Inflation: Origin and Global Dynamics

NATURAL ECONOMIC THEORY
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INFLATION:
ORIGIN AND GLOBAL DYNAMICS
NEW ECONOMIC THEORY OF GENERAL EQUILIBRIUM,
POSITIVE NATURE AND GLOBAL SCOPE
GONZALO PÉREZ-SEOANE
May 2019
THIS DOCUMENT REPRODUCES CHAPTER XVI ON "INFLATION"
OF THE NATURAL ECONOMIC THEORY
Next publication (english)
COPYRIGHT © GONZALO PÉREZ-SEOANE
1998,1999, 2000, 2002, 2004, 2010, 2013, 2015, 2017

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CHAPTER XVI
INFLATION:
ORIGIN AND GLOBAL DYNAMICS
I. THEORETICAL APPROACH
“There is no single type of inflation. Like diseases, it originates for different reasons”,
(Samuelson, Nordhaus1
).
The natural economic theory (NAT), having points in common on the origin of inflation
with the Neoclassical doctrine and the Austrian School, proposes a new hypothesis that
can be summarized as the inverse to marginalist thinking. This hypothesis, in a singular
way, expands the theory of cost-push inflation, only suitable path to this new theory of
general equilibrium.
If the economic operation is adjusted to the cost of production theory of value (Smith),
as has been explained, the economy, in the end, is a huge price system. Of all the prices
of the economy there are three special ones, the prices of the basic economic markets:
the wage, the interest rate, and the price of the non-renewable natural resources (NRRs).
The variation of these prices, contrary to the rest of prices, affects the entire value chain
of the economy, or the price system as a whole.
Thus, and according to this hypothesis, inflation would be: the generalized and constant
increase in prices born of the variation in the prices of the three basic economic
elements, being able to speak of: wage inflation, interest rate inflation and NRR price
inflation. The three inflations have velocities and sign not identical in time. The general
index of consumer prices, and its variation, is the additive result of the three inflations
after passing through the entire value chain of the economy. This new definition of
inflation allows, for the first time, a unified theoretical approach to the origin of
inflation and, also, its empirical demonstration.
1
SAMUELSON, P.; NORDHAUS, W.; (1996); “Economía”, McGraw Hill, p.596.

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II. INFLATION ORIGIN
I. WAGE INFLATION
What increases the labor cost per employee?. In the labor market, along with the natural
variation of wages derived from the spontaneous value system, there are two relevant
exogenous factors: the government's labor policy and union action.
The indexation of salaries to inflation, the rigid collective agreements, the increase in
the cost of social security and other charges associated with work, are actions that,
among others, increase the labor cost per employee. Although the increase in the
aggregate wage cost raises the aggregate production cost and, with this, finally the
prices, at the time, of the labor force productivity is born, which affects the cost of
aggregate production in the inverse way mentioned. The final wage inflation that
transcends the economy is the difference between the two opposing forces. The
empirical evidence attached shows that if productivity grows above the aggregate wage
increase, the inflationary wage will fall and vice versa. The evidence confirms, from a
different theoretical perspective, Keynes “cost-push inflation”.
II. INTEREST RATE INFLATION
As discussed in the new hypothesis of the diverse nature of interest rates, in normal
economic circumstances the short and long term reference interest rates of the economy

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are not determined according to Marshall's laws, each of them varying in time
according to different underlying variables. Only in exceptional economic situations the
equilibrium in the monetary and financial markets is achieved via quantity and not price
(Natural Rule exception). On the other hand, the power of creation of effective money
supply, strictu sensu, does not reside in the central banks but in the banking system
(Schumpeter, Fisher: theory of credit creation). In short, the supply of money in the
economy is endogenous and the interest rate is exogenous (horizontalism), or, the
opposite hypothesis to that maintained by Neoclassical thinking (verticalism).
If the hypothesis of monetary horizontalism is true and if the economy works according
to the cost of production theory of value, the variation in time of interest rates acquires
an unsuspected dimension to date. The variation of the cost of money, being money a
basic economic element, will affect the entire value chain of the economy, or, in other
words, interest rates produce inflation.
The empirical evidence attached, easy to reproduce, shows that raising the effective
interest rate of the economy (weighted average of the cost of money) will increase
interest rate inflation and vice versa.
The evidence shown, confirming the suggested hypothesis, opens the way to three
interesting considerations:
i. Underlying variables of inflation of interest rates. The generation of interest rate
inflation is linked to the variation over time of the underlying variables of the interest
rates, or: monetary policy on the neutral rate (inflation expectation); intrinsic monetary
risk, and, sovereign risk. Thus, for example, in a scenario of low intrinsic monetary risk
and sovereign risk, it is the central bank's policy on the neutral rate that directs the
process of creating interest rate inflation (ceteris paribus wages and prices of NRRs). If
the neutral rate does not move or it moves slowly in the described scenario, the effective

