Economics of competing fear.

From the constant chatter about interest rates in India it may seem that everyone who matters is totally focused on what our RBI does but the truth is that everyone is waiting with bated breath about what the Federal Reserve in the US is going to do. The US added 280,000 jobs in May which increases the chances of a rate rise this year. The IMF has advised the Fed not to increase rates this year because growth in the US economy is still weak, the dollar is overvalued and an increase in rates will have repercussions all over the world. Just the prospect of a rate rise has already brought down bond prices, increasing yields. Yields on old 10 year government bonds rose to 8%. Rising yields means that the government will have to pay more to borrow and if banks are earning so much from sovereign bonds, considered totally safe, they will ask for much more when lending to riskier businesses. That partly cancels out the fall in the repo rate, announced this week. Increase in employment in the US means more people working, which means more spending money, which means greater demand, which means rising prices, ergo interest rate must rise. But apparently it is not so simple. The consumption of durable goods is weak although their price index has fallen for 15 quarters. If durable goods are becoming cheaper why are people not buying them? Because there is a hedonic price adjustment of such goods. This adjustment deducts a calculated value for improvement in quality from the actual increase in prices. For instance, according to this calculation, car prices have risen by 1.14% from January 1997 to February 2015 but in dollar terms the average price in 1997 was $17,000 while it is $33,000 today, near 90% increase. ' Hedonic ' means ' relating to pleasure', which makes it similar to the luxury tax in India. By understating inflation the government saves money by not having to increase pensions or social security and allows the Fed to keep interest rate lower than it should be. Does that mean that the rate is definitely going to rise? Apparently not. Despite interest rate at 0% and injecting around $4 trillion into banks through quantitative easing growth in the economy remains weak. Growth was just 0.7% in the first quarter, which has been blamed on poor weather. Europe grew by 0.4% in the first quarter. So, no risk of deflation. But what about Greece? Greece has delayed a payment of 300 Euros to the IMF to the end of the month and is unable to reach a deal with its creditors. Seems that European countries enforced huge sacrifices from the Greeks, driving its economy down by 33% and unemployment up to 27%, worse than it was in the US during the Great Depression, only to buy time. Now that the ECB and other Eurozone countries think they are safe they are trying to drive Greece out of the Euro. But as the East Asian crisis, the dot-com bubble and the sub-prime disaster have shown you never can tell. A banana peel maybe lurking.