00:01
So here we are making a loan.
00:03
And let's start off just making that loan.
00:07
Now, when we make a loan, we have to agree on terms.
00:11
We can agree on a fixed rate of interest, and i'll call the rate of interest r, or a variable rate of interest.
00:19
And the fixed interest means that the terms are set once and for all, and variable means that the rate of interest will change with the prevailing interest rate, right? and now we're going to have something happen to the economy, which is unexpected inflation.
00:35
Something maybe a war or a gas price shock, some unexpected policy is going to cause a lot of inflation.
00:43
And let's think about the situation that each of those borrowers and lenders find themselves in, right? here, the unexpected inflation means that future dollars are worthless.
00:56
That's what inflation means, right? the dollars don't buy as much.
01:00
They don't go as far.
01:01
Everyone gets more dollars and all those dollars are worth less.
01:04
So when we are paying back a fixed amount, the conclusion here for a fixed interest rate is that the repayment is worthless...