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interest rate of the economy will remain stable, with no inflation of interest rates or
being very slight (Japan, USA and some EMU countries in the current or recent dates).
ii. Quantitative theory of money. The quantitative theory raises the hypothesis of a close
functional relationship between volume of money supply and general level of prices
(Fisher, Friedman, Chicago Monetarist School…). However, in recent situations of
quantitative expansion the observed effect is the opposite. Summers comments after the
Subprime crisis: "In my opinion, the quantitative expansion is less effective for the real
economy than what most people suppose (...) if the quantitative expansion does not have
a great effect on the [aggregate] demand, it will not have a big effect on inflation
either” 2
. Summers' comment, globally observed, is not new. This reflection has been
previously expressed in similar terms by Stiglitz and studied in a profound and brilliant
way by Krugman and Bernanke3
, associating the disruption or inefficacy of the
expansive monetary policy with Keynes “liquidity trap” (case of Japan).
For the NAT the quantitative theory is true in a gold standard system and without
fractional reserve banking system ("price revolution", XVI century), being ineffective
in order to explain the current monetary system.
iii. Gibson´s paradox. In 1923 Gibson observed that long-term nominal interest rates
and the general price index (CPI) were highly positively correlated during long periods
of economic history. The reality is that the evidence4
found by Gibson (or Tooke)
contradicts what was predicted in classical monetary theory. The quantitative theory
established that a slow growth of money led to a slow growth of the price level. On the
other hand, the slow growth of money generated a slow growth of loanable funds and,
thus, an increase in the interest rate. Gibson's evidence showed exactly the opposite of
what was stated: as the general price index went down, the interest rate went down and
vice versa.
In 1930 Keynes claimed that Gibson's evidence was "one of the most thoroughly tested
empirical facts in the entire field of quantitative economics”5
, and he called the
theoretical anomaly the “Gibson paradox”. The Gibson paradox has been studied by
countless economists, although, "the Gibson paradox continues to be an economic
phenomenon without theoretical explanation", (Friedman, Schwartz6
). Fisher
comments: "No problem in the economy has been debated so heatedly“7
. To date,
Gibson's paradox remains a mystery of Economic Science.
2
SUMMERS, L.; (2013); Conference Drobny Global, Santa Monica (Financial Times), April 3
3
“(…) BOJ has for some time now pursued a policy of setting the call rate, its instrument rate, virtually
at zero, its practical floor. Having pushed monetary ease to its seeming limit, what more could the BOJ
do? Isn’t Japan stuck in what Keynes called a “liquidity trap”?. BERNANKE, B., S.; (1999); “Japanese
Monetary Policy: A Case of Self-Induced Paralysis?, Presentation at the ASSA meetings, Boston MA,
January 9, 2000, Princeton University
BERNANKE, B, S.; (2002); “Deflation: Making Sure “It” Doesn’t Happen Here,” Remarks before the
National Economists Club,
BERNANKE, B. S.; (2009); “The Crisis and the Policy Response”, Remarks at the Stamp Lecture, London
School of Economics
4
GIBSON, A.H., (1923), “The Future Course of High Class Investement Values”, Bankers Mag., 115.
5
KEYNES, J.M., (1930), “The Treatise of Money” , Vol.2, p.198
6
FRIEDMAN, M.; SCHWARTZ, A.; (1976), “From Gibson to Fisher”. Explorations in Economic Research
NBER vol. 3,2 (Spring)
7
FISHER, I., (1930), “The Theory of Interest”

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From the natural theory, the evidence of Gibson comes to ratify the validity in the
economy of interest rate inflation. Nonetheless, it is convenient to make three
considerations that complete the understanding of Gibson's evidence.
Interest rate inflation varies by reason of:
i. the underlying variables of interest rates,
ii. the level and composition of total national debt (the higher the national total debt,
the higher the inflationary impact and vice versa; the higher the percentage of foreign
debt in hard currency, the greater the impact and vice versa) (Mexico 1982);
iii. the monetary system. As explained in the chapter on "interest rate":
i) in the gold standard monetary system, the variation in the general price index
will be positive and very close to the long-term sovereign debt yield, (Gibson
evidence);
ii) in the fiduciary monetary system with full exchange freedom, although the
creation of interest rate inflation is equally true, Gibson's evidence is more
difficult to observe because the transcendent economic inflation is not domestic
inflation but differential inflation. Along with this, it should be taken into
consideration that the variation of prices of the economy is the additive result of
three different inflations.
III) BANKING INFLATION
The hypothesis of banking inflation is old. Hypothesis different from the quantitative
theory of money, although not far.
As is well known, among many other economists and institutions, this hypothesis was
sustained by: Rothbard, Wicksell, Fisher (“100% reserve system”), University of
Chicago 1937 ("Chicago Proposal"), decisions of the Federal Reserve Committee in
19378
(...).
However, surprisingly, simple empirical evidenceN
shows the opposite to the hypothesis
of banking inflation, seriously questioning the sentiment expressed by exceptional
economists and academic and monetary institutions during the Great Depression of
1929 and later years. Were these economists and institutions wrong?.
The attached empirical evidence, chosen intentionally among other possible in the same
direction (natural equation of exchange), shows that if the effective interest rate of the
economy is increased, the effective money supply will increase and vice versa.
8
FEINMAN, J.; (1993); “Reserve Requirements: History, Current Practice, and Potential Reform”,
Federal Reserve Bulletin, (June)
N
The data of the annual variation of the credit portfolio of the US banking system ("Total Loans and
Leases") for the period 1983 to 2016, and the annual US inflation rate (or its variation) for said period,
show that there is no relationship between both variables.

