UNIVERSIDAD AUTÓ NOMA DE NUEVO LEÓ N,

FACULTAD DE CONTADURÍA PÚ BLICA Y ADMINISTRACIÓ N

Relation Between
Inlfation and Growth
During Times of Crisis
[Report]

[Cd. Universitaria, San Nicolás de los Garza, Nuevo León, México; 27-04-2010]
Index

Index..................................................................................................................................................1

Introduction.......................................................................................................................................2

Historical Reference...........................................................................................................................3

Theories of a relation between Growth and Inflation........................................................................4

Some Real Cases.................................................................................................................................6

What happens on Mexico this last decade?.......................................................................................6

How was our economy affected in terms of Inflation and Growth?...................................................7

Interpretation of data........................................................................................................................9

Conclusions......................................................................................................................................11

Bibliography.....................................................................................................................................12

1
Introduction

The objective of this work is to find a relation between the inflation and the GDP Growth
Rate in Mexico from 2008 – now day and having as comparison base the whole decade of
2000-2009.

I’ll use the data obtained from this years about this topics, and through a basic economic
analysis I’ll look for a relation that can be shown in numbers for explaining the interaction
between these three variables. This is to verify how Mexico is going with this economic
crisis and the effects it’s leaving in our country. Through the analysis of the information
we would be able to found this relation and why it was provoked, the factors that lead to
it and how it was supported by the country or how affected we were with it, depending on
the info that will be found.

This work will be based on data obtained from reliable sources such as government
databases, books about the topic (for the analysis), magazines, newspapers, specialized
webpages, etc.

I choose this topic because is something that primarily caught my attention and because is
one of the keys to understand what happen, why it happen, and how it happen to learn
from it so in the future it can be avoided. Not that this work will lead to the solutions in
future cases, but it’s, in my understanding, and as I say before, one of the keys factors,
that’s why I’m interesting on it.

The first step is to put an historical reference of our country before this decade. After that,
I’ll mention some of the theories of some economists and schools so they can be
compared. Is important to mention some of the Happenings in Mexico during this decade
and why they can affect the economy. After that, i will make a brief analysis of raw data
and then make interpretation and conclusions.

2
Historical Reference

Mexico has always been a small economy compared with the big economies of the world.
Even though, Mexico has always showed certain indexes of economic stability or growth.
Yes, it has also has bad times, but those times are part of our history, and history is what
make us to have a nowadays economic potential in big levels, potential, not growth. The
difference between the potential of something and its actual performance is the
management of that something, and the government administration, with the addition of
our own culture and social idiosyncrasy, have restrain our possible growth during all our
history.

A peculiar example of this is the “Mexican Miracle 1” from the 1940’s until the 1970, a
period where, thanks to some policies and government’s actions like the ones took by Mr.
Lázaro Cárdenas during his period as President or the relation of Mexico and the allies
where Mexico gave to the Allies raw material and the Allies pay with technology and
machinery, Mexico experienced a big jump in the Gross Domestic Products of those years
with a focus on external development, that means, with a base on importations and
exportations. The political and economic stability during those years enhance the growth
of the period. During the period of Gustavo Díaz Ordáz the economic policy change from
an external to internal focus, the government looks to replace the importations with
products made in Mexico. This was the end of the Mexican Miracle because the
sustainable growth that Mexico had during those years was based on a protected
environment for Mexican enterprises that don’t allow our companies to develop at the
rate of the world development which causes that our economy to have a disadvantage.

The next years after the Mexican Miracle, our interest rate increase in tremendous rates
due the failure in previous government policies and the incapability of government to
maintain stability on prices. Also, there where external factors, such the Earthquake of
1985, the murder of the candidate for president, Mr. Colosio, and the rise of EZLN that

1
El milagro mexicano. In http://www.economia.com.mx/el_milagro_mexicano.htm
3
 don’t give the external investors the total security to put their money in the country so
Mexico has a recession in Direct Economic Inversion that finally leads to the crisis of 1994,
the year that Ernesto Zedillo became president. During his government, the policy was
focused in reducing the interest rate. The Growth those years was of an acceptable level
between 3.6 % and 6.7 %2 leading to a final deficit on the end of 2000 due to the change
of government, a phenomenon that generates many speculations and usually affect the
levels on economy indicators by lowering its levels because the uncertainty of the new
government, its policies and capacity.

