Is global inflation in the offing?
Are nations about to beggar their neighbors?
The question arose when the Group of 20 met in Seoul in November, ostensibly to forge an agreement between the United States and China over a yuan that Americans regard as too weak. Is the most critical undervaluation in Beijing -- or in Washington, D.C.? Dollars newly created by the Fed -– the “Quantitative Easing II” in today’s headlines -– might someday reduce the foreign value of a dollar, just as an increase in the supply of toothbrushes tends to lower their price so that people will buy the new toothbrushes.
Under a pact of the International Monetary Fund –- the Jamaica Agreement of 1976 -– a country should not devalue to try to make its exports cheaper than those of its neighbors, since they could respond by devaluing as well. Beggaring the neighbor could lead to global inflation, in two ways. Since Home’s exports are now cheaper, in terms of foreign currency, foreigners will buy more of them, driving up their prices at Home. Second, the devaluation raises the cost of imports to consumers at Home, so they will buy more Home goods instead, bidding up these prices again. That scenario can occur in every country that plays the beggar. Kazakhstan may worry that a weak yuan can undermine demand for its manufactured exports.
In the long run, an episode of inflation might not matter much. When workers and machines are idle, the natural tendency is to put them to work eventually, regardless of whether most prices are low or high. Over the long haul, the price is just a number on a pricetag. But in the short run, prices that rise more rapidly for some products than for others -– which is what inflation entails for a while -– confuse buyers and sellers alike. They won’t make their best decisions. Global confusion could reduce global output.
Clobber thy neighbor
These days, however, observers worry about a new way to beggar thy neighbor. Return for a moment to the Fed’s “quantitative easing.” Expanding the dollar supply will likely lower the price of holding a dollar. This price is the U.S. interest rate, since the holder of the dollar forgoes the interest payment. In order to express the purchasing power of this payment foregone, let’s adjust the interest rate for changes in product prices. As this “real” interest rate falls in the U.S., interest-bearing assets in other countries will look more attractive to financial investors than before. Why settle for a 1% return on an American bond when you can get a 2% return on a Korean one? Money will flow into South Korea.
This may look delightful for the Koreans, but it isn’t. The extra money will lead to more spending on products in Korea, pushing up prices in an economy that had already been growing 5% annually early this year. To avoid inflation, the Korean central bank might raise its interest rate in order to discourage production -- funded by borrowed won -- that might overheat the economy. But the rise in Korea’s interest rate will make the won look all the more attractive. As financial investors bid higher for the won, its foreign value will increase. Thanks to the Fed, the dollar weakened 8% against the won last year, according to the New York Times. That’s bad news for Korean exporters, since it raises the cost to foreign buyers of their products.
“The recent Korean recovery was mainly due to export growth,” writes Sang H. Lee, an associate professor of finance at KIMEP who studies money supply. “The exporters' margin will be squeezed by the undesirable appreciation of the won.
“Should the Korean government implement restrictions on capital inflows and be blamed as a protectionist? Or should it manage the exchange rate?”
Holding back the tide
Beyond the argument over whether the government should intervene in currency markets, lies a more troubling one: Can intervention work? Its effects are usually ephemeral, because the private foreign-exchange market -– exceeding two trillion dollars of trading each day -- swamps their attempts. If intervention can succeed, then surely it would have done so in 1995, when the two major players in the dollar-yen exchange -- the U.S. and Japan – coordinated to try to shore up the dollar. The U.S. had wanted to avert inflation; Japan had wanted more exports. That August, while speculators were on vacation, the dollar rose for a while; but by September, they were selling dollars on the hunch that the stimulus had ended and thus the yen value of the dollar had peaked. That prophecy fulfilled itself.
Intervention, carried to its logical extreme, implies adopting one monetary rule around the world, such as a gold standard. Global markets have had no such standard since the early 1970s, when the United States abandoned the Bretton Woods system, in which the dollar was backed by gold and other currencies were backed by the dollar.
Under a gold standard, banks would buy and sell gold, and a currency backed by it, at a fixed rate -– say, $500 for an ounce of gold. The central bank’s reserves of gold would limit the amount of paper money that it could issue, since otherwise speculators could exchange worthless paper for gold until the bank ran out of ounces. So constrained, the bank would no longer be tempted to print money and hand it over to the government so that it could buy more than before. (That is, the government could buy more until prices rose to reflect the increase in money supply, reducing the government’s purchasing power to its original level).
