this is a raw attempt to explain the relationships between the terms mentioned in the title.
Why am i writing this stuff?
- to make my understanding clearer.. mom used to say writing down once is equivalent to reading it 10 times..
- the article is in simple terms.. so may be u would enjoy reading it and tomorrow morning u might appreciate the Economic Times more..
THE TITLES
inflation - rise in prices of goods
Interest rates - cost of borrowing money from banks or the rates that we earn by depositing money in banks
Unemployment - a state of not having any work ... my state right now
GDP - gross domestic product - the total value of goods and services produced with in the geographical boundaries of a country
BACKDROP
- During periods of high inflation there would be low unemployment and during periods of low inflation there would be higher levels of umemployment. ( basic premise of keynesian economics or philip's curve.. dont bother ). However this inverse relation failed to explain stagflation during the 1970's. However we shall deal with stagflation in another article.
- When we talk abt GDP we always talk in terms in growth rate of GDP. So growth rate of GDP is the rate at which the total value of goods and services produced in a country is growing. Same is the case with inflation, we talk in terms of inflation rates
THE MOVIE BEGINS
Prices are rising fast that means inflation is on a rise , unemployment levels are very low.
Lot of people are employed but the high prices are not letting them buy stuff in the market. So the Central bank rises interest rates. So wtf would happen ?
Rising interest rates .. hmm banks give me good interest so I might want to put my money in the bank. ( thats the family man in me responding)
Rising interst rates .. hmm fk... its so costly to borrow money from bank, I cant expand my factory to produce more goods. ( thats me ..the owner of a soap factory)
the family guys not caring to buy stuff in the market .. so demand going down so prices are falling .. inflation rate is falling ...
- So interest rates followed inflation .. there by bringing inflation down
the factory owners not getting cheap money .. so no expansion .. so no new employment .. no increase in goods produced.
- SoGDP growth rate fell down, unemployment increased
So high inflation forces interest rates to rise .. reducing GDP, increasing unemployment and thereby moderating inflation. We may say that low prices for a lot of people is at the cost of some unemployment in the country..So RBI is very cautious dealing with interest rates as they have to balance inflation and unemployment.. both important for the ppl of the country.
- Simlarly during periods of high unemployment .. banks reduce interest rates, enabling companies to borrow more , which expand creating more employment , more gdp. On the other hand ppl find no point saving money in banks start spending money on goods causing a rise in inflation.
_________________________INTERVAL__________________________________
Some more points of view of the same relationships
- when the bank observes that GDP is very much above the normal rate .. it feels that this is a precursor to inflation so it cools of the economy by slightly rising interest rates .. reducing GDP growth as well as curbing inflation .. but some of our friends would be unemployed now..
- Similarly when the bank observes that GDP is very much below normal rate.. it stimulates the economy by lowering interest rates , enabling easy borrowing , leading to higher GDP, lesser unemployment. PPL would now splurge money on goods causing rise in inflation... and the cycle goes on.. :)
Now do u understand why
Chidamabaram parrots " we need to grow at a rate > 8% consistently to eradicate unemployment"
YV reddy says " inflation is still not very high.. so we wont rise interest rates in the near term"
think over..