Theories of a relation between Growth and Inflation

As mentioned in the beginning, these works is about looking for a relation between these
two variables and find out how it works. First of all, we need to look in already available
literature to find what others have already said and what discoveries they have made.

The classic theory says that in short-run and low rates, inflation has a positive relation
with growth, but in long-run and/or high rates, it becomes a negative relation. This is
because the inflation is called as a
dependent variable of GDP in the
relation of aggregate demand and
aggregate supply (Figure 1), so, when
aggregate demand shift because a recent
change in monetary policy or
consumption, the relation is positive, but
when there is a shift in aggregate supply
Figure 1: Aggregate demand and aggregate supply because the producers reacts to the
change on demand or because high levels of inflation, the relation turns negative.

2
International Monetary Fund, IMF World Economic Outlook (WEO) - Rebalancing Growth, April 2010 --
Table of Contents, April 2010. In http://www.imf.org/external/pubs/ft/weo/2010/01/
4
Keynes, one of the classical theorists of
economy, says that economic growth
cause inflation because inflation is an
inherent of economic growth’s features.
Hamilton and Rostow were
predecessors of Keynes in this theory,
arguing that inflation is necessary for
promoting growth, but was Keynes who
gave more bases for this policy and
promotes it saying that “is better to Figure 2: Phillip’s Curve
disappoint the renter than to provoke unemployment”. This statement can be explained
in the Phillip’s Curve (figure 2) that shows the relation between inflation and
unemployment.3

Keynes say that this positive relation has to be under relative low inflation rates because
with high rate rates the economy will be in crisis. His theory also shows what happens on
the short-run, but in the long-run is a little more difficult to have a precise consistency and
this theory don’t make it clearer.

Some critics of the Keynes’ theory reject this idea and say that there is no relation
between those. The Monetarist school, that leads Milton Friedman, says that to control
inflation is not an effect of aggregate demand, but it’s because variations in monetary

policy.4 He says that “inflation is always and everywhere a monetary phenomenon.”

Wallich’s study of 43 countries of time series and cross-section analysis that reveals a
significant negative relation instead of the positive that he was looking for. 5
3
Relation between Economic Growth and Inflation. In
http://development.wanakalapa.com/2010/02/13/relation-between-economic-growth-and-inflation/
4
Monetarist Economic Policy. In http://homepage.newschool.edu/het/essays/monetarism/mpolicy.htm

5
Bruno, Michael, William Easterly. Inflation and Growth: In Search of a Stable Relationship. Washington, D.C.
In https://research.stlouisfed.org/publications/review/96/05/9605mb.pdf. 26-Abril-2010. p.2
5
Barro and Sala-i-Martin’s don’t mention the inflation in any of the list they give of
variables for a basic growth regression.6

Some Real Cases

Let now review briefly some cases in real life so we can start making connections. In Israel
for example, during 1948-1973, the inflation rate was about 6-7% and the growth rate was
still around 10%. During the 1950s and 1960s, Brazil was an example used for the critics of
the classic economic notion that inflation is bad for economy, it had high-inflation and
high-growth rates in this period. In Indonesia, they have very high fluctuations on inflation
rates, from 13-+100%, but the growth rate don’t fluctuate more than 5 percentual points
from 1951-1990. In Mexico, during the 90’s crisis, we have a deficit in growth in 1995, but
from that year on, the inflation rates were starting to decrease and the percentage growth
start increasing even those inflation rates were still high.

What happens on Mexico this last decade?

Mexico has some interesting economic situation over this decade (2000-2009). We have
even been among the 10 biggest economies around the world, but last time, Mexico was
listed 13th. Here is a list of some external situations that happen in Mexico this last
decade.