Gold can restrain inflation -- brutally. Suppose, with the world on a gold standard, that prices suddenly spike in Kazakhstan. Since the country’s goods become more expensive than before, compared to other goods around the world, global consumers will stop spending gold on Kazakhstan’s products and spend it elsewhere. Kazakhstan’s supply of gold will fall.
To maintain the given rate of exchange between gold and tenge, the National Bank of Kazakhstan will have to withdraw tenge from circulation. If the Bank’s gold supply falls by half, then the Bank must withdraw half of the tenge in circulation. With fewer tenge and ounces of gold making the rounds, product prices in Kazakhstan must fall, reversing the initial inflation.
This is not an arid exercise. The deflation will raise real debt owed by firms and so will bankrupt some of them. Workers at these firms will lose their jobs. Other firms, seeing their output prices falling but unable to cut wages accordingly, will lay off employees. Stabilizing prices can hurt.
John Maynard Keynes pointed this out in 1925, when the Chancellor of the Exchequer, Winston Churchill, decided to strengthen Britain’s pound sterling until it was worth as much gold as before World War I. This implied that the pound would be able to buy more goods than before -– i.e., that product prices would fall. For this to happen, production costs would have to fall, or producers would go bankrupt. The largest cost of production was for labor. But English unions would resist wage cuts. Firms would be forced to lay off employees. Churchill’s deflation would bring about a depression. And it did. In fact, it may have raised the curtain on the Great Depression. –- Leon Taylor, taylorleon@gmail.com
Good reading
Sewell Chan and Martin Fackler. Currency move changes S. Korea plan. The New York Times. November 9, 2010
John Maynard Keynes. Essays in persuasion. New York: Palgrave Macmillan. 2010.
Roy Ruffin and Paul Gregory. Principles of macroeconomics. New York: Pearson. 2001. The seventh edition includes a clear introduction to currency markets and briefly discusses the 1995 intervention.
Thursday, February 24, 2011
Friday, February 18, 2011
Thought for food
Kazakhstan’s farm problem roots in a failed land market
Over the past year, prices have tripled for such staples of the Kazakhstani diet as meat, grain and beets. A large bakery in Petropavlovsk suspended bread deliveries because it could not recover cost increases with higher bread prices, reports a newspaper, Delovoy Kazakhstan.
Immediate causes of the food shortages include bad weather and the growing demand of Chinese consumers. But we went through this exercise in 2008. What are the long-run causes of recurring shortages? What, if anything, should the government do about them?
Although Kazakhstan accounts for nearly a third of the farmland in the transition economies of Europe and Central Asia, the importance to it of agriculture has been shrinking over the decades. While four fifths of our land is agricultural, farming accounted for just 8% of the economy (measured as gross domestic product) in 2005, having dropped 40% in gross output since 1990. After the twin crises of 1998, when the Russian ruble and the price of oil collapsed, agriculture failed to recover as strongly as the rest of the national economy, noted an agricultural economist, Zvi Lerman, and the Food and Agriculture Organization of the United Nations.
This is disproportionately unfortunate for Kazakhstan: Nearly half of its population is rural, and a quarter survives on subsistence farming, according to the World Bank.
Kazakhstani farms can produce more than they do. Farm labor productivity here had led the Soviet states from 1965 to 1990 -- 8,400 rubles of farm output per worker, nearly a tenth higher than Russia could manage, according to raw data from Lerman and coauthors. Why isn’t productivity higher now?
One problem may be the land market. When it works well, entrepreneurs can buy farms losing money and make them more efficient. In Kazakhstan, the farmland market has developed haltingly.
Novel markets
In the early years of the republic, the government owned most farmland. Land reform in the mid-Nineties sought to encourage entrepreneurs to take over the 2,500 soviet farms, including the sovhoz (averaging 95,000 hectares) and the kolhoz (38,000 ha), noted Steven Hendrix. But individuals could own plots of only up to 1 hectare; the government continued as the nominal owner of larger farms, noted Lerman and coauthors.
