Chronic inflation

Chronic inflation occurs when a country experiences high inflation for a prolonged period of time (several years or decades) due to undue expansion or increase of the money supply. In countries with chronic inflation, inflation expectations become 'built-in', and it becomes extremely difficult to reduce the inflation rate.^[1]

Occurrence and causes

Even more so than hyperinflation, chronic inflation is a twentieth-century phenomenon, being first observed by Felipe Pazos in 1972.^[2] High inflation can only be sustained with unbacked paper currencies over long periods, and before World War II unbacked paper currencies were rare except in countries affected by war - which often produced extremely high inflation but never for more than a few years. Most economists believe chronic inflation first emerged in Latin America following World War II, with the result that it was originally called “Latin inflation”.^[3] Some economists, however, argue that the experience of France in the 1920s was the first case of chronic inflation.^[4] Japan (see below) in the years surrounding World War II is another case with characteristics very akin to well-studied cases of chronic inflation.

Early observers from the 1960s and 1970s attributed the ultimate political cause of chronic inflation as powerful group interests with radically divergent policy demands, arguing that the power of labour unions to demand high wages for workers in frequently outdated economic sectors conflicted with the basically feudal political structures of affected countries.^[5] Under these conditions, a return to a commodity money that would curb inflation quickly is politically suicidal, with the result that governments affected by chronic inflation have invariably had to resort to more subtle methods of reducing inflation, such as central bank reforms or indexing price and wage levels to the future value of money. This, however, leads to inflation inertia^[6] and ultimately to a public that becomes sceptical of attempts to reduce inflation: unlike hyperinflation, history has shown that it is possible for communities to live with chronic inflation relatively easily.

Other sources have argued that chronic inflation is caused by governments seeking to optimise seignorage taxes in order to pay most efficiently for public programmes, or because the societies in which it developed have consistently imported more than they can export and their currencies have had to devalue consistently to make their imports more expensive without elasticity being sufficient to reduce demand.^[7] There have on this line also been arguments for demographic causes of chronic inflation as resulting from populations growing more rapidly than production in developing nations from the 1950s to the 1980s, and until today in sub-Saharan Africa.

Examples

Bulgaria

In 1996, the Bulgarian economy collapsed due to the slow and mismanaged economic reforms of several governments in a row, shortages of wheat, and an unstable and decentralized banking system, which led to an inflation rate of 311% and the collapse of the lev, with the exchange rate to dollars reaching 3000. When pro-reform forces came into power in the spring 1997, an ambitious economic reform package, including introduction of a currency board regime and pegging the Bulgarian Lev to the German Deutsche Mark (and subsequently to the euro), was agreed to with the International Monetary Fund and the World Bank, and the economy began to stabilize.

Chile

Chile had prolonged inflation for the greater part of the twentieth century.^[8] Inflation first became persistent at the tail end of the 1930s as the government began a process of import substitution, rising steady to 84 percent in 1955.^[9] After slowing in the late 1950s, inflation rose again under Allende and peaked anywhere between 500% and 1,000% in late 1973 (which some consider hyperinflation, though the monthly inflation rate reached 30% for a single month^[10]). A 1973 coup d'état deposed Allende and installed a military government led by Augusto Pinochet. Pinochet's free-market economic policy gradually ended chronic inflation, which stabilised in single figures for the first time in forty-five years. Overall impact of chronic inflation: 1 current peso = 1,000,000 pre-1960 pesos.

Israel

Inflation accelerated in the 1970s, rising steadily from 13% in 1971 to 111% in 1979. From 133% in 1980, it leaped to 191% in 1983 and then to 445% in 1984, threatening to become a four-digit figure within a year or two. In 1985 Israel froze most prices by law ^{[citation needed]} and enacted other measures as part of an economic stabilization plan. That same year, inflation more than halved, to 185%. Within a few months, the authorities began to lift the price freeze on some items; in other cases it took almost a year. By 1986, inflation was down to 19%.

Iraq

Between 1987 and 1995 the Iraqi Dinar went from an official value of 0.306 Dinars/USD (or $3.26 USD per dinar; the black market rate is thought to have been substantially fewer dinars per dollar) to 3000 Dinars/USD due to government loss of their Swiss printing press and the printing of inferior quality notes. This equates to approximately 315% inflation per year averaged over that eight-year period.^[11]

Japan

As Hirohito prepared for war to gain access to rubber and mineral resources, Japan began experiencing steady inflation from 1934. By the end of 1949, retail prices were more than 150 times their level in 1939, and the highest denomination was a 75,000,000,000 Yen bank cheque. The Japan wholesale price index (relative to 1 as the average of 1930) shot up to 16.3 in 1943, 127.9 in 1948 and 342.5 in 1951. In the early 1950s, after achieving independence from USA, Japan controlled its own money. Through its rapidly growing export trade, Japan stabilized the yen quickly.

Madagascar

The Malagasy franc had a turbulent time in 2004, losing nearly half its value and sparking rampant inflation. On 1 January 2005, the Malagasy ariary replaced the previous currency at a rate of one ariary for five Malagasy francs. In May 2005, there were riots over rising inflation. Disinflation calmed the situation from 2005 to 2008, but riots ensued in 2009 as prices continued to rise.^[12]

Mexico

In spite of the oil crisis of the late 1970s (Mexico is a producer and exporter), and due to excessive social spending, Mexico defaulted on its external debt in 1982. As a result, the country suffered a severe case of capital flight and over a decade of chronic inflation and peso devaluation. On 1 January 1993, Mexico created a new currency, the nuevo peso ("new peso", or MXN), which chopped 3 zeros off the old peso, an inflation rate of 10,000% over the decade of the crisis. (One new peso was equal to 1000 of the obsolete MXP pesos).

North Korea, 1947–

Though the North Korean Won never technically failed, and is still the official currency of the reclusive communist nation, a 2009 revaluation showed the rest of the world rare cracks in the monolithic image Pyongyang presents. The government gave citizens seven days to turn in their old won for new won – with 1,000 of the old worth 10 of the new – but allowed a maximum exchange of 150,000 of the old won. That means each adult can exchange about US$740-worth of won. The revaluation and exchange cap wiped out the savings of many North Koreans, and reportedly caused unrest in parts of the country. According to a September 2009 BBC report,^[13] some department stores in Pyongyang even stopped accepting North Korean won, instead insisting upon payment in U.S. Dollars, Chinese Yuan, Euros, or even Japanese Yen.

Mozambique

Mozambique was one of the world's poorest countries when it became independent in 1975. Mismanagement and a brutal civil war from 1977-92 led to continued inflation. The highest denomination in 1976 was 100 meticals. By 2004, it was 500,000 meticals. In the 2006 currency reform, 1 new metical was exchanged for 1,000 old meticals.

Turkey

Throughout the 1990s Turkey dealt with severe inflation rates that finally crippled the economy into a recession in 2001. The highest denomination in 1995 was 1,000,000 lira. By 2005 it was 20,000,000 lira. Recently Turkey has achieved single digit inflation for the first time in decades, and in the 2005 currency reform, introduced the New Turkish Lira; 1 was exchanged for 1,000,000 old lira.

Venezuela

As of January 2014, Venezuela had the highest inflation rate in the world.

Zambia

See also

• Disinflation
• Inflationism

References