Ex1 – Ex2 = In1 – In2
The mathematical equation you are viewing is probably one of the most feared one in the world—so feared in fact that it led to the removal of this famous American economist Irving Fisher’s theories from economics text-books in India since liberalization. The simplicity of this equation is that it empowers people to check what is happening in their country. Science has always to be simple and a tool to enhance the knowledge of people and empower them for self-governance. Though on governmental propaganda this greatest economist was slandered and ridiculed in US, but post the US collapse he was dug out from his grave and elevated to his rightful honour in US and Europe.
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time. Inflation is classified into two parts. The relation between the inflation real interest rates and nominal interest rates (approximated to inflation) and thus the foreign exchange rates is given by the famous American economist Irving Fisher. When governments want to manipulate inflation rates first thing they do is remove Fisher and his theories from economics text-books as was done in India since liberalization.
Letting r denote the real interest rate, i denote the nominal interest rate, and let π denote the inflation rate, the Fisher equation is (π is not mathematical value here but only symbol to denote inflation):
This is a linear approximation, but as here, it is often written as an equality:
i = r + π so the inflation rate of any country is π = i + r or
Real interest Rate is r = π – i
Real Interest Rate
The “real interest rate” is the rate of interest an investor expects to receive after allowing for inflation. It can be described more formally by the Fisher equation, which states that the real interest rate is approximately the nominal interest rate minus the inflation rate. If, for example, an investor on his deposit was able to get in a 5% interest rate for the coming year and anticipated a 2% rise in prices, he would expect to earn a real interest rate of 3%.
Let us consider the Indian scenario. Banks offer 5% on savings deposits. If we assume Government figure of inflation at around 6.8% then the investor or saver will lose 1.8% of the value of his total savings every year. This is if we assume the inflation at 6.8%.
Nominal Inflation Rate
Nominal interest rate is the total interest that one gets on his savings for a period of one year before adjusting (deducting) inflation or expected inflation.
How much one wants to earn in real interest varies from country to country or within country depending on the different group that want to invest. In India according to Government 6% real interest is reasonable as that was awarded to one and all for delay in payments.
If the investment is done with one’s own funds then the real interest rate will be low. If we borrow money to invest then we have to pay borrowers also so the interest we have to earn should cover the cost of borrowing also.
If we save money in banks they pay interest for us. And banks make money by lending to investors and charging higher interest than savings thus making money to run operations.
Gross National Product GNP
First year economic students like some of those of Indian Finance Minister candidates were taught that the GNP equals the total of Public Consumption plus Investment plus Government spending (it is assumed that Investment and Government Spending also aides in creation of or demand of goods and services that are consumed by the people of the country).
GNP = C + I + G.
By the rules of mathematics, if we subtract the same amount from both sides of the equation both sides will still equal each other.
Government spending is printing notes, borrowing or raising taxes.
Printing notes will increase money supply in the economy. The extra money is borrowed by investors to produce something and sell thus generating interest to government which again will spend it on public purposes. If money is simply handed over under welfare schemes or subsidies then people demanding goods with the extra money raises prices because subsidy costs are added to product costs and thus the prices rise. In either case printing notes will lead to inflation.
Borrowing will attract interest. If the money is borrowed from domestic people from their savings then the interest accrues to domestic people. If borrowing is made from foreign sources interest is paid to foreign countries. To the extent the interest earnings are not available within a country the spending or savings component decreases within that country.
If we allow investment from foreign sources into our economy to the extent of 51% or 100% (under FDI) then 51% or 100% profits generated will get out of the country and to that extent the savings component within the country is decreased. This investment could be from either international banks like IMF, World Band or Asian Development Bank or from private investors (private equity funds, hedge funds, etc.) who will either funnel the black money from either third world or from western world. So too if government borrows from foreign institutions like IMF etc. they have to repay the loan amount and interest.
These foreign investors will take the investment and profits out of country…