other buyers in the market who will chip in.
Why US/Japan is not failing despite this much debt?
The reason US is not going to go under despite the massive deficit, is due to the fact that its currency, the dollar is the world's reserve currency and most of the trade in gold, oil is dollar denominated. In short the buyers for dollar are always there. As for Japan, since about 95 percent of Japan’s debt is held domestically, there’s no risk of capital flight. Japan borrows from its companies and people, an arrangement that’s roughly the mirror image of the U.S.
Next week on stagflation, credit swaps, foreign exchange and bonds.
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