Macroeconomics Macroeconomics Hyperinflation Inflation and Monetary Policy Terminology The idea • The price level is a measure of average prices • Study inflation by looking at extreme cases – We label it P • [Like studying the flu via ebola?] – Measured in units of currency (how many dollars it takes to buy some collection of goods) • Inflation is the rate of growth of the price level – Buying goods takes more currency – Or: a unit of currency buys less (same thing, of course) • We call it deflation if growth rate is negative • Hyperinflation is inflation > 100% per year 3 4 The idea The idea • Tom Sargent, interview • La Nacion, via Google translate, March 25, 2012 – The way to start a hyperinflation is run sustained – [Argentina's] Central Bank president, Mercedes Marco del government deficits and then have the monetary authority Pont, said it “is totally false to say that the issue [of money] print money to pay for it. That always works. How do you generates inflation.” She continued: ”only in Argentina does stop a hyperinflation? You stop doing it. This isn’t high the idea remain that the expansion of the money [supply] economic theory. generates inflation.” • What is he saying? Does it make sense to you? • What is she saying? Does it make sense to you? 5 6 1 The idea: Argentine data Roadmap • Terminology • Hyperinflation show and tell • Money and inflation: the quantity theory • Money supply mechanics • How deficits enter the picture Source: Foco Economico, March 2012. 7 8 German currency October 1923: 20 USD = 1 billion RM Hyperinflation show and tell 10 Argentine currency Turkish currencies After 2008 Before 2008 This note dates from 1980s. What’s it worth now? 11 12 2 Brazilian currencies REAL, Jun 1994 – present Highest inflation rates ever CRUZEIRO REAL, Aug 1993 - Jun 1994 CRUZEIRO, Mar 1990 – Aug 1993 Example Highest Daily Inflation Hungary, Jul 1946 207% CRUZADO, Feb 1986 – Jan 1989 CRUZADO NOVO, Jan 1989 – Mar 1990 Zimbabwe, Nov 2008 98% Yugoslavia, Jan 1994 65% CRUZEIRO, May 1970 – Feb 1986 CRUZEIRO NOVO, Feb 1967 – May 1970 Germany, Oct 1923 21% MIL-RÉIS, Oct 1833 – Oct 1942 CRUZEIRO, Oct 1942 – Feb 1967 13 14 Inflation in Argentina (annual %) Inflation in Brazil (annual %) 3500 3000 3000 2500 2500 2000 2000 1500 1500 1000 1000 500 500 0 0 1986 1987 1988 1989 1990 1991 1992 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 Source: EIU database. 15 Source: EIU database. 16 Inflation in Russia (annual %) Inflation in Turkey (annual %) 1800 120 1600 100 1400 1200 80 1000 60 800 600 40 400 20 200 0 0 1992 1993 1994 1995 1996 1997 90 91 92 93 94 95 96 97 98 99 '00 '01 '02 '03 Source: EIU database. 17 Source: EIU database. 18 3 Buying lunch in Zimbabwe Zimbabwe timeline • December 2006: inflation over 1000% • February 2007: inflation ruled illegal • October 2008: inflation over 200 million percent! • January 2009: – Transactions permitted in foreign currency – Soldiers and teachers to be paid in USD • February 2009: 12 zeros knocked off • April 2009: government abandons currency, people use USD (also South African rand – ZAR) 19 20 Zimbabwe timeline Inflation in Israel (annual %) • Long tragic history… 400 350 300 250 200 150 100 50 0 1981 1981 1982 1983 1984 1985 1986 1987 21 Source: EIU database. 22 Israel in the 1980s Iran • American Rabbi visiting Israel: • Graeme Wood, “Hyperinflation vacation,” The – During Israel’s hyperinflation, I had a mortgage at a 5% Atlantic, April 2013: fixed annual interest rate. As inflation increased, fixed – The Iranian rial was hovering under 40,000 to one U.S. rate mortgage payments became laughably easy to make, dollar, weaker by nearly half compared with six months because salaries more or less kept pace with inflation. earlier. Authorities tried to ban currency trading for a few Finally, I received a notice canceling my mortgage, weeks in October, when the inflation