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Video transcript

what we're going to do in this video is talk more about inflation and deflation which we've talked about in other videos but we're going to talk about it in the context of who benefits and who gets hurt especially in a situation where people are lending money to each other at fixed rates so let's set up a little scenario here so let's say that this is today and this is in one year so in one year and today I need my teeth cleaned it's an emergency but I don't have money to clean my teeth at cost one hundred dollars and you're my okay friend and you say yes you do need your teeth cleaned I will lend you a hundred dollars but I want to charge some interest so today from my point of view I am going to borrow I am going to borrow $100 from you my okay friend and in a year I have to pay back you're gonna charge me ten percent interest so I'm gonna have to pay back pay back one hundred and ten dollars now let's think about some different scenarios on inflation so let's imagine a world where there's no inflation so let's say and let's say today is my base period where the CPI is 100 and let's imagine that the actual basket of goods in our country is actually a hundred dollars it'll help us visualize things a little bit more and let's say we have no inflation so in one year the CPI that basket of goods is still 100 dollars so in real terms and in future videos we'll talk more about real and nominal terms but in real terms you could buy 10 percent more with a hundred and ten dollars than you could with that hundred dollars so you really got a real 10 percent return but now let's imagine a scenario with a little bit of inflation a reasonable amount where in our base here our CPI is 100 and then in a year maybe we've had 2 percent inflation so now our consumer price index is 102 well in this scenario you're now and especially if we view that basket of goods as actually costing a hundred dollars in the first year and then 102 dollar one year later as we've talked about that's not always going to be the case in fact in most countries it's not that that you can actually buy that basket of goods for $100 the hundred is usually just to be indicative but this is to be to help us make things a little bit more tangible in this world you're going to buy be able to buy more than a basket of goods but not ten percent more you're going to be able to buy a little bit less than eight percent more and then we can set up a scenario where we have fairly extreme inflation and this will make things very clear where our CPI goes from 100 to let's say that price is more than double so let's say we go to a world where our CPI so this would be pretty pretty extreme inflation where CPI goes to 220 so this is really interesting because in right now at the present what you are lending me that's equivalent to the basket of goods I could actually buy the basket of goods there while in year one what I'm paying back to you you can only buy half a basket of goods and so you lent me money and even though nominally it looks just superficially like you're getting 10% more in terms of dollars you can buy half as much with that hundred and ten dollars as you could have bought a year ago with that hundred dollars so in this world even though it looks like you're getting a 10 percent nominal return your real return is pretty bad your real return is negative 50 percent you can buy half as much with what you're getting paid back as what you originally lent and so the general trend here is when you are in an inflationary environment especially when the inflation is more than expected oftentimes the interest rate will bake in some inflation people will expect some inflation in the interest rate but in general inflation is going to the more inflation you have and we think about it from my point of view I borrowed something where I could have bought the basket of goods if you imagine the basket of goods actually costs $100 and I'm paying back something where that would only buy half a basket of goods you could even imagine what that hundred dollars I buy a basket of goods and then a year later I sell that basket of goods for $220 and then I only have to pay off of that $220 back to you and so I and I wouldn't have gotten my teeth clean in that situation but I would have been able to profit from that thing and so inflation especially when it's more than expected inflation it benefits borrowers at fixed rates benefits borrowers at fixed rates and I keep saying at fixed rates because it's possible that your interest rate might somehow be pegged to inflation in which case it might not benefit you so much and it hurts lenders it hurts lenders at fixed rates now as you can imagine deflation is going to be the opposite and to make this very clear I'll make a very extreme deflationary scenario imagine we go from a CPI of 100 to a CPI CPI of 55 and if we literally view our that same basket of goods that would have cost $100 only cost $55 now think about it I am borrowing equivalent of a basket of goods and that I'm paying back to you two baskets of goods $110 would buy two baskets of goods in a year and so in this deflationary scenario in this deflationary scenario you are actually getting even though nominally it looks like you're getting a 10% return the lender is getting a 10% return the real return they're getting a hundred percent return they're able to buy twice as much with what they get back then what what they lent and so this deflation hurts borrowers at fixed rates hurts borrowers at fixed rates and it helps and it helps lenders lenders at fixed rates
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