Topic: Finance, Banking & Monetary Policy

Venezuela: Not Hyperinflating—Yet

Although Venezuela’s inflation has soared (see: Up, Up, and Away), Venezuela is not experiencing a hyperinflationary episode–yet. Since the publication of Prof. Phillip Cagan’s famous 1956 study The Monetary Dynamics of Hyperinflation, the convention has been to define hyperinflation as when the monthly inflation rate exceeds 50%.

I regularly estimate the monthly inflation rates for Venezuela. To calculate those inflation rates, I use dynamic purchasing power parity (PPP) theory. While Venezuela’s monthly inflation rate has not advanced beyond the 50% per month mark on a sustained basis, it is dangerously close. Indeed, Venezuela’s inflation rate is currently 45% per month (see the accompanying chart).

If inflation moves much higher, the legacy of Hugo Chavez’s Bolivarian Revolution will be that Venezuela joins the rather select hyperinflation club as the 57th member. Yes, there have only been 56 documented hyperinflations

Venezuela's Monthly Inflation Rates

Ten Things Every Economist Should Know about the Gold Standard

At the risk of sounding like a broken record (well, OK–at the risk of continuing to sound like a broken record), I’d like to say a bit more about economists’ tendency to get their monetary history wrong. In particular, I’d like to take aim at common myths about the gold standard.

If there’s one monetary history topic that tends to get handled especially sloppily by monetary economists, not to mention other sorts, this is it. Sure, the gold standard was hardly perfect, and gold bugs themselves sometimes make silly claims about their favorite former monetary standard. But these things don’t excuse the errors many economists commit in their eagerness to find fault with that “barbarous relic.”

The false claims I have in mind are mostly ones I and others–notably Larry White–have countered before. Still I thought it would be useful to address them again here, because they’re still far from being dead horses, and also so that students wrapping-up the semester will have something convenient to send to their misinformed gold-bashing profs (though I urge them to wait until grades are in before sharing!).

For the sake of those who don’t care to wade through the whole post, here is a “jump to” list of the points covered:

  1. The Gold Standard wasn’t an instance of government price fixing. Not traditionally, anyway.
  2. A gold standard isn’t particularly expensive. In fact, fiat money tends to cost more.
  3. Gold supply “shocks” weren’t particularly shocking.
  4. The deflation that the gold standard permitted wasn’t such a bad thing.
  5. It wasn’t to blame for 19th-century American financial crises.
  6. On the whole, the classical gold standard worked remarkably well (while it lasted).
  7. It didn’t have to be “managed” by central bankers.
  8. In fact, central banking tends to throw a wrench in the works.
  9. “The “Gold Standard” wasn’t to blame for the Great Depression.
  10. It didn’t manage money according to any economists’ theoretical ideal. But neither has any fiat-money-issuing central bank.

Venezuela’s Inflation: Up, Up, and Away

Like the 2009 Oscar award-winning Pixar film Up, Venezuela’s annual inflation rate has soared sky high (see the chart below). On December 31, 2014, Venezuela’s bolivar traded at a VEF/USD rate of 171 and the implied annual inflation rate stood at 169%. In May of 2015, Venezuela’s bolivar collapsed and the implied annual inflation rate broke the 500% barrier. On May 28, 2015, the VEF/USD rate was 413, a 59% depreciation in the bolivar since January 1st. Not surprisingly, the implied annual inflation rate stood at a staggering 495%.

Venezuela's Annual Inflation Rates

Evaluating Quantitative Easing

In my prior post, “The Futility of Stimulus,” I examined whether Federal Reserve Policy has provided economic stimulus. I employed standard measures of money-supply growth to evaluate the question. I concluded that Federal Reserve policy has resulted in less expansion of the money supply than would normally be expected. The weakness of the current economic expansion testifies to that.

In this post, I employ an alternative measure of monetary stimulus. I rely on a recent lecture at the University of Nevada Reno by Professor John Taylor of Stanford University. With a series of charts, he made a convincing case that successive rounds of Quantitative Easing provided no monetary stimulus. Taylor looked at the interest-rate channel, particularly longer-term interest rates. If monetary policy stimulates the economy through real capital investment, then we must look to longer-term interest rates.

Taylor specifically examined the effects on 10-year Treasury yields of each round of Quantitative Easing by the Fed. In each case, there was an announcement effect. When the Fed announced a new round of bond purchases, interest rates on 10-year Treasuries did drop. As QE was executed, however, the 10-year rate recovered to its previous level or even moved higher. On the assumption that rates on corporate bonds price off Treasuries, there was no measurable effect on investment and economic growth. Again, the weakness of the economic expansion is consistent with Taylor’s argument.

There is policy background here. Taylor is the author of a monetary rule, which others have dubbed the Taylor Rule. It is a rule for adjusting short-term interest rates (the Fed Funds rate) to changes in inflation and real economic activity. The Taylor Rule calculates that the Fed Funds should by 1.5 percent versus the current reality of near-zero. Taylor did not advocate an immediate increase to that level, but the beginning of gradual increases.

What of the economic recovery? If Taylor is correct, then low short-term interest rates have not contributed to the economic expansion and raising them will not slow economic growth.