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How to interpret the evidence ?.
i. Interest rate and bank supply. The banking supply (effective money supply of the
economy) depends on the level of interest rates. The banking supply will increase when
the interest rate (and risk) is attractive for the business of intermediation between active
and passive rate. More specifically, the banking supply is adjusted to the functioning of
the entire economy, or, relationship between WACC of the economy and expected rate
of real return on assets (ROA of the economy) (Keynes “economic cycle hypothesis
extended”).
ii. Keynes “liquidity trap”. The years of negative effective money supply of the
evidence correspond to the years of crisis (2009, 2010), showing that while there was a
strong monetary expansion, forcing the fall of reference interest rates in the short and
long term, (beginning QE november 2008), the banking supply contracted severely. The
evidence, without clarifying whether there is a relationship between banking activity
and inflation, encourages to consider, as did Krugman and Bernanke, the “liquidity
trap”.
In crises, the expansive monetary policy has a known double formal objective: to force
the fall of the reference interest rates and guarantee the liquidity of the government,
banking and productive system. To achieve the fall in interest rates, the central bank
will use a substantial part of the QE in the partial nationalization of the yield curve
(mainly short-term and long-term public debt, three months and ten years), sound
monetary action after a crisis. This monetary action will have three background effects.
Keynes economic cycle hypothesis extended. According to the NAT, this is the heart of
the functioning of the current free market economy. The monetary expansion will force

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the reduction of the effective interest rate of the economy and, with this, that the WACC
of the economy will be equal to or lower than the expected rate of real return on assets
(ROA of the economy); which will promote economic recovery in an accelerated
manner.
Intrinsic monetary risk and sovereign risk. It will force the intrinsic monetary risk and
sovereign risk not to emerge, a relevant aspect as it is later exposed.
Banking propensity to liquidity and spillover effect. After a crisis, the banking sector,
either for endogenous reasons (crisis in the sector), or for exogenous reasons (low
interest rates and depleted and unstable payment capacity of the economy) will remain
inactive, giving a mild or severe banking propensity to the liquidity and, with it, the
spillover effect to the productive system of the banking inaction. The final consequence
of the paralysis of the effective money supply will be the low effect of the quantitative
expansion on aggregate demand, as Summers mentioned. Keynes “liquidity trap” arises:
i) from the bank's propensity to liquidity, and ii) from the effect of retraction of business
profitability expectations. The bank's propensity to liquidity is the main cause in the
blockade of the policy of monetary expansion.
Thus, and for the exposed, it is not possible to maintain that there is a relationship
between the banking supply and the creation of inflation in the normal course of the
economy and in some exceptional situations (QE policy). But, is it always like that?.
What happens if a systemic banking crisis starts and the interbank interest rate suddenly
increases?. The increase in the interbank interest rate will increase the intrinsic
monetary risk, affecting the effective interest rate of the economy, which will result in
the rapid increase of interest rate inflation. In other words, for bank inflation to exist
there must be banking risk (liquidity, solvency, or systemic, not controlled by the
Central Bank). Consideration, that although from a new theoretical perspective,
converges with the final opinion maintained by Fisher, the Chicago School, the Federal
Reserve (1937) and the Austrian School after the Great Depression of 1929.
Bank's propensity to liquidity and its spillover effect and banking inflation (due to risk)
reopened the theme of moral hazard in the banking business.
IV. FISHER INFLATION
The variation of the free exchange rate is the first step in the natural path by which the
monetary standards are adjusted in terms of relative value. The adjustment between
monetary standards is completed with the variation of the long-term reference interest
rate inverse to the exchange rate variation, or the brilliant Fisher open hypothesis.
The process described, curiously, does not end in the monetary system, it transcends the
productive system and, thus, the price system. When the currency is devalued, the long-
term interest rate will increase, which will cause a gradual increase in the effective
interest rate of the economy, creating interest rate inflation and vice versa. In the end,
the adjustment between monetary standards will induce, internally, the adjustment
between the relative prices of the productive systems.

