User's blog

Month: July 2022

  • IMF predicts further slowdown for the world economies

    The International Monetary Fund in its latest World Economic Outlook report, published on July 26, 2022, has lowered its estimate of Economic growth for the world economies. This is a downward revision from their April 2022 projections of GDP growth rate for both 2022 and 2023. Below is the chart I took from the IMF website showing their growth projections by region.

    I have tried to summarize the main points of the report for you. If you are interested in reading the full report, please click here. https://www.imf.org/en/Publications/WEO/Issues/2022/07/26/world-economic-outlook-update-july-2022

    Lower GDP growth but higher inflation globally in 2022-23

    The GDP of the World is now expected to grow at 3.2% this year and 2.9% next year, compared to what they had predicted in April to be 3.6% in both 2022 and 2023.  While they predicted lower GDP growth across the globe, they raised their inflation estimates. The report predicts a 6.6% inflation in advanced economies and 9.5% in emerging and developing economies.

    What are the main factors behind this?

    The report cited various reasons for its downgrade revision. On top of the pandemic after effects, higher-than-expected inflation has been a major cause of worry worldwide, especially in the US and major European countries. This has caused the central banks of these countries to raise interest rates, making financial conditions tighter.

    Additionally, China’s economic slowdown has been worse-than-expected due to its zero covid policy. This has caused longer lockdowns, affecting their exports to the major US and European economies, and causing supply chain issues. This has also led to a supply-induced inflation.

    The report fears that given the current scenario, the Russian – Ukraine war could continue for long and sanctions associated with it could go up further. This will, unfortunately, cause more problems in energy and food markets’ supply.

    They also ran an alternative scenario of a possibility of a full shutdown of Russian gas flows to Europe by the end of 2022. If that happens, GDP global growth might fall further to 2% next year. The report also stated that since 1970, global growth has only been lower five times, so this does look very gloomy.

    What should the countries do to overcome this?


    The report suggests that controlling elevated inflation should remain the priority of policymakers around the world. This requires tightening monetary policy, and many central banks have started to do that already, both in advanced economies and emerging markets.

    They also noted the role of Fiscal policy is important here to protect the vulnerable population. But it is important that the fiscal policy (like in the form of subsidy or stimulus payments) should only target the weaker population and should not interfere with the overall disinflationary motive of monetary policy. Because a lot of inflation in the advanced economies was caused by this issue, where too much money was chasing too few goods. In other words, people got the money to spend, but not that many goods and services were getting made, causing excess demand and inflation.

    The report concluded that policymakers must continue to work on increasing vaccination rates to protect against future outbreaks. Lastly, countries must collaborate to address climate change and speed up the green transition to avoid their dependence on oil.

    Please let me know in the comment section your feedback on what topics you would like me to write about.

  • Why did Fed raise interest rates again, making borrowing more expensive?

    Ending their two-day meeting, the Fed (central bank of the US) has once again raised interest rates. The reason for the hike is to control inflation. The United States Congress has given the Fed a dual responsibility – to achieve maximum employment and keep inflation around the rate of 2% over the longer run.

    The average consumer in the US has been feeling the burden of rising prices, especially since the start of this year, esp. in gas, housing (including rental), and food prices. The Consumer Price Index, which measures inflation in the US has been at an elevated level for quite some time. In their press release, as of July 13, 2022, the BLS published inflation at 9.1%.

    How does the interest rate affect inflation?

    Going back to today’s news, let’s understand how the interest rate mechanism works. The FOMC (Federal open markets committee) is responsible for determining the federal funds rate target range. This is the rate at which banks borrow from each other. The Fed doesn’t set this rate, but market forces determine it.

    The reason this rate is very important to us is through its linkages to other rates. This federal funds rate impacts all the other interest rates such as on credit cards, housing, auto, and education loans.

    How much did Fed raise interest rates?

    In today’s meeting, the Federal open market committee decided to raise the target range for the federal funds rate from 2.25% to 2.5%. This increase has moved the Federal funds rate to its highest level since December 2018. During their June 13, 2022 meeting, they increased the target range for the Federal funds rate to be 1.25% – 1.75%. You can see the graph of this rate over time here.

    So how does the Fed steer the federal funds rate?

    It uses “interest on reserves balance” as its main monetary policy tool for that. To understand it better, you can read my article here, which explains this in detail. When the Federal funds rate (borrowing costs of banks) is high, banks will pass on these added costs to their final consumers. These consumers include people like you and me, and businesses.