Belatedly, the government permitted a land market. This enabled family farms to increase their share of agricultural output from 28% in 1990 to 75% in 2000, according to the World Bank. The number of peasant farms increased from 3,300 in 1992 to 58,400 in 1999. At that time, their share of agricultural land, nearly one eighth, was unusually high for the post-Soviet region, noted Max Spoor and Oane Visser. Today, there are more than 91,000 peasant farms. Even this may be an underestimate, since subsistence farms and household plots tend to be unregistered, according to the World Bank. Most rural families surveyed by the World Bank in 1996 reported that they maintained plots on their own, such as a backyard. Of the livestock herd, family farms claimed 90% in 2002, compared to 29% in 1990, according to Lerman and co-authors.
These trends are encouraging. A study of the 23 transition economies between 1992 and 2004 found that agricultural growth increases with the share of land owned by individuals. But corporate farms (including cooperatives and limited-liability farms) still dominate, especially in the north, accounting for 60% of agricultural land in recent years, estimated Johan F. M. Swinnen and Liesbet Vranken.
To some extent, corporate dominance results from geography. Kazakhstan is land-intensive, with 114 hectares of agricultural land per farm worker in even the late Eighties, before the emigrations of the Nineties. The average registered farm here is 10 times larger than in the Czech Republic, according to the World Bank.
Block that market
But the most important reasons for corporate dominance seem institutional. Under the land code, the collective could deny the individual’s claim for land and offer cash instead, Hendrix noted. The code justified such barriers to breakups of estates as protection of the environment.
The unequal distribution of land shares also led to corporate concentration. A 1994 decree of the Cabinet of Ministers permitted closed auctions of state farms to small groups of educated specialists. A presidential decree allowed farm directors of 20 years’ standing to receive a fifth of the capital shares, but this was dropped after public protest, according to the Food and Agriculture Organization. Under the 2003 land code, corporate farms could claim ownership to properties that they had rented, said the World Bank.
To some degree, this could have improved farming. Some collectives reorganized as limited partnerships. Healthy corporate farms in north Kazakhstan – especially grain operations that integrated several stages of production – took over bankrupt properties, said the World Bank. But this vertical integration stemmed from a government decision to let farms buy cheap shares in the enterprises that processed their products, according to the Food and Agriculture Organization. Such control of suppliers may give a farm undue power in the food market – power that it may exercise by restricting output in order to sustain high prices. Soft budget constraints on reorganized farms – politically powerful in their regions -- discouraged efficiency. In the mid-Nineties, large farms in Kazakhstan had about the same yield per hectare as small farms but incurred higher costs, said Hendrix. The farms had yet to replace their old machines.
A farmland market exists, barely. As of 2004, fewer than 5% of rural households and family farms had sold any land. Fewer than 5% of unregistered farms had bought land, and no corporate farm had done so. They rented from farm members, although it is not clear that the latter received payments, noted Swinnen and Vranken. Cash payments to unregistered farms averaged 500 tenge for a fifth of a hectare, estimated the World Bank. Generally, corporate farms paid in-kind rent to households. Nearly half of the farm workers received payment only in kind, according to a World Bank survey in 2000.
More than 70% of farms surveyed in recent years reported difficulties in renting in land, estimated Swinnen and Vranken. More than half of family farms, and 30% of corporate farms, said the main problem was identifying the authority in charge of land rents – a virtually unknown problem in other CIS countries surveyed. Among corporate farms, nearly 30% reported that they didn’t know if they could rent legally; 35% said they couldn’t find anyone to whom to rent.
The creaky operation of the land market is not the only problem. Of family farms surveyed, nearly two-thirds said they didn’t buy more land because they lacked farm tools. Finding spare parts was also troublesome. But such markets may fall into place if the main one – the land market – worked more smoothly. – Leon Taylor, tayloralmaty@gmail.com
Good reading
Kelley Cormier. Farm restructuring in Kazakhstan: An institutional economics approach. Michigan State University, Department of Agricultural Economics, Agricultural Economics Report 612. December 2001. http://www.aec.msu.edu/aecreports/aec612.pdf.
Yulia Dubovytskyx. Tseni vzyaly razgon. Delovoy Kazakhstan. February 11, 2011. Page 1.
Steven E. Hendrix. Legislative reform of property ownership in Kazakhstan, Development Policy Review 15: 159-171. 1997.
