India’s new government have the challenge of trying to bolster its GDP from the industrial sector. For too long its economy has been going backwards with investment dropping and households shifting their money away from savings and into gold. The Economist identified 3 tasks for the incoming government:
1. Sort out the corrupt banks – bad debts have escalated and banks have chosen to “extend and pretend” loans to zombie firms. The cost of cleaning up the banks is estimated to be 4% of GDP. Healthy banks are needed to finance a new cycle of investment.
2. Stagflation must be dealt with – high inflation and high unemployment (see graph below). High borrowing has fueled inflation and consumers have run to the safety of gold as a store of value for their money. This has meant an increasing deficit in the balance of payments. The central bank is looking at introducing inflation targeting (1-3% in NZ)
3. Developing higher skilled jobs – a lot of Asian countries have benefitted greatly from low cost labour. With labour costs rising in China and 10 million people entering the labour force each year in India, there is a great opportunity to attract foreign investment. This is particularly prevalent when you consider that Japanese firms are now nervous about the on-going military tensions with China and therefore looking at other low cost countries.
For the Indian economy to move forward they will have to ensure investors that the factors of production – land, labour, capital – are reliable and at a competitive price.
Here is a chart from WSJ Graphics which shows the level of interest rates in the US from 1980 to today. With the stagflation of the 1970’s Paul Volcker was faced with some very tough decisions. Below is an extract from an interview with him on the PBS Commanding Heights documentary.
It came to be considered part of Keynesian doctrine that a little bit of inflation is a good thing. And of course what happens then, you get a little bit of inflation, then you need a little more, because it peps up the economy. People get used to it, and it loses its effectiveness. Like an antibiotic, you need a new one; you need a new one. Well, I certainly thought that inflation was a dragon that was eating at our innards, so the need was to slay that dragon.
If you had told me in August of 1979 that interest rates, the prime rate would get to 21.5 percent, I probably would have crawled into a hole. I would have crawled into a hole and cried, I suppose. But then we lived through it.
Below is a graphic from the WSJ which outlines inflation and unemployment under the last 3 Fed Chairmen – Paul Volcker, Alan Greenspan and Ben Bernanke. From the stagflation that was slain by Volker to the irrational exuberance of the Greenspan years and finally the financial contraction under Ben Bernanke. In the 1970’s Volcker tightened the money supply, the economy slowed and contracted – unemployment reached 10 percent. By August 1979 the prime interest rate got to 21.5% but by 1982 the inflation problem had been extinguished. However this was after 3 years of real hardship for the American people. Today we see that inflation isn’t the problem that it used to be and that stimulating growth and job creation is required.
Recent growth and inflation figures spell bad news for the Brazilian economy. You would normally associate inflation as a consequence of higher growth rates but this looks like potential stagflation – stagnant growth and inflation. Although it is not as threatening as the stagflation era of the 1970’s, one wonders how the economy will get on hosting the World Cup and the Olympics games. You would have thought with these forthcoming events that economic growth would be generated with the huge infrastructure development required.
Here is a really funny video by the students of Columbia Business School (CBS) – you may have seen it before but I find it very useful when you start teaching monetary policy and interest rates.
Back in 2006 Alan Greenspan vacated the role of chairman of the US Federal Reserve and the two main candidates for the job were Ben Bernanke and Glenn Hubbard. Glen Hubbard was (and still is) the Dean at Columbia Business School and was no doubt disappointed about losing out to Ben Bernanke. His students obviously felt a certain amount of sympathy for him and used the song “Every Breath You Take” by The Police to voice their opinion as to who should have got the job. They have altered the lyrics and the lead singer plays Glenn Hubbard.
Some significant economic words in it are: – interest rates, stagflate, inflate, bps, jobs, growth etc.
The Guardian newspaper recently produced a useful article about inflation. Although UK based it covers issues such as: stagflation; a historical look at inflation globally (see below); is high inflation good for anyone; why do governments target inflation. Click here for the article.
The record of the highest inflation globally was long held by Germany in the Weimar Republic years when money was carted around in wheelbarrows. In December 1923 prices were more than 85,000,000,000% higher than a year earlier and the highest denomination bank notes had a face value of more than 1,000,000,000,000 marks. In post-revolution Russia, inflation reached 60,804,000% that year – some economic historians believe the government deliberately stoked inflation to impoverish the better off.
But after the second world war, Hungary suffered the highest inflation ever recorded. In the peak month of July 1946, prices were doubling in little more than 12 hours. Other countries that have seen sky-high price rises include China during the civil war from 1945 to 1949, Greece in 1944, Argentina in the 1980s and war-ravaged Yugoslavia in 1994.
More recently, Zimbabwe made headlines for soaring inflation, with price rises hitting 66,212% in December 2007 – the highest inflation in the world at that time. The highest denomination bank note had a face value of 10,000,000 Zimbabwe dollars.
By contrast, Japan experienced a long period of deflation during the “lost decade” of the 1990s.