    In a nutshell

    The main idea behind this repeated increase in the interest rate is that expensive loans will discourage people from spending. When the cost of borrowing (interest rate) is high, general consumers (households) borrow less for a big purchase such as a car or a house. Similarly, businesses also invest less in the expansion of their plant, inventories, machinery, buildings, etc. All of this will reduce the demand for goods and services these businesses make and they will also hire fewer workers. And when the excess (increased) demand is lower, the prices will eventually start falling, which will control high inflation. Thus, interest rate hikes are the Fed’s main tool to control inflation.

    Inflation happens because of strong consumer demand, which supply can’t match. Supply bottlenecks with China during the Covid pandemic, Ukraine war, etc have all contributed to a weaker supply of many essential items we use every day. Since many of the supply chain issues will take a long time to fix, the Fed is trying to control the demand aspect of inflation. By raising interest rates, and making borrowing more expensive, the Fed is hoping to weaken Americans’ willingness to spend money and ultimately bring inflation close to its 2% target level.

  • Commonly used macroeconomic terms that you should know

    Today, I explain some of the most widely used macroeconomic terms relating to a country’s economic performance. These are the terms we often read in the news, so we need to understand what they are and how they affect us. My list is not comprehensive, but I feel it is a good start. In my future posts on Economic Glossary, I will be explaining the meaning of some other important economic terms, so please stay tuned for that. For now, let me explain the ones that are coming to my mind as I type.

    Interest rate: It is the cost of borrowing money or the return we get from saving our money. By changing interest rates, the Fed (central bank) can influence economic growth. Low-interest rates encourage spending and investments and make the economy grow. On the other hand, rising interest makes loans more expensive and lowers investment. This reduces firms’ hiring, employment, and thus total demand in the economy and can lower both inflation and GDP growth.

    GDP: It measures the size of the economy. It is the market value of everything (final goods and services) produced in a country, whether it is made by its citizens and companies or by the rest of the world. Market value is how much we pay for something, such as the market price for that bread we eat or the plumbing service we get. The US GDP number is published every quarter to see its trend. Economists at the U.S. Bureau of Economic Analysis estimate GDP by using a lot of data gathered by other federal agencies and private data collectors. As of Q1, 2022, the US Real GDP was $19.7 trillion. The US is the number one economy in the world when measured by real GDP.

    GDP Per capita is the GDP divided by the total population. It shows the standard of living of its people and this number is published once a year. Real GDP is the GDP at constant price or base year prices. This measure removes the effect of rising prices on GDP. GDP growth rate is a % measure that calculates real GDP growth as compared to the previous quarter or the previous year. This could be a positive or negative % depending on an increase or decrease in real GDP. To know more about US GDP growth, click here.

    Recession: A recession is a significant fall in the economic activity of an economy. It is mostly seen as a decrease in income and employment. During a recession, there is a significant drop in consumer spending. Some businesses can go bankrupt, people out of school don’t find good jobs and people might lose their homes when housing prices fall. If you want the exact definition of recession or expansion in the US, here’s a good source https://www.nber.org/business-cycle-dating-procedure-frequently-asked-questions

    Inflation: The inflation rate is a sustained rise in the average price level during a specified period, usually a month or a year. It is calculated as a % increase or decrease in prices from the previous period. Inflation exists when prices increase but our purchasing power reduces over some time. As seen in my post here, demand, supply, and future expectations about inflation affect inflation. 

    US Government and the Fed both measure and publish inflation numbers every month. They use CPI and PCE respectively for measuring inflation. Sometimes, the CPI can give us misleading information because it includes food and oil/gas prices. These numbers are usually more volatile. The core inflation rate excludes food and energy prices and thus is a better measure of the inflation rate. The Personal Consumption Expenditures price index is another measure of inflation. It includes more business goods and services than the CPI. For example, health care services paid for by health insurance companies are part of PCE and not CPI.

    Unemployment rate. Every country sets a target unemployment rate that it seeks to achieve. In most advanced economies it is a lower % compared to developing economies. In the US, The BLS publishes this % every month. The Fed aims to keep the unemployment rate around 4%. The unemployment rate represents the number of unemployed people as a percentage of the labor force. People in the labor force include people 16 years of age and older, who are either employed (have a job) or unemployed (those who have looked for a job in the past 4 weeks but couldn’t get one).

    As of June 2022, the unemployment rate in the US was 3.6%. The total number of unemployed persons was 5.9 million.

    Monetary policy or the Fed: Federal Reserve is the central bank of the U.S. The Fed performs many important functions such as supervising the nation’s commercial banks, conducting monetary policy and providing financial services to the U.S. government. It also promotes the financial system’s stability by taking measures to prevent crises like recession and bank failures.

    The Fed is not just one bank but consists of 3 main components.

    1. Seven Board of governors guide the entire monetary policy and set the discount rates for member banks
    2. 12 regional federal reserve banks are located in Atlanta, Boston, Chicago, Cleveland, Dallas, Kansas City, Minneapolis, New York, Philadelphia, Richmond, St, Louis, and San Francisco.
    3. FOMC, the Federal open market committee. It meets eight times a year and makes decisions that help promote the health of the U.S. economy and the stability of the U.S. financial system.   