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The violent variation of the exchange rate parity can have multiple origins, such as:
competitive devaluations of the government, massive capital flight for various reasons,
sudden change in sovereign risk as a result of the increase in the current or expected
fiscal deficit, level of national indebtedness or excessive public debt (...), in all cases,
Fisher's inflation will be activated. This unique interest rate inflation has been called
Fisher inflation, because it is linked to the adjustment between monetary standards, a
situation described and resolved exceptionally by Fisher.
V. NRR SUPPLY AND DEMAND INFLATION
The existence of a conflict or extreme natural phenomenon near a relevant deposit of a
NRR, can produce a precipitous drop in supply, raising the price and producing NRR
supply inflation. On the other hand, and in the situation described, if the uncertainty
about the future supply is high, this situation can induce financial speculation,
temporarily increasing the demand above the normal market equilibrium, which will
push up the price again , creating NRR demand inflation.
VI. COLLAPSE INFLATION
The extreme inflation or collapse inflation, would be born: of the productive collapse,
monetary collapse or market collapse of an NRR. Example of the productive collapse
would be Venezuela in 2015-2016, the monetary collapse corresponds to the case of the
Weimar Republic in 1921-1922, and the market collapse of an NRR would be given by
the situation provoked by OPEC in 1970. Between the first two types of collapse
inflation there is an intense communication.
III. DOMESTIC DYNAMICS OF INFLATION
I. PHILLIPS CURVE
The pragmatic transcendence of the Phillips curve9
, or negative correlation between the
rate of unemployment and wage variation (inflation), has been remarkable since its
appearance in 1958. Solitary voices, such as Friedman and Phelps10
, once questioned the
overall Keynesian sentiment about the subject, or Samuelson and Solow11
. Says
Friedman (1976): "In recent years higher inflation has often been accompanied by
9
PHILLIPS, W.; (1958); “The relation between Unemployment and the Rate of Change of Money Wage
Rates in the United Kingdom, 1851-1957”, Economica, n.s., 25, no. 2: 283–299
10
FRIEDMAN, M.; (1968); “The Role of Monetary Policy”, American economic Association 58 n.1
FRIEDMAN, M.; (1975); “Unemployment versus inflation”, IEA, Lecture No. 2, Occasional paper
PHELPS, E.; (1967); “Phillips Curves, Expectations of Inflation and Optimal Employment over Time.”
Economica, n.s., 34, no. 3 (1967): 254–281
11
SAMUELSON, P.; SOLOW, R.; (1960); “Analytical Aspects of Anti-Inflation Policy.” American
Economic Review 40 (May): 177-94.

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higher and not lower unemployment (...) A simple statistical Phillips curve for such
periods seems positive, not vertical slope”12
.
The reality is that the appearance of stagflation, high inflation and unemployment,
opened a wound, never cured, in the traditional theory about the Phillips curve. Since
Phillips' evidence is much more than a statistical coincidence, as numerous subsequent
studies confirm (Hussman13
), the central question about this broad and divided debate
is: why does the Phillips curve have a positive and negative slope?.
II. OKUNS´S LAW
Okun's law (Okun´s evidence14
) establishes that from a certain rate of economic growth
the unemployment rate will decrease and vice versa. From the academic perspective,
Okun's law is considered as an isolated evidence, without reflection or union to any
theory. Unique situation, until the date unresolved.
III. DOMESTIC DYNAMICS OF INFLATION
For the natural theory, the evidence of Phillips and the evidence of Okun are part of the
same economic phenomenon, they are an integral part of the domestic dynamics of
inflation. The attached synthesis reflects the opinion of the natural theory.
12
FRIEDMAN, M.; (1976); Nobel Memorial Lecture: “Inflation and Unemployment”, Nobel Foundation.
13
HUSSMAN, J. P.; (2011); “Will the Real Phillips Curve please stand up”, April 4, (Internet)
14
OKUN, A.; (1962),; “Potencial GNP, its measurement and significance”, Cowles Foundation, Yale Uni.

