Tag Archives: Bolivia

Hyperinflation – can be controlled with a different government.

Venezuela has been in the news for sometime with its economy spiralling out of control with the inflation rate last year at 100,000% – doubling roughly once a month. The occurrence of hyperinflation in economies has become more common with governments now printing money rather than that money being backed by the amount of gold that they held – gold standard. Because the gold supply is quite inelastic, being on the gold standard would theoretically stop government overspending and keep inflation under control. The country effectively abandoned the gold standard in 1933, and completely severed the link between the dollar and gold in 1971 – this was around the time of the Vietnam War.

The more recent hyperinflation in Zimbabwe, Bolivia, Argentina etc have come about through government’s not been able to control the printing presses and succumbing to the desire to stay in power at the expense of crippling the economy. Huge fiscal deficits and excessive borrowing are the common denominator here – see flow chart below:

Hyperinflation usually happens amongst chaotic domestic conditions, whether social unrest or that country being involved in conflict – e.g. post war Germany. However as reported by The Economist hyperinflation can occur under more mundane circumstances. For instance in Bolivia’s inflation reached 60,000% which was started by a commodity boom which allowed them to borrow heavily from overseas but once resource prices tumbled there was a significant reduction in government revenue. The  government under Hugo Banzer increased spending to satisfy the voters who supported them in the election and this created further inflationary pressure. In a way this is similar to the Venezuela experience with high oil prices generating significant revenue for the government but once the oil prices fell the printing presses started to work overtime. And once inflation starts to accelerate Inflationary expectations kick in and then it becomes very difficult to control. However these inflationary expectations could reflect the lack of seriousness of government policy to rectify the problem as a change of government which is focused on prices can end hyperinflation in weeks. This reflects the trust in the incoming regime and was true of Bolivia (see video below).  Here the incoming government under Gonzalo (Goni) Sánchez de Lozada were serious about the ravages of inflation and to deal with it  didn’t use highly sophisticated economic theory.  See below:

  • Government spending was slashed
  • Price controls were scrapped
  • Import tariffs were cut
  • Government budgets were balanced.
  • No borrowing from the Central Bank

As Jeff Sachs – advisor to the Bolivian government –  said:

“All this gradualist stuff just doesn’t work. When it really gets out of control you’ve got to stop it, like in medicine. You’ve got to take some radical steps; otherwise your patient is going to die.”

Sources:

The Economist – February 2nd 2019

Commanding Heights – PBS Video

AS Economics – Hyperinflation causes and ends

Starting with a definition. In 1956 Phillip Cagan, an economist working at America’s National Bureau of Economic Research, published a seminal study of hyperinflation, which he defined as a period in which prices rise by more than 50% a month.

There seems to be common patterns when hyperinflation occurs in an economy. These include:

  1. Fiscal pressure – cost of funding a war, increased social welfare payments, corrupt officials taking money from the budget.
  2. Dependence of a particular resource – the resource curse. Some economies rely on exports of oil, iron ore or other resources to fund its spending. This has the effect of increasing the value of the currency and although this will make imports cheaper once the resource runs out or global prices start to drop the overvalued currency falls causing a large increase in imported prices. Furthermore governments come to depend on revenue from oil and a sudden drop in prices saw a massive drop in tax revenue – 90% of Venezuela’s revenue came from oil.
  3. Printing money – like Bolivia in the 1980’s, Venezuela overcame their shortfall in income by printing more money. The increase in the supply of money pushes up inflation. But what makes it worse is, as the inflation rate impacts the real value of government revenue, they continue to print money to finance the budget deficit which in turn exacerbates the problem – bigger budget deficit and further inflation.
  4. Exchange rate – at some stage the exchange rate will collapse as people lose confidence in the currency. Imports become ever increasingly expensive and feed into the inflation calculation.
  5. Inflationary expectations – In recent years more attention has been paid to the psychological effects which rising prices have on people’s behaviour. The various groups which make up the economy, acting in their own self-interest, will actually cause inflation to rise faster than otherwise would be the case if they believe rising prices are set to continue. This is evident in Venezuela as people become accustomed to higher prices and expect them to continue which makes inflation likely to continue.Workers, who have tended to get wage rises to ‘catch up’ with previous price increases, will attempt to gain a little extra compensate them for the expected further inflation, especially if they cannot negotiate wage increases for another year. Consumers, in belief that prices will keep rising, buy now to beat the price rises, but this extra buying adds to demand pressures on prices. In a country such as New Zealand’s before the 1990’s, with the absence of competition in many sectors of the economy, this behaviour reinforces inflationary pressures. ‘Breaking the inflationary cycle’ is an important part of permanently reducing inflation. If people believe prices will remain stable, they won’t, for example, buy land and property as a speculation to protect themselves.