    The Fed is an independent entity and is not affected by U.S. politics. Congress has given Fed a dual mandate of stable inflation and maximum employment. The Fed tries to keep prices stable with a long-term 2% inflation target and also promotes maximum employment. Please see my detailed post on how Fed in the US uses its monetary policy tools to keep inflation in the target range.

    Fiscal policy : Fiscal policy is the term used to describe the spending and taxation decisions of a government that can influence an economy. For example, the government can lower taxes and raise spending to boost the economy when needed. Governments often spend on infrastructure projects to create jobs and grow income to take the economy out of a recession.

    Similarly, the Fed increases business investment and spending by lowering interest rates. In a boom situation, when the economy is overheating with high inflation and very low unemployment, they do the opposite. The government reduces its spending and raises taxes. Alternatively or in addition, the Fed raises the federal funds rate which in turn increases all the other interest rates in an economy and thereby puts a break on overall economic activity. Thus, either fiscal or monetary policy or both can be used to expand or contract the economy.

    If you like my posts or think I can do better, please provide your feedback in the comment section below. I will be happy to research and write about any topics you might be interested in learning more about. Thank you!

  • What does a vaccine, a park and a factory have in common?

    These are all examples of externalities. Sorry, if this sounds too complicated at the beginning, it will all make sense as you read along. Externalities can happen when the after-effects of certain actions can spill over to other people not directly involved in it. These could be either positive or negative spillovers.

    Externalities can arise between producers, between consumers or between consumers and producers. Externalities can be negative when the action of one party imposes costs on another, or positive when the action of one party benefits another.

    Let’s look at an example of a positive externality. Vaccination for any infectious disease would be a positive externality because vaccination will reduce the overall severity, symptoms, and thus the possibility of spread of infection of that particular disease. This will also benefit people who are not vaccinated through positive spill overs by others who are. People who didn’t receive the vaccine are less likely to get an infection if more and more people around them are vaccinated. Vaccination also reduces the burden on a country’s healthcare and benefits society. Most recent example of this is the Covid 19 vaccine, which was provided mainly by the government in many countries to stop the spread of infection.

    In both positive or negative externalities, government intervention is required to make sure the businesses that create externalities get the benefits for positive externalities or pay the price for negative externalities.

    If a factory is producing toys but at the same time polluting the environment, people are bearing the cost of pollution. This is a negative externality. From an economic perspective, the business is transferring some of its cost of production to society. Without any tax on pollution, that business factory’s actual cost of production is less than what it should be, so it can charge lower prices from the people for the toys it produces. This reduced price creates more demand for toys, making the business produce more and more toys and thus polluting the air more.

    In our first example above, the factory will find ways to reduce its chimney smoke from polluting air if it has to pay the price for its pollution. Government can impose taxes in these cases. Tax will also increase the overall cost of production for the business. The business will be forced to charge higher prices from the consumers, which will, in turn, reduce the demand for it and the over-pollution problem will be solved to some extent. Similarly, water pollution that is caused by industrial effluents can harm ocean life, other plants, animals, and humans. The government imposing a tax on factories creating water pollution can limit it to some extent. In economics, the use of tax to limit negative spillovers is known as internalizing the externality.

    Another type of negative externality is caused by smoking. The government wants to discourage smoking and thus impose heavy duties and taxes on cigarette manufacturers because active or passive smoking both are harmful to society. Thus, cigarettes sell at a fairly expensive price. People who can’t afford to buy can refrain from consuming it. Also, smoking is banned in public places and to minors, these are all attempts to reduce the consumption of smoke.

    Similarly, to encourage businesses with positive externalities, government can provide subsidies to those producers. When producers get subsidy it lowers their cost of production and it encourages them to produce more. Also, the subsidy is a government expenditure, which government meets through taxation on general public. This taxation on general public is either form of direct tax (like income tax) or indirect taxes (like those paid on goods and services when we buy them.) Thus, the society who is reaping the fruits of a positive externalities ultimately ends up paying the price of subsidy.

    One example of this is public (government funded) education, when the government subsidizes public education, a greater quantity of education (more schools and colleges) is made and the society as a whole reaps the spillover benefits of more educated people. Also, parks, the police force, and public hospitals provided by the government provide benefits to any person who lives in the neighborhood. These are called public goods with positive externalities that are nonexcludable and benefit the larger public who indirectly pay for them through taxation.

    https://accounts.home.sophos.com/install/2643462108c52a5001a27160720a2cd5/281c5ca0ca35495b1856a577a19d6e5c