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i. Phillips' evidence. According to the synthesis, the relationship between inflation and
unemployment may have a negative slope as maintained by Phillips, Samuelson, Solow,
and, likewise, positive slope as Friedman and Phelps said. The slope will depend on the
existence or not of intrinsic monetary risk and sovereign risk.
ii. Okun's evidence. For NAT, there is an optimal differential inflation. Moving away
from this optimum has consequences for economic growth and, inversely, for the
variation in the unemployment rate. The optimal differential inflation facilitates, in the
short term, greater relative economic growth and a low unemployment rate. Contrary to
Okun's opinion, it is not the improvement of productivity in the short term that increases
the unemployment rate, but because of differential inflation. The evidence of Okun,
together with the evidence of Phillips, ratify the pragmatic validity of the presented
synthesis on the domestic dynamics of inflation.
iii. Optimal differential inflation. If the inflation is positive, low and stable, it will be
around the one denominated by Blanchard and Gali "divine coincidence"15
, or,
according to this theory, around the optimum of differential inflation.
iv. Inflation scenarios. The synthesis raises four possible scenarios born of the
relationship between inflation, economic development and employment: deflation,
stagflation, hyperinflation and inflation optimum. Scenarios that depend on the variation
over time of the only three variables underlying short-term economic functioning, such
as: neutral rate, intrinsic risk and sovereign risk. Underlying variables of interest rates.
These underlying variables determine, to a large extent, expected inflation, nominal
inflation and differential inflation, being the yield curve and its variation in time the
mechanism that counted all the exposed. The yield curve is the short-term rudder of the
free market economy.
Briefly, the scenarios can be explained as follows:
Deflation. Low inflation, low real economic growth and low job creation. Normal state
after the explosion of a bubble in an asset market, being the distinctive feature that there
is no intrinsic monetary risk and sovereign risk since this is blocked by quantitative
expansions (Great Depression 2009, Japan 1990), which leads to a slight or zero
inflation of interest rates, banking inflation and Fisher inflation. From the productive
perspective, and as already commented, the extreme banking propensity to liquidity and
spillover effect, will result in the contraction of aggregate production (supply), and, with
it, of the purchasing power of the economy (natural equation of exchange), being, the
final result, the decrease in effective aggregate demand (the functional relationship
between effective aggregate supply and effective aggregate demand is always positive).
Stagflation. High relative inflation, low real economic growth and low job creation.
This state is common in economies with structural wage inflation, which will also be
accompanied by some inflation of interest rates. The high relative rates of inflation will
give rise to inadequate differential inflation, subtracting external competitiveness from
the economy, reducing domestic and foreign investment and reducing, with all this, its
15
BLANCHARD. O.; GALI, J.; (2005); “Real wage rigidities and the New Keynesian model”, Journal of
Money, Credit and Banking 39, (1): 35-65

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potential growth and job creation. There is usually no intrinsic or sovereign risk or this
is not high.
Hyperinflation. Very high relative inflation, negative real economic growth and severe
unemployment. It can be reached from a previous deflation or stagflation. The
distinctive element of this state is that, for endogenous or exogenous reasons, intrinsic
monetary risk and sovereign risk become, at some point, sharply elevated and
increasing over time. The increase in intrinsic and sovereign risk will cause the nominal
increase in interest rates, which will have three relevant effects. First, the expected real
rate of return on assets (ROA of the economy) will be lower than the WACC of the
economy, slowing production and banking activity, and, thus, all new investment,
economic growth and employment. Second, by increasing the effective interest rate of
the economy, inflation of interest rates will increase. Third, the currency will be
devalued in the opposite direction to the long-term interest rate.
If the productive paralysis is notable and prolonged, the "shortage" will lead to the
productive collapse inflation, which will exacerbate the devaluation of the currency and
the inverse rise of interest rates, with the initiation of the monetary collapse inflation.
The growing inflation will cause a continued decline in the purchasing power of the
currency (and society), while the central bank issues huge amounts of high-powered
money that, in part, never entered the economy as a result of the bank's propensity to
liquidity and the retraction of business profitability expectations. The continued fall of
the purchasing power of the currency will eventually lead to the loss of credibility on
the domestic currency.
IV. EXTERNAL DYNAMICS OF INFLATION
I. DIFFERENTIAL INFLATION OPTIMUM
The common denominator of the formal objectives of central banks is price stability
(inflation), however, there is no unanimous criterion in the search for such stability. For
example: for the ECB the inflation objective is a static target (2%) (Maastricht Treaty),
while for the US Federal Reserve the inflation objective is a term target ("inflation
target rate", Bernanke16
) .
The NAT moves away from the described hypotheses and advances alone towards a
suggestive and relevant hypothesis, but largely discarded by the Neoclassical thought,
the existence of an optimal inflation. Hypothesis discarded because if there were an
optimal inflation there should be a monetary optimum; monetary scenario that, if true,
refutes the "neutrality" of monetary policy.
What does the reality say about the “neutrality” of monetary policy?.
After the subprime crisis, and thanks to one of the largest monetary expansions of the
Federal Reserve throughout its history, that has made possible the existence of interest
rates in historical minima, the US economy has achieved the longest job creation stage
16
BERNANKE, B.; LAUBACH, T.; MISHKIN, F.; POSEN, A.; (1998); “Inflation Targeting”

