“THE US FEDERAL RESERVE IS LOOKING TO PRINT NEW MONEY INTO US ECONOMY” --- DOES THIS MEAN WE HAVE MORE MONEY TO SPEND?

The answer to this question can be manifold. Before we try to answer this question let us try to understand why Federal Reserve is taking this step. As we know that the financial crisis and the global recession has slowed down the US economy to a great extent. During a time of recession or economic slowdown there could be two tools that government can look into to inject some money into the economy to facilitate the growth of the economy. These are of course the Fiscal and Monetary Policy.

Fiscal Policies involve policies related to public finance which involves the government to reduce taxes or to invest in Government Spending. This is evident from the great Fiscal Equation: Y = C + I + G + (X-M) where Y is the output of the economy or the GDP, C is the consumption, I is the investment and (X-M) which is the Current Account also called net exports.

When the government will reduce taxes à people will have more money to spend à consumption(C) will raise à causing output (Y) to rise à increase in GDP à increase in growth. The effect will be similar when the government invests in government spending (G).

This tool may look to be a very useful tool but there are loads of implications to this. For one if the taxes are brought down it would mean a bigger gap in the Fiscal Deficit of the government (T-G) { Taxes – Government Spending} which is unwanted as this deficit can only be bridged with a raise of taxes in the future.  So it is not always wise to directly cut taxes. The government can also not raise the taxes as there is lot of political implications. Thus if they can’t raise taxes they will not have money to spent. But there is one more thing that the fed can do to increase the government spending which I will explain a little later. First let’s look into the other tool of Monetary Policy.

Monetary policy changes may involve any one of the following: i) Open market operations ii) changes in interest rates. Now the interest rates in US already being at 0.25% which is very close to nil there is not much scope for the Fed to change this. But there is still scope in open market operations which is exactly what they are doing.  You may ask what open market operations are. These are the buying and selling of the government Treasury bonds to either influx more money into the economy or to take money out of the economy. In case of economic slowdown it is necessary to put in more money into the economy. So what the fed is doing is they are buying back the government bonds that they had sold before. What this will do is it will give more cash to companies and common man to investà causing more money to be invested in the economyà leading the economy to grow.  

This sounds pretty simple right? But there is a catch. One important thing that the authorities must ask themselves: where is it that the investors investing this extra money? Any guesses? Of course in markets which are hot right now: INDIA and all the growing economies. Before we move into this discussion let me bring you back to that other way how fed might have raised money.

When they neither are unable to tax the people nor can borrow the money from them due to high burden then they may go directly to print money. Say for example they required 10billion to invest to get a new submarine build they can directly print the money and spent it. This sounds to be a wonderful way to raise money right? It will look even better when the concept of Seigniorage is brought in. This concept basically says that when government prints a new $1 bill which costs them 4 cents to make the remaining 96 cents goes into the “vault cash” of the Federal Reserve. This money though does not directly go into the economy. It goes to reserve requirement of other banks. Thus, the banks are at liberty to borrow this money at the interest rate which is 0.25% and invest it or lend it out. This idea sounds extraordinarily easy way to infuse money into the economy but it has a huge backdrop. This money which goes into the economy will indirectly deflate the money that is already in circulation thus causing future raising of money more expensive. Hence this tool is not used widely but has been used more by the fed in the recent times to bring back their economy to life.

But this is what is happening:

Open Market OperationàInvestors and Banks in US get more money to invest à Spent them in hot markets like Indiaà more foreign investments for INDIA à more money is bound to come to the different companies via FDI àInvestors in India anticipates this à buys more shares of different sectors à SENSEX rises à we have more money to spend!

But there is a downside to this as well:

High investor confidence globally à Indian currency appreciates à Indian rupees is costlier against dollar than before à people in US buys goods domestically made rather than goods imported from India à Indian export falls à export industry gets a hit à Export (X) is lesser than Imports(I)à Current account (X-M) suffers àchances of output (Y) to fall according to  

Y = C + I + G + (X-M)

Thus, next time you read about something that is going to happen in some other part of the world, stop for a second and think how it might affect us. Believe me when I say even something as trivial as a sneeze in the United States may cause us to shiver. But saying that I must say the latest crisis has shown India and China have managed to decouple themselves from the West.