Hyperinflation Paranoia Guides the Fed
Move over Zimbabwe: Venezuela has replaced you as the poster child for monetary disaster. Citizens of that country are carrying backpacks of cash to buy their daily necessities. Prices there are expected to rise by 720 percent this year, making Venezuela’s hyperinflation the most severe on planet Earth.
There is no precise numerical definition to hyperinflation. Hyperinflation is a situation where the price increases are so out of control that the concept of inflation is meaningless.
That is brilliant, because it captures the abnormality of the phenomenon. What Americans think of as high inflation -- for example, the 12 percent or 13 percent annual rates in late 1979 and early 1980 -- just seems like a fundamentally different animal from the 1,000-plus-percent rates seen in the past in countries like Zimbabwe, Argentina or Weimar Germany.
Not all economists make this distinction. The famed macroeconomist Thomas Sargent, for example, wrote an economic history paper in 1981 called “The Ends of Four Big Inflations.” Sargent concluded that hyperinflations ended when central banks credibly promised to stop printing large amounts of money. The implication is that if the U.S. central bank loses its credibility -- if people believe that the Federal Reserve is willing to print money without limit -- then the dollar could easily suffer the same fate as the Venezuelan bolivar.
That helps to explain why Fed policy makers are paranoid about losing their inflation-fighting credibility -- so much so that they refused to consider even a 4 percent inflation target during the Great Recession. Even so, the Fed’s quantitative easing caused hawkish macroeconomists like the University of Chicago’s John Cochrane to warn in 2009 that the U.S. was in danger of hyperinflation.
Personally, I’m not very satisfied with the consensus opinion. Given the disastrous consequences of hyperinflation, and how much the fear of it informs policy making, there really ought to be a lot more research on this topic than there is. Economists and policy makers basically bought Sargent’s story from the early ’80s and haven’t revisited it. But maybe they should.
Hyperinflations tend to happen in countries with political problems. Venezuela’s government, for example, has been trying to transform a capitalist economy into a socialist one, while at the same time placing constraints on the country’s democratic institutions. The famed Weimar hyperinflation occurred after Germany lost a huge war and amid severe externally imposed war reparations, and also involved an unstable government. Argentina and Zimbabwe were similarly undergoing highly unstable political transitions. This should be a clue that hyperinflation is at least partly a political phenomenon, not just an economic one.
Another odd thing about hyperinflation is how fast it happens. The very sudden and enormous depreciation of a currency’s value looks a lot like the collapse of an asset bubble, a run on a bank, or sudden capital flight from a destablized emerging market. Economists have suggested that these phenomena are due to coordination problems -- everyone trying to flee for the exits at the same time, trying to get out first. Hyperinflation looks an awful lot like a run on a currency.
That suggests that hyperinflation is not simply a more severe form of the sort of inflation the U.S. saw in the 1970s. Normal macroeconomic models, which are designed to allow for ’70s-style inflation, don’t say anything about what would cause a wholesale run on a currency. Presumably, a sudden loss of central bank credibility might be the trigger, but there could also be many other causes. For example, the availability of an alternative currency -- U.S. dollars, euros, gold or bitcoin -- might raise people’s willingness to abandon their local money. Political instability also probably figures into the equation -- if people believe that a dictator or foreign occupiers will commandeer the central bank for their own purposes, that might make hyperinflation much more likely.
So economists should be working much harder on understanding why hyperinflations happen. The question is especially important for countries like Japan, where huge government debts, aggressive monetary policy and negative interest rates have raised the specter of hyperinflation, but where political stability is strong and credible alternative currencies don’t really exist. If hyperinflation is easy to create, central banks should be worried, but if it requires political instability and other extraordinary factors, then using easy money to help sustain fiscal deficits is relatively safe. Despite Venezuela’s experience, the U.S. fear of hyperinflation seems overblown.
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