G.P-S / MAY 2019 14
ever recorded, or, 100 consecutive months of job creation (Sept.2010-Jan.2019). The
high and prolonged creation of employment in the USA evidences that monetary policy
is not innocuous in terms of economic development. So?.
The optimal inflation exists, and thus, also the optimal monetary policy. The optimal
inflation is the general level of prices where the real rate of return of assets is
maximized in global relative terms, promoting a constant new domestic and foreign
investment, and, with this, a greater relative growth of production, aggregate demand,
employment, etc. This price level is dynamic and is specified in differential inflation.
Thus, there is an optimum of global differential inflation that is determined by the
inflation behavior of all nations. From this optimum is born the optimum of inflation
and the monetary optimum (neutral rate) of each nation.
The existence of an optimum of world differential inflation, can lead to think that the
optimal inflation and monetary optimum of each nation should be the same, it is not so.
The differential inflation of each nation is calculated based on its competitive
environment, including the relative risk, which is always a singular variable.
II. BLACK AND WHITE EFFECT
The economy is a price system, where all prices, (exception of the price of the NRRs),
are related and adjusted in relative terms. In the case of monetary and financial assets,
these are related and adjusted worldwide following the axiom "higher real return and
lower relative risk" (Natural Rule), thus, of the easily observed high positive correlation
in the variation of prices of monetary and financial assets worldwide. But, what happens
to the savings of a country if there are other countries with more attractive expected real
return on assets?.
The black and white effect means the mobilization of savings, or future new investment,
generated in one country towards others because of the substitution effect between
monetary and financial assets in its search for a more attractive real return. The
consequence of this phenomenon is extremely serious because it has its roots in the first
problem of the economy or poverty and global inequality. Saving, acting honestly and
legitimately in the search for the highest real return and lowest relative risk, without
knowing it, works with an asymmetric objective to the global economic convergence.
Thus, some countries are permanent beneficiaries of this negative monetary externality,
while others suffer from it temporarily or permanently, seeing their savings fall, and,
with it, the future new investment, the growth of employment and, ultimately, the
relative economic and social progress.
Therefore, it can be said that in the world monetary and financial market there is no type
of “Nash equilibrium”. Some win and others lose, permanently affecting the relative
development between nations. The commented thing comes to clarify, without looking
for it, the well-known "Lucas paradox"17
(or Lucas puzzle): "the capital does not flow
from the developed nations to the undeveloped ones, even though the less developed
ones present a lower degree of capital for employed person ".
17
LUCAS, R.; (1990); “Why doesn´t Capital Flow from Rich to Poor Countries?”, AE Review

G.P-S / MAY 2019 15
III. EXTERNAL DYNAMICS OF INFLATION
The external dynamic of inflation is specified in the variable: differential inflation.
Thus, there is a worldwide optimum of differential inflation, from which the optimal
inflation and the optimal monetary of each nation is born.
To be close to the optimum of world differential inflation is the most important
competitive weapon of relative development among nations in the short term. This
variable is more relevant than the two natural causes of economic growth (natural
growth of the population and productivity). Conversely, those countries that move away
from the optimum of world differential inflation will have a real rate of return on assets
that is less attractive in relative terms. If the differential inflation is negative, the savings
will disappear and, thus, the new investment and the future development, or, black and
white effect.
This negative monetary externality, which decapitalizes the countries of higher inflation
and relative risk, is the biggest obstacle to the achievement of global economic
convergence, the root of other serious economic and social imbalances. The
“Millennium Development Goals” of the United Nations18
, accurate and necessary, they
will never be reached in the economic area while the black and white effect persists.
The black and white effect could be corrected without affecting the system of market
freedom and the monetary and economic sovereignty of each nation. In truth, the
correction will enable a higher and stable growth of the developed economies, opening
for the first time, and in a real way, the path to the economic convergence of the
underdeveloped nations.
18
UNITED NATIONS; (2000); “Declaración del Milenio”, Cumbre del Milenio, September.

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V. INFLATION FORMULATION
As explained, the natural exchange equation (Fisher's exchange equation
reformulated), it leads to a new tautology of three equations. The third equation
reveals the origin of inflation from this general theory.
VI. SUMMARY
I. DEFINITION OF INFLATION
Inflation is the generalized and constant increase in prices originating in the variation in
the prices of the three basic elements of the economy, being able to speak of: wage
inflation, interest rate inflation, and, NRR price inflation. The three inflations have
velocities and sign not identical in time.
II. GLOBAL DYNAMICS OF INFLATION
Being the multiple origin of inflation of undoubted scientific interest, more important
for society and Economic Science is to determine the dynamics of this variable in terms
of economic development and job creation. From this perspective, critical inflation for
the economy is not, strictly speaking, domestic inflation but the differential inflation
between nations. The natural economic theory affirms, alone and term in a novel way,
that the relative development between nations depends in the short-term on this singular
variable. The optimum of world differential inflation determines the optimal inflation
and the monetary optimum of each nation (neutral rate).
FIGURE 3. INFLATION FORMULATION!
PIBR! = GDP real!
"! = Inflation!
"D! = Inflation Differential!
CR! = Sovereign Risk!
MSE! = Effective Monetary Supply! !
V! = Velocity of Money!
PMP! = Production Purchasing Power!
EI! = Total Indebtedness!
ie! = Effective Interest Rate of the Economy!
PMP + (EI x ie) !
PIBR !
MSE x V !
PIBR !
= " = !
GDPR x " = PMP x (EI x ie) = MSE x V !
Domestic Fisher´s Exchange Equation (reformulated)!
NAT Inflation Formulation!
Note: The natural exchange equation can be formulated in global terms by
substituting: ! for !d /!, and, GDPR for GDPN (GDP natural). Also, ie is adjusted
inversely to the aformentioned, and, the stock market is given by 1/CAPE, or,
“Fed effect”.!

