When it comes to inflation, I agree with Lord Kelvin. From a lecture the British physicist deliveredat the Institute of Civil Engineers on May 3, 1883: “I often say that when you can measure what you are speaking about, and express it in numbers, you know something about it; but when you cannot measure it, when you cannot express it in numbers, your knowledge is of a meager and unsatisfactory kind; it may be the beginning of knowledge, but you have scarcely, in your thoughts, advanced to the stage of science, whatever the matter may be.”
At present, the world's highest inflation rate is in Venezuela, where the annual rate is 15,657%. Venezuela's bout of hyperinflation began on November 13, 2016, when the monthly inflation rate first breached the 50% per month hyperinflation threshold. Today, Venezuela's monthly inflation rate stands at 167%. So, Venezuela is a member of the rogues' gallery of hyperinflation episodes, of which there have only been 58 in recorded history. The chart below paints the picture of Venezuela's hyperinflation calamity.
The inflation rates in the chart above are measured by The Johns Hopkins-Cato Institute Troubled Currencies Project (TCP), which I direct. In 2013, after the Banco Central de Venezuela (BCV) stopped reporting inflation statistics on a regular basis, we began measuring Venezuela's inflation. We employ high-frequency data that allow for the daily measurements of both monthly and annual inflation rates. We measure. We do not forecast. Indeed, forecasting in a hyperinflationary setting is a mug's game.
How do we measure? The most important price in an economy is the exchange rate between the local currency – in this case, the bolivar – and the world's reserve currency, the U.S. dollar. As long as there is an active black market (read: free market) for currency and the data are available, changes in the black market exchange rate can be reliably transformed into accurate measurements of countrywide inflation rates. The economic principle of purchasing power parity (PPP) allows for this transformation. And the application of PPP to measure elevated inflation rates is rather simple.
During periods of elevated inflation, PPP is the proper theory to use for measurement. Indeed, PPP holds during episodes of hyperinflation, and it holds very tightly. So, with Nobel Prize-winner Tjalling Koopmans's admonishment to economists in mind, we are measuring, and we are measuring with the correct theory.
Beyond the theory of PPP, the intuition of why PPP represents the ‘gold standard' for measuring inflation during hyperinflation episodes is clear. All items in an economy that is hyperinflating are either priced in a stable foreign currency (the U.S. dollar) or a local currency (the bolivar). If they are bolivar prices, they are determined by referring to the dollar prices of goods, and then converting them to local bolivar prices after checking with the spot black-market exchange rate. Indeed, when the price level is increasing rapidly and erratically on a day-by-day, hour-by-hour, or even minute-by-minute basis, exchange rate quotations are the only source of information on how fast inflation is actually proceeding. That is why PPP holds and why we can use high-frequency (daily) data to calculate Venezuela's inflation rate.
So much for the way things should be measured correctly. With that in mind, let's take a look at the International Monetary Fund's (IMF) treatment of Venezuela's inflation. We conduct this analysis not only because the IMF is the premier international body that deals with the monetary matters of its 189 member countries, but also because whatever the IMF utters is treated by the financial press as gospel. In consequence, IMF data are widely reported and drive public opinion.
In the past year and a half, the IMF has reported a variety of numbers for the annual inflation rate in Venezuela. None of the IMF's numbers can be replicated. This is a problem — one that renders all of the IMF's inflation numbers unusable because, among other things, they fail to pass the scientific smell test. Never mind. The following is a catalogue of the IMF's inflation numbers for Venezuela that have been reported since September 2016.
- IMF World Economic Outlook, October 2016
- End of 2015 annual inflation rate (Data Source - BCV): 180.9%
- End of 2016 annual inflation rate projection: 720.0%
- End of 2017 annual inflation rate projection: 2,200.0%
- IMF World Economic Outlook, April 2017
- End of 2016 annual inflation rate (Data Source - BCV): 274.4%
- End of 2017 annual inflation rate projection: 1,133.8%
- End of 2018 annual inflation rate projection: 2,529.6%
- IMF World Economic Outlook, October 2017
- End of 2016 annual inflation rate (Data Source - BCV): 302.6%
- End of 2017 annual inflation rate IMF projection: 1,133.0%
- End of 2018 annual inflation rate IMF projection: 2529.6%
- IMF World Economic Outlook, April 2018
- End of 2016 annual inflation rate: 2,818.4%
- End of 2017 annual inflation rate IMF projection: 12,874.6%
- End of 2018 annual inflation rate IMF projection: 12,874.6%
Until the April 2018 World Economic Outlook(WEO), the IMF wrote the same general disclaimer about its Venezuelan numbers in each issue of its report:
Projecting the economic outlook in Venezuela, including assessing past and current economic developments as the basis for the projections, is complicated by the lack of discussions with the authorities (the last Article IV consultation took place in 2004), long intervals in receiving data with information gaps, incomplete provision of information, and difficulties in interpreting certain reported economic indicators in line with economic developments.”
In the April 2018 WEO, the disclaimer was altered. It now includes:
The effects of hyperinflation and the noted data gaps mean that IMF staff’s projected macroeconomic indicators need to be interpreted with caution.”
These disclaimers are laughable. No one has ever been able to accurately forecast the course or the duration of an episode of hyperinflation. But, that hasn’t stopped the IMF from offering up inflation forecasts for Venezuela that have proven to be wildly inaccurate. And, for an example of the absurdity of the IMF’s projections, just consider its year‐end forecasts for 2018 and 2019. Both values for the annual rate are 12,824.6%. These forecasts are absurd. After all, the current measured annual inflation rate is already 15,657%, and climbing. And the same forecast for both 2018 and 2019 contain a touch of spurious accuracy to boot: note the decimal point.
What makes the IMF’s inflation numbers for Venezuela so troubling is that they should have never been reported in the first place. There is no practical basis for making a forecast of inflation during episodes of hyperinflation, which the IMF has repeatedly done. One can measure hyperinflation accurately, but one cannot forecast its course or duration. And if the IMF’s Original Sin is not bad enough, the financial press has regularly and religiously published the IMF’s forecasts of Venezuela’s hyperinflation. This is disturbing. It has left the public with the false impression that it is possible to forecast episodes of hyperinflation.