Inflation is the consequence of Ukrainian - Russian war ??????
Good morning everybody. The real reason I am writing this small article is not in order to talk about the Russian-Ukrainian war, and neither to give personal opinions on it.
The real purpose of this article is merely economical, but in response to the outrageous statements I read and hear every day from politicians and spread at the speed of light by mainstream media. The topic is a very basic one of Macroeconomics: Inflation.
Yeah all right, that is it. It’s very recently discussed and I heard literally heresies from every sides about it. No matter right wing or left wing parties… Always the same…. MALAKIES!
I start with the most common and very popular MALAKIA, heard every damn day.
“Inflation is the result of the war in Ukraine”.
I will dismantle this MALAKIA by explaining the concept starting providing the definition of Inflation and then describing economic cycles, the related Aggregated Supply and Aggregated Demand, by keeping a close eye on the last one and what causes changes on it. Finally, I will put all together in a simple model that is not necessarily addressed only to people who studied economics. It is accessible for every type of reader.
What I am going to discuss on this article, is not my opinion, but it’s simply a share of known facts proven by decades of hard work of the greatest minds of Economics, most of them awarded of Nobel Prize of Economy.
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Let’s start with inflation.
The inflation between two points in time is defined as the percentage increase of the price index between these two points in time. Here some few facts about it:
1.??????Price index is calculated at a particular point in time, inflation over a time period, typically one year.
2.??????Inflation may just as well be defined as the percentage change in the price level.
3.??????Inflation is independent on which year we use as our base year for our price index.
4.??????You often hear the that inflation is the “percentage change in prices” but keep in mind that “prices” is then short for the price level.
5.??????If the price index decreases between two points in time we say that the inflation is negative or that we have deflation.
6.??????Inflation finally depends on how much currency is printed by Central Banks (it is a powerful tool of political economics in order to influence the level of prices and the national product)
Given this simple definition, let’s go deeper, in order to dismantle this fake new proposed above, and I will do that by sharing a very simple model, no mathematical or economical skills are needed.
The mentioned very simple model is the very well known AS – AD Model. ?
First of all, one of the very first thing someone learns approaching Macroeconomics, is the trade-off between the level of production/occupation and inflation. It is very well known that the goal to contain inflation might very likely lead to a rising level of unemployment.
In order to describe AS – AD Model, it’s important to provide a definition of its main “guests”, the Aggregated Supply (from now on AS) and the Aggregated Demand (from now on AD).
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The AS is the amount of products that companies are willing to produce and sell at a given level of prices, costs and market conditions. The AD is the overall expense for all the components of the national product related to the overall level of prices. Those components are: a) Consumption (from now on as C), which depends on the available income; b) Investments (from now on as I), who are related to interest rates, to taxation level and to market expectations; c) Public Expense for goods and services (from now on expressed as G) and finally d) Net Exportations (from now on as X), related to production level, currency exchange rates and the level of prices of both internal end from above. Given those definitions, you just need to keep in mind the equation of Aggregated Demand:?AD=C + I + G + X.
We can finally say that the economy is at its equilibrium, when the AS is equal to AD. If for some reasons, the level of AS is higher than AD, this will lead to accumulation of stocks pushing companies to cut the level of production till reaching the equilibrium.
Keeping in mind what discussed, we can now define the concept of economic cycles, who can be described as the fluctuations of national product, national income and occupation caused by expansion and contraction of many sectors of the economy and happen in all advanced worldwide Countries.
We often read articles which talk about depression, recover and expansion of the economy. These are exactly known phases of the economic cycle.
Let’s analyse the what typically characterizes a recession:
-?????????Often, purchases made by consumers drastically drop, while stocks of cars and other long term products held by companies increase unexpectedly. Companies react by reducing the level of production, leading to a reduction of the Gross Domestic Product. Sooner, as a consequence, even investments of companies on assets drop very quickly.
-?????????The employment demand drops as many employees are no longer needed at a lower level of production. Many will lose their job.
-?????????While the national production drops, the inflation slows down, and as a consequence, even the raw material demand drops, causing the reduction of prices.
Expansions are basically the opposite or recessions.
Fluctuations of production levels, of employment and of prices during economic cycles are often caused variation of the AD as a response of consumers, companies and governments adjust the total expense according to the productive capacity.
There are many theories about economic cycles which basically differ about the importance given to exogenous and endogenous factors. Very often a lot of importance is given to fluctuations related to exogenous factors like technology, the political elections, fluctuations of exchange rates, energetic shocks and wars.
All we need to know is exogenous factors cause a movement of the AD curve towards right when they impact in a way to an expansion (for example typical was the boom of Internet that boosted positively most economies for short time), while they cause a movement towards left when they cause a contraction, in this case the energetic crisis related to the Ukrainian – Russian conflict.
What is a big MALAKIA is to believe that Ukrainian – Russian conflict caused the increase of prices. I will show you a simple graphic that it is not the case. On the opposite, I will show that Ukrainian – Russian war should have supposedly have led to a reduction of price levels!
There is no doubt that the conflict impacted the economies of most countries in the world. The war and the energetic crisis that followed are a clear example of exogenous factor discussed and there is no doubt that impacted negatively to the AD causing a movement towards the left of the curve.
As shown in the graphic, a movement towards the left of the curve cause a drop of the production level (from Q1 to Q2) and a reduction of price levels (from P1 to P2). The impact is a recessive level, so this is agreeable to say that the war worsens the recession of the Countries that were already experiencing it before the conflict while the ones that were experiencing an expansion or were stagnant, are now very likely experiencing a recessive moment.
So what is the real cause of the inflation phenomena we are experiencing?
Simple question… simple answer…
THE CENTRAL BANKS ARE PRINTING CURRENCY NO STOP.?
This is a short video from Milton Friedman about the relation between printing money and inflation