G.P-S / MAY 2019 17
CHAPTER XVI BIBLIOGRAPHY
BERNANKE, B. S.; (1999); “Japanese Monetary Policy: A Case of Self-Induced Paralysis?, Presentation at
the ASSA Conference, Boston MA, January 9, 2000, Princeton University.
BERNANKE, B. S.; (2002); “Deflation: Making Sure “It” Doesn’t Happen Here,” Remarks before the
National Economists Club.
BERNANKE, B. S.; (2009); “The Crisis and the Policy Response”, Remarks at the Stamp Lecture, London
School of Economics.
BERNANKE, B.; LAUBACH, T.; MISHKIN, F.; POSEN, A.; (1998); “Inflation Targeting”.
LUCAS, R.; (1990); “Why doesn´t Capital Flow from Rich to Poor Countries?”, American Economic
Review.
BLANCHARD. O.; GALI, J.; (2005); “Real wage rigidities and the New Keynesian model”, Journal of
Money, Credit and Banking 39, (1): 35-65.
FEINMAN, J.; (1993); “Reserve Requirements: History, Current Practice, and Potential Reform”, Federal
Reserve Bulletin, (June).
FISHER, I., (1930), “The Theory of Interest”.
FRIEDMAN, M.; SCHWARTZ, A.; (1976), “From Gibson to Fisher”, Explorations in Economic Research
NBER vol. 3, 2 (Spring).
FRIEDMAN, M.; (1968); “The Role of Monetary Policy”, American Economic Association 58 n.1.
FRIEDMAN, M.; (1975); “Unemployment versus inflation”, IEA, Lecture No. 2, Occasional paper.
FRIEDMAN, M.; (1976); Nobel Memorial Lecture: “Inflation and Unemployment”, Nobel Foundation.
GIBSON, A.H., (1923), “The Future Course of High Class Investement Values”, Bankers Mag., 115.
HUSSMAN, J. P.; (2011); “Will the Real Phillips Curve please stand up”, April 4, (Internet)
KEYNES, J.M., (1930), “The Treatise of Money” , Vol.2, p.198.
OKUN, A.; (1962),; “Potencial GNP, its measurement and significance”, Cowles Foundation, Yale
University.
PHELPS, E.; (1967); “Phillips Curves, Expectations of Inflation and Optimal Employment over Time”,
Economica, n.s., 34, no. 3 (1967): 254–281.
PHILLIPS, W.; (1958); “The relation between Unemployment and the Rate of Change of Money Wage
Rates in the United Kingdom, 1851-1957”, Economica, n.s., 25, no. 2: 283–299.
SAMUELSON, P.; SOLOW, R.; (1960); “Analytical Aspects of Anti-Inflation Policy.” American Economic
Review 40 (May), 177-94.
SAMUELSON, P.; NORDHAUS, W.; (1996); “Economía”, McGraw Hill, p.596.
SUMMERS, L.; (2013); Conference Drobny Global, Santa Monica (Financial Times), April 3.
UNITED NATIONS; (2000); “Declaración del Milenio”, Cumbre del Milenio, September.