rate peaked. because the cost of record-keeping had become more than the monthly payment. – Wood’s First Rule of Budget Travel: where there is runaway inflation, there are great deals for travelers with hard cash. So in January, I boarded a flight from Dubai to Kish, an Iranian holiday resort in the Persian Gulf. 23 24 4 Other examples • Personal experiences with hyperinflation? The quantity theory of money 25 Quantity theory: picture Quantity theory: words • The more currency (money) in circulation, the less each unit is worth Money Growth Inflation 27 28 Quantity theory: math Quantity theory: math • One equation (a production function for transactions) • One equation (technology for transactions) M V = P Y M V = P Y – M = stock of money in circulation (amount of currency) • In growth rates – V = velocity (how often a unit of currency is used in a year) γM + γV = γP + γY – P = price level (the GDP deflator or other price index) – γM = growth of money supply (think: currency) – Y = real GDP – γV = growth of velocity – γP = growth of price level (the inflation rate) – γY = growth of real GDP 29 30 5 Quantity theory Quantity theory: long-run evidence • Two hypotheses 2 – V is constant ( γV = 0) P – Y not affected by changes in M 1.5 [Or: changes in Y small relative to changes in M] M/Y • One conclusion 1 – Money growth causes inflation γP = γM – γY andM/Y scale) P (log .5 0 1960 1970 1980 1990 2000 2010 31 32 Quantity theory: short-run evidence Quantity theory: small inflations 15 • Lots of other things relevant in small inflations • Link between money and prices not as tight 10 • More on this next week 5 Year-on-Year Year-on-Year Growth 0 blue=P growth, brown=M/Y growth -5 1960 1970 1980 1990 2000 2010 33 34 Money supply mechanics • How the central bank manages the money supply – Money = currency for our purposes – Supply changed by buying/selling bonds in market • Works through balance sheets for Money supply mechanics – Treasury – Central bank – Private agents (households and firms) 36 6 Money supply mechanics Money supply mechanics Treasury Treasury Assets Liabilities • Where does treasury Assets Liabilities • How does central Bonds 200 debt come from? Bonds 200 bank increase money supply? • Where does money Central bank supply come from? Central bank • Why do households Assets Liabilities Assets Liabilities go along? Bonds 0Money 0 Bonds 20Money 20 Households and firms Households and firms Assets Liabilities Assets Liabilities Money 0 Money 20 Bonds 200 Bonds 180 37 38 Money supply mechanics Quantity theory: revised picture Treasury Assets Liabilities • Where do deficits Bonds 200 come in? • Does there need to be Central bank a connection with Assets Liabilities Government Money money growth? Inflation Deficit Growth Bonds 20Money 20 • Why so in hyperinflations? Households and firms Assets Liabilities Money 20 Bonds 180 39 40 Hyperinflation recap Fiscal dominance in the US and EU • Hyperinflations – always! – stem from • Fiscal dominance means – Lack of fiscal discipline [= government deficit] – Government debt and deficit are so large that the only – Accommodation by central bank [= printing money] alternative to explicit default is printing money • How to end them: “stop doing it” • US/Fed view of the world – Balance government budget – Need aggressive monetary policy to recover from crisis – Make central bank independent, prohibit it from buying debt • EU/ECB view of the world directly from Treasury – Need to resist inflation with tight monetary policy – US guilty of “soft fiscal dominance” 41 42 7 What have we learned? Something to think about • Hyperinflation comes from • Would the US be better off with gold? – Large increases in money supply • Would Argentina be better off using USD? – Triggered by government deficits • Solution: Stop doing it. • Essential tools – Quantity theory – Central bank balance sheet 43 44 8.