Hi there. Welcome to our fourth week. We have seen everything about GDP, Kahn's multiplier. Now we are going to cover inflation, monetary policy, and balance of payments. Let us start with inflation since we have touch base with some concepts of real economy, such as GDP, Gross Domestic Product. Remember, C plus I plus G plus X minus M Kahn's multiplier, we know that. Let's start with some problems that may occur when either policymakers choose wrong alternatives or economic shocks may affect your economy. I'm speaking about a huge problem that affect for a long time, mainly developing countries in Latin America during the '80s, inflation. What is inflation? Inflation, if you want a concept is just a monetary phenomenon, that is characterized by a rise in general price level. Did you see how I spoke a little bit louder, general price level. Sounds easy, but not so fast. Let me ask you something to see if you really grasp the understanding. Let suppose you, yes you that look at me, you love pizza, tequila, and soda, and all your money is spent in these three healthy products, basket of goods. How much in percentage you spend in each product would be, 30 percent in pizza, 40 percent in tequila, and 30 percent in soda. Just that, yes, that's what you consume. Sorry. That's your diet. Pizza, tequila, soda 30, 40, 30. How much would be? That's a question I'm going to do, pay attention. How much would it be, the inflation if all these three products price go up by a 100 percent? Well, if your basket of goods rise by a 100 percent, hence, inflation must be a 100 percent. No. Remember when I said, inflation is the rise of the level of a general price. It must be a huge basket of goods, and service that the government or some other institutions analyze to see by how much those prices are going up. Eventually, I understood, you understand. But what happened to me? Your cost of living went up by a 100 percent. But bear in mind that not every one in your country that consumes exactly at the same proportion what you consume, remember tequila, pizza, and soda. That's your cost of living. That's your problem. But this is not inflation. Because inflation, as we say, is the general price level. That's the problem. That's sometimes we say, "Well, the government said that inflation is well controlled." But I spend my money much faster. Yes, because your cost of living sometimes is different from an inflation. But the question not remains, but let me pose another one. What could cause inflation? Again, don't go too far. Don't think about macroeconomics, is that difficult. Don't block your mind. What could be a very logical reason to trigger inflation? Let's see. Let's suppose that the economy or our GDP is booming, overheated. But the existing productive capacity has not been able to attain all those demands from household investment, etc. What I mean, if demand is higher than supply, the price must go up as the companies want also to maximize their profit and the society is dying for more products, price should go up. If you want to really understand, we can say that if demand is higher than supply, inflation will take place. Do you want to put eventually in the graph? We can do that. Let, suppose in a vertical axis we have price level, the economy, and the horizontal X, we have GDP. Y, that's my current GDP, and Y star, you see that you have a vertical axis as well. That's my potential GDP, full capacity. It's no way the economy can grow beyond that wall, I'll call wall because eventually it's easier to understand. Potential capacity or potential GDP. No way you can grow beyond that wall because everybody is employed all you're productive capacity is booming, that's it. What's the difference between Y and Y star? Well, where my economy is and where my economy potentially could be? That's what we call unemployment or idle capacity. This declining line DD, that's what we call my aggregate demand, y equal to c plus, yes, that's the equation. Why it's declined? Because they lower the price the more I want to buy. But let's suppose for some particular reason, my GDP increases. How? I don't know, maybe the central bank decides to decrease interest rates, investment increase, what would happen? Well, my GDP increase, boom, eventually reach the wall. We are in a full capacity, full employment. Everybody's working, you're never going to have zero unemployment. Sometimes we will have what is called frictional unemployment, two, three percent, your economy is already overheated. But if the policymaker decide to try to increase the GDP further, for example, with high household consumption by decreasing interest rates, what's going to happen? Can you see inflation will take place because you cannot go beyond that wall. If you try to go beyond that wall, you don't have enough products to attend the society, so price will rise, your economy is overheated. That's why policymakers will have to take some actions. We will see later on. Obviously, this is not the only cause of inflation, we might spot other cause as well, such as supply shock. Like the pandemics. The pandemics was a supply shock because everybody was in a lockdown and the industry, the productive capacity, blockage, stopped completely. Or oil shock, exchange rate depreciation. Remember this is all some said that could trigger an inflationary pressure. It seems that we can think of putting some concepts together now. Let's see if my GDP, let me see if you guys understand and if you do not lose the thing now. If my GDP growth because of higher household consumption and these consumption is above the potential GDP Y star, inflation will take place. That's our conclusion we took from the graph. Let's also bear in mind because this terms I have heard many times, inflation is not the problem. Are you sure? I'm going to make you a question after this statement I'm going to make. Inflation actually is the worst tax for the poorest. Why? They don't have their wage adjusted and many of them cannot protect the value of money by investing in government bonds or other investments to protect you against inflation. I don't believe. Let me do this for example. How much do you think inflation could be reasonable? Five percent, 10 percent, and then you might say, give me five percent of all your income, everything you earn. No. You see inflation is not good. If you cannot protect the purchasing power of your money, inflation will affect the poorest. Inflation is the worst tax that we can experience. Obviously, in order to avoid prices to raise that much, policymakers must act. What I mean by policymakers, government, Treasury, and Central Bank. We will see Central Bank in a minute, in the next lesson.