 2000, Vicente Fox Quesada is elected president of Mexico. Uncertainty is created,

this year the GDP falls 0.157%, Inflation rise 4.403%. Free trade agreements with
European Union and Israel.
 2001, The World Trade Center in NY is attacked by terrorist, as consequence, the
U.S. government creates several Migration and Importation Policies. This affects us
because a significant percentage of our Exportation are to the U.S. and our
economy is growing due to exportations. Trade Agreement with Guatemala, El

6
Bruno, Michael. p.3
6
 Salvador and Honduras. FTEA (Free Trade European Asociation) with Islandia,
Norway, Liechtenstein, Switzerland.

 2002, The European Union start using Euros (€) as currency. The whole world is
affected by this change due to a new emerge of an economic power.

 2004, Free Trade Agreement with Uruguay

 2005, Free Trade Agreement Mexico-Japan.

 2006, Felipe Calderón was elected president of Mexico. He promises to be the

“government of employment”, and start a new Politic in Security.

 2007, Technological Boom, Increase of transactions and commerce by internet,

and operation efficiency desirable. Start of the war against organized crime.
Insecurity levels start rising, the society is shocked, commerce is affected, and
tourism start falling.

 2008, Barack Obama is elected U.S. President, uncertainty because he is the first
Afro-American president. Start of the World Economic Crisis.

 2009, Increase in the war against the Organized Crime, society is more relaxed but
still afraid. Emerge of the Influenza A (H1N1). Tourism decrease drastically, net
exports too.

How was our economy affected in terms of Inflation and Growth?

Seen the theory background, some cases, and some of the important happenings in
Mexico during the last decade, now is time to see some raw data and see what happens to
our economy and try to find out a relation between the inflation rate fluctuations and the
growth rate.

DATA7 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

7
IMF World Economic Outlook (WEO) - Rebalancing Growth, April 2010
7
Inflation % 8.959 4.403 5.701 3.977 5.191 3.333 4.053 3.759 6.528 3.574
Inflation % index8 100 104.403 110.355 114.743 120.699 124.722 129.777 134.656 143.446 148.572
GDP Index9 80.557 85.293 91.226 100 109.071 114.026 121.941 127.385 135.852 141.666
GDP % changes10 6.602 -0.157 0.827 1.684 4.048 3.205 4.933 3.341 1.49 -6.538

GDP in Billions $ 7,381.3 7,369.7 7,430.6 7,555.8 7,861.6 8,113.6 8,513.9 8,798.3 8,929.4 8,345.6
1 2 5 0 8 8 0 4 6 5

As we can see in this table, the GDP fluctuates all the years between falling and rising. Let
analyze it a little.

1. On the column of the year 2000, the inflation decrease from 12.319% to 8.959%
against previous year, a difference of 3.36 percent points; the GDP grew 6.602%. Is
seen here a negative relation between them.
2. On the 2001 GDP falls -0.157% that could be affected by the 9/11 situation and the
previous year presidential elections. While inflation this year also falls from 8.959%
to 4.403%. They present a positive relation.

3. On the 2002 the Inflation rise to 5.701% and GDP also rise to .827%. Both rise
around 1%, showing positive relation between them.

4. On the 2003 inflations falls almost 1.8% from 5.701% to 3.977%. The GDP rises
1.684%. Here is presented again a negative relation of almost the same
percentage.

5. On the year 2004, the GDP shows a better improvement of 4.048% is when the
Free trade agreements start giving dividends. Inflation also rises to 5.191%
showing again the positive relation and almost the same percentage.

8
Index, 2000=100, given by the IMF
9
Index, 2003=100
10
Annual percentages of constant price GDP are year-on-year changes; the base year is country-specific.
8
 6. On the year 2005, the inflation get down to 3.333% while the growth rate diminish
making GDP to increase just 3.205%. Another positive relation in short-run with
low inflation rates.