Hyperinflation tends to end in two ways.

  1. The paper currency becomes so utterly worthless that it is supplanted by a hard currency. This is what happened in Zimbabwe at the end of 2008, when the American dollar took over, in effect. Prices will stabilise, but other problems emerge. The country loses control of its banking system and its industry may lose competitiveness.
  2. The second, hyperinflation ends through a reform programme. This was very much the case in Bolivia in the 1980’s – Government spending was slashed. Price controls were scrapped. Import tariffs were cut. Government budgets were balanced. Therefore this typically involves a commitment to control the budget, a new issue of banknotes and a stabilisation of the exchange rate—ideally all backed with confidence-inspiring foreign loans. Without such reform, Venezuela’s leaders, though scornful of America, may find that its people are forced eventually to adopt its dollar anyway.

Sources:

  • The Economist “The half-life of a currency” September 15th 2018
  • The Economist “The roots of hyperinflation” February 12th 2018

1980's hyperinflation in Bolivia

When you think of hyperinflation countries like post-war Germany and Zimbabwe come to mind. However Bolivia in the 1980’s seems to have been a forgotten example. Below is a very good video about the hyperinflation in Bolivia from the PBS Commanding Heights series. I use it teaching the impact of hyperinflation on an economy and policies that to try and control its impact. Some of the main issues from the video are:

  • Inflation reached 23,500%
  • 7 out of 10 Bolivians live in poverty – the poor get hurt by inflation
  • Inflation averaged 1% every 10 minutes
  • One of the causes of the inflation was government finances – they just printed money and didn’t collect taxes
  • How do you stop a hyperinflation or an inflation? Gradualist steps don’t work and as Jeff Sachs said: “All this gradualist stuff just doesn’t work. When it really gets out of control you’ve got to stop it, like in medicine. You’ve got to take some radical steps; otherwise your patient is going to die.”
  • Bolivia didn’t use highly sophisticated economic theory to deal with hyperinflation: Government spending was slashed – Price controls were scrapped – Import tariffs were cut – Government budgets were balanced. 

Inflationary Expectations

A lot of the inflationary problems in Bolivia were caused by inflationary expectations which accelerates the problem. In recent years more attention has been paid to the psychological effects which rising prices have on people’s behaviour. The various groups which make up the economy, acting in their own self-interest, will actually cause inflation to rise faster than otherwise would be the case if they believe rising prices are set to continue.

Workers, who have tended to get wage rises to ‘catch up’ with previous price increases, will attempt to gain a little extra compensate them for the expected further inflation, especially if they cannot negotiate wage increases for another year. Consumers, in belief that prices will keep rising, buy now to beat the price rises, but this extra buying adds to demand pressures on prices. In a country such as New Zealand’s before the 1990’s, with the absence of competition in many sectors of the economy, this behaviour reinforces inflationary pressures. ‘Breaking the inflationary cycle’ is an important part of permanently reducing inflation. If people believe prices will remain stable, they won’t, for example, buy land and property as a speculation to protect themselves.