G.P-S / MAY 2019 18

G.P-S / MAY 2019 19
APPENDIX I
The scientific research of the Natural Economic Theory developed by G.Perez-Seoane has lasted 20 years
March 1998 - November 2018). Between 1999 and 2002 he wrote three books with the macroeconomic
research carried out until that date. Investigation imperfect but containing the main empirical and
theoretical foundations of the economic general theory completed in 2018.
Books published: i) El Equilibrio de las Naciones (1998), ii) Modelo Macroeconómico Natural (1999),
iii) Natural Macroeconomic Model (2000), iv) The World Stock Market and the Natural Price Theory
(2002), v) Teoría Economica Natural (2017).
NAT Papers: 1. “The Natural Value Theory: Empirical Evidences of the Purchasing Power Parity and
the Long Term Stock Market Function” (19 December 2002), 2. “Natural Value Theory: Empirical
Evidences of the Long Term World Financial Market Function” (27 September 2004), 3. “Empirical
Evidences of Long Term World Exchange Rate Market Function” (26 January 2008), 4. “World
Financial Market Funtion: Empirical Evidence of Long Term Stock Market Function” (2008), 5. “The
World Macroeconomic Dilemma 2008-2012, World Monetary Stabilization Plan” (14 February 2009), 6.
“The World Gold Coeficient: Proposal for the Reform of the Internacional Monetary System”” (12
December 2011), 7. “Stochastic Monetary Policy Paradigm? Empirical Evidences of a Monetary
Optimum: The Natural Monetary Policy Model” (2012), 8. “Natural Price Theory and Positive
Economics” (June 30, 2014)
The Papers were authorized by the Scientific Committees of the following International Conferences:
V Encuentro Internacional de Economistas sobre Globalización y Problemas de Desarrollo, Cuba
(2002); 1International Applied Business Research Conference, The Clute Institute (USA) Puerto Rico
(2004); Conference on “Econometrics of Stock Markets”, Applied Econometrics Association (AEA)
Modem Université Paris X, France (2004); 2004 Annual Conference, European Economics and Finance
Society "European Integration and World Economy" University of Gdansk, Poland (2004); 2004 Annual
Conference, International Academy of Business and Economics (IABE), USA, (2004); 5th Conference of
Taiwan's Economic Empirics, Feng Chia University, Taiwán, (2004); Conference of International
Finance, Athens University, Greece,(2004); Conference on Money and Finance, Research Centre on
Financial Economics, Technical University of Lisbon, Portugal, (2004); V Encuentro Internacional de
Finanzas, (Chile) Universidad de Santiago, Chile (2005); MicFinMa Conference “International
Conference on High Frequency Finance”, The Center of Finance and Econometrics, University of
Konstanz, Germany (2006); “Korea and the World Economy”, VI Korean Economic Association.
Conference University of Wollongong, Korea (2007); 6th Global Conference on Business and
Economics, Gutman Conference Center, Harvard University, USA (2006); VI Encuentro Internacional de
Finanzas, Universidad de Santiago, Chile (2006); International Conference of Economics-TEA, Turkish
Economic Association, Turkey (2006); 3RD International Business Research Conference (Australia)
Australian Economic Association, Victoria University Melbourne, Australia (2006); 31st Annual
Economic Policy Conference (USA) Federal Reserve Bank of ST. Louis has invited as a guest to GPS to
the Conference, October 19-20, (2006); 6th International Conference on Applied Financial Economics,
Samos Island, Greece (2009); "Korea and the World Economy", VIII Conference, Kangwon National
University, Hong Kong (2009); 2009 The International Conference on Industrial Globalization and
Technology Innovation, China (2009); The Critical Studies Finance Conference II, Brussels, Belgium
(2009); “Impact of the Recent Financial Crisis on Trade”, FDI and Logistics, University of Le Havre,
France (2009); 9th International Economic Conference - IECS, Romania (2009); International Conference
on Applied Business Research; Mendel, Kasetsart and Malta University, Malta (2009); 3rd SNSPA
International Conference "Implications of the Global Economic Crisis", Romania (2009); Asia Pacific
International Conference on Changing Business Practice in Current Scenario, 2012, Mumbai, India
(2012); Conference IECS 2012, "The Persistence of the Global Economic Crisis", Lucian University of
Sibiu, Romania (2012);14th EBES Conference, Barcelona 23-25 October, 2014, Spain; Annual Shanghai
Business, Economics and Finance Conference, November 3-4, 2014, Shanghai University of International
Business & Economics, Shanghai, China 56th Annual Conference ISLE, (Indian Society of Labour
Economics), December 18-20, 2014, Mesra, Ranchi, Jharkhand, India; 1st IBESRA Conference,
December 29-30, 2014. Istanbul, Turkey; SIBR 2015 Osaka Conference, University Osaka, Japan; 33
Cambridge Business & Economics Conference, Cambridge University, July 1-2, 2015, U.K.; 2015
Eastern Economic Association Meeting. Quinnipiac University, New York February 2105, USA.

G.P-S / MAY 2019 20
APPENDIX II
GONZALO PÉREZ-SEOANE MAZZUCHELLI
G. PÉREZ-SEOANE has a Degree in Law from the Madrid Complutense University. He completed an
M.B.A. at Instituto Tecnológico Autónomo de México, I.T.A.M., (monetary award, high marks); a
Business Management Programme at I.E.S.E., Navarra University; and Advanced Corporate Finance
Programme for Senior Management at I.E.S.E., Navarra University; and Phd. Course in Business
Administration at the Madrid Complutense University. He worked in Mexico, London and Madrid for
different banks in the areas of risk analysis, corporate banking, international corporate banking,
international portfolio management, accounting and financial banking modeling and portfolio asset risk
modeling, holding management positions. He went on to become the C.E.O. of a Corporate Finance
Consulting firm formed by I.E.S.E. Finance Professors; Corporate Finance Director of a leading
international Asset Valuation firm and Chairman of an Global Investment Consulting firm. He has three
years' experience as a university lecturer on finance and business economics.

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