7. On the year 2006, The GDP shows an increase of 4.933%, is almost the end of the
Presidential period and inflation rate is 4.053%.

8. On the year 2007, the GDP growth rate, as expected because the change in
government, falls 3.341% and inflation remains stable at 3.759%, less than .3
points against 2006.

9. On the year 2008, When the crisis start and the actions of the Mexican
government against organized crime becomes a real warfare, the GDP can only go
downs, its growth rate falls to 1.49% while the inflation rate actually rises 6.528%
because the insecurity and uncertainty levels on the country. Here is found a
negative relation between the variables again.

10. On the year 2009, Mexico was the epicenter of the World Epidemic Influenza
A(H1N1), added to the developing insecurity due to the war against crime. GDP
loses 6.538%, but in the positive side, inflation rate also falls to 3.574% level. The
variable has positive relation again, but is important to understand that positive
relation between the variables is not necessarily referring to something good for
the country economy.

11. The International Monetary Fund says that in the 2010, Mexico will have an
increase in the GDP of 4.16% and an inflation rate of 5.315%.

Interpretation of data

Using the data above, one can found certain relation, but not a regular one, for example
the next graph:

9
 We can see her how they show the
same pattern in some years, but,
not all of them, and even they both
falls, the difference of the change
don’t show a relation between
them. The biggest differences are
shown in both sides of the Graph,
probably because the period of
uncertainty and crisis that Mexico
live on both periods of times,
showing that the more stable period was in the middle of this decade, where Mexico has a
Comparision of Growth and Inflation rates (% cahnge) healthy economy and almost no
external factors affecting the country’s economy

As an extra of this work, here is the graph showing the monthly inflation of this past decade and
the level pretended by the government11.

As we can confirm here, the

better years for our economy, in
inflation terms, were those in
the middle of the decade,
approx. since July 2001 –
December 2008. Not even on
the crisis our inflation rises so
much that we can say that we
were in hyperinflation levels.

11
Inflation. In http://www.banxico.org.mx/PortalesEspecializados/inflacion/inflacion.html
10

Monthly Inflation (2000-2009) and Desired level by Government

Conclusions

Even though some theories explain how the relation between the Inflation and the Growth is
positive, for Mexico is not totally applicable now days. Yes, a movement on growth provokes a
reaction on inflation and it can be seen in the graphics showed before, but it not always applies, or
sometimes it applies backwards. This is because the external factors that we are having in our
country that affect directly to the economy pattern that we try to follow. As Michael Bruno and
William Easterly says in their work12, there is not a palpable relation between these two variables,
even though sometimes they seem to react to one another. They actually found a relation in High-
inflation rates economies, but this is not the case of Mexico in the last decade, our inflation has
remain stable at relative low levels, and our GDP is still growing, we are still an emergent
economy, there is a lot to do, but we’ll continue beg affected by the insecurity in the country, one
of the external factors that is hitting more in the GDP. But we have some advantages such as the
trades we have and out potential capacity, we just need to find how to explode it.

12
Bruno, Michael. p. 8
11
Bibliography
 Bruno, Michael, William Easterly. Inflation and Growth: In Search of a Stable
Relationship. Washington, D.C. In
https://research.stlouisfed.org/publications/review/96/05/9605mb.pdf. 26-Abril-
2010. p.2
 El milagro mexicano. In http://www.economia.com.mx/el_milagro_mexicano.htm
 Inflation. In
http://www.banxico.org.mx/PortalesEspecializados/inflacion/inflacion.html

 International Monetary Fund, IMF World Economic Outlook (WEO) - Rebalancing

Growth, April 2010 -- Table of Contents, April 2010. In
http://www.imf.org/external/pubs/ft/weo/2010/01/

 Monetarist Economic Policy. In

http://homepage.newschool.edu/het/essays/monetarism/mpolicy.htm

 Relation between Economic Growth and Inflation. In

http://development.wanakalapa.com/2010/02/13/relation-between-economic-
growth-and-inflation/

12