Have very low short-term interest rates had any effect? Janet Yellen recently hinted they might have contributed to unsustainably high equity prices. I will not argue with the Fed Chair on that point, but only suggest that other financial bubbles may also have been financed by Fed policy. To repeat a hackneyed phrase (nonetheless accurate), Wall Street has benefited but not Main Street.

To sum up, following Taylor’s analysis of the interest-rate channel, I conclude that Fed policy has not stimulated economic growth. It has had consequences, which some would consider undesirable. Taylor has provided a reasonable case for beginning to raise interest rates. I doubt that will happen soon. But the debate should continue.

[Cross-posted from]

The Futility of Stimulus

George Selgin has recently focused on the failure of Federal Reserve policy to finance a normal recovery. The Fed has greatly expanded its balance sheet and created a large quantity of excess reserves, which, for a variety of reasons, commercial banks have not mobilized into credit creation. Instead, banks seem content to earn the 25 basis points of interest the Fed now pays on reserves.

This anomalous behavior shows up in the M1 money multiplier, which is at record lows – less than half its value before the financial crisis. The Fed is creating reserves, but commercial banks are not creating as much bank money as has been historically true. Compounding this is the fact that the velocity of M1 – the rapidity with which each dollar is spent annually – has hit a 40-year low. Consequently, the Fed’s efforts to produce monetary stimulus have failed.

(A similar story can be told for other money supply measures. Data and charts can be found at FRED, the online data center at the Federal Reserve Bank of St. Louis.)

I do not think economists fully understand all of the factors contributing to this policy failure. But Selgin has surely identified one relevant factor, the payment of interest on reserves. On the margin, it creates a disincentive for commercial banks to create money and credit in a normal fashion. There are also fiscal reasons for ending the payments, as they reduce the payments the Fed makes to the Treasury. As it is, the payment of interest on reserves constitutes a fiscal transfer from taxpayers to commercial banks. In a normal world, I would endorse his call to end the interest paid on reserves.

We do not live in a normal world. The Fed has replaced liquid, short-term assets on its balance sheet with illiquid, long-term assets. Normally, to raise the Fed Funds rate, the Fed would sell Treasury bills. It has none to sell. Analysts and pundits speculate on when the Fed will raise interest rates. They should be asking how the Fed will raise interest rates.

Stanford’s John Taylor thinks the Fed will need to increase the interest rate paid on reserves to accomplish that goal. Markets through arbitrage would then increase the interest rates banks pay each other to borrow reserves. I suspect he is correct, with two caveats. First, there is no longer much of a market for federal funds. Banks aren’t lending each other reserves. Second, there are other possible mechanisms for raising short-term interest rates like the tri-party, reverse repo facility at the New York Fed. This, and other facilities, are untested as a means to implement a policy change. Their use would put monetary policy in unchartered waters.

To sum up, monetary policy has failed to simulate economic activity. It has failed even to finance a normal economic recovery. In pursuing a failed stimulus policy, the Fed has tied its policy hands going forward. At some point, interest rates will need to rise. The Fed will need to rely on novel means to accomplish a turn in policy. Paying higher interest rates on bank reserves may be one method. It is an unpleasant reality. It is only one consequence of the Fed’s experiment with extraordinary monetary policy.

[Cross-posted from]

Venezuela: World’s Highest Inflation Rate

Venezuela’s bolivar is collapsing. And as night follows day, Venezuela’s annual implied inflation rate is soaring. Last week, the annual inflation rate broke through the 500% level. It now stands at 510%.

When inflation rates are elevated, standard economic theory and reliable empirical techniques allow us to produce accurate inflation estimates. With free market exchange-rate data (usually black-market data), the inflation rate can be calculated. The principle of purchasing power parity (PPP), which links changes in exchange rates and changes in prices, allows for a reliable inflation estimate.

To calculate the inflation rate in Venezuela, all that is required is a rather straightforward application of a standard, time-tested economic theory (read: PPP). Using black-market exchange rate data that The Johns Hopkins-Cato Institute Troubled Currencies Project has collected over the past year, I estimate Venezuela’s current annual implied inflation rate to be 510%. This is the highest rate in the world. It’s well above the second-highest rate: Syria’s, which stands at 84%.

Venezuela has not always experienced punishing inflation rates. From 1950 through 1979, Venezuela’s average annual inflation rate remained in the single digits. It was not until the 1980s that Venezuela witnessed a double-digit average. And it was not until the 1990s that Venezuela’s average inflation rate exceeded that of the Latin American region. Today, Venezuela’s inflation rate is over the top (see the accompanying table).

Average Annual Inflation Rates

Is the Fed on Track?

That’s more-or-less the question that asked Dean Baker, co-founder of the Center for Economic and Policy Research, and me after last month’s FOMC press release. Dean said yep. I said…uh, not really. Our full answers appeared recently in the online publication’s “Wealth of Opinions” column. There’s even a little poll at the end, allowing you to pick your favorite answer. Of course you don’t have to vote. It’s really entirely up to you. I mean, I’m not trying to pressure you or anything like that.


No, really!

[Cross-posted from]