Zvi Lerman. The impact of land reform on rural household incomes in Transcaucasia and Central Asia. Hebrew University of Jerusalem, Center for Agricultural Economic Research and the Department of Agricultural Economics and Management. Discussion paper, 9.05, 2005. http://departments.agri.huji.ac.il/economics/lerman-vol.pdf
Zvi Lerman, Csaba Csaki, and Gershon Feder. Agriculture in transition: Land policies and evolving farm structures in post-Soviet countries. Lanham, Md.: Lexington Books. 2004. http://www.agri.huji.ac.il/%7Elermanzv/book/Ch1Heritage.pdf
Max Spoor and Oane Visser, The state of agrarian reform in the former Soviet Union. Europe-Asia Studies 53:6. 2001.
Johan F. M. Swinnen and Liesbet Vranken. The development of rural land markets in transition countries. The Food and Agriculture Organization of the United Nations. http://www.fao.org/regional/seur/events/landmark/docs/swinnen.pdf
United Nations Food and Agriculture Organization. A profile of Kazakhstan’s agricultural reforms. 1995. http://www.fao.org/docrep/v6800e/V6800E0h.htm#A%20profile%20of%20Kazakhstan's%20agricultural%20reforms
World Bank. Untitled book, chapter 3: The role of labor markets and safety nets. http://siteresources.worldbank.org/INTECA/Resources/ch3-poverty.pdf
World Bank. Emerging challenges of land rental markets: A review of available evidence for the Europe and Central Asia region. March 2006. http://siteresources.worldbank.org/INTECA/Resources/EmergingChallengesofLandRentalMarkets_FullReport.pdf
Over the past year, prices have tripled for such staples of the Kazakhstani diet as meat, grain and beets. A large bakery in Petropavlovsk suspended bread deliveries because it could not recover cost increases with higher bread prices, reports a newspaper, Delovoy Kazakhstan.
Immediate causes of the food shortages include bad weather and the growing demand of Chinese consumers. But we went through this exercise in 2008. What are the long-run causes of recurring shortages? What, if anything, should the government do about them?
Although Kazakhstan accounts for nearly a third of the farmland in the transition economies of Europe and Central Asia, the importance to it of agriculture has been shrinking over the decades. While four fifths of our land is agricultural, farming accounted for just 8% of the economy (measured as gross domestic product) in 2005, having dropped 40% in gross output since 1990. After the twin crises of 1998, when the Russian ruble and the price of oil collapsed, agriculture failed to recover as strongly as the rest of the national economy, noted an agricultural economist, Zvi Lerman, and the Food and Agriculture Organization of the United Nations.
This is disproportionately unfortunate for Kazakhstan: Nearly half of its population is rural, and a quarter survives on subsistence farming, according to the World Bank.
Kazakhstani farms can produce more than they do. Farm labor productivity here had led the Soviet states from 1965 to 1990 -- 8,400 rubles of farm output per worker, nearly a tenth higher than Russia could manage, according to raw data from Lerman and coauthors. Why isn’t productivity higher now?
One problem may be the land market. When it works well, entrepreneurs can buy farms losing money and make them more efficient. In Kazakhstan, the farmland market has developed haltingly.
Novel markets
In the early years of the republic, the government owned most farmland. Land reform in the mid-Nineties sought to encourage entrepreneurs to take over the 2,500 soviet farms, including the sovhoz (averaging 95,000 hectares) and the kolhoz (38,000 ha), noted Steven Hendrix. But individuals could own plots of only up to 1 hectare; the government continued as the nominal owner of larger farms, noted Lerman and coauthors.
Belatedly, the government permitted a land market. This enabled family farms to increase their share of agricultural output from 28% in 1990 to 75% in 2000, according to the World Bank. The number of peasant farms increased from 3,300 in 1992 to 58,400 in 1999. At that time, their share of agricultural land, nearly one eighth, was unusually high for the post-Soviet region, noted Max Spoor and Oane Visser. Today, there are more than 91,000 peasant farms. Even this may be an underestimate, since subsistence farms and household plots tend to be unregistered, according to the World Bank. Most rural families surveyed by the World Bank in 1996 reported that they maintained plots on their own, such as a backyard. Of the livestock herd, family farms claimed 90% in 2002, compared to 29% in 1990, according to Lerman and co-authors.
These trends are encouraging. A study of the 23 transition economies between 1992 and 2004 found that agricultural growth increases with the share of land owned by individuals. But corporate farms (including cooperatives and limited-liability farms) still dominate, especially in the north, accounting for 60% of agricultural land in recent years, estimated Johan F. M. Swinnen and Liesbet Vranken.
To some extent, corporate dominance results from geography. Kazakhstan is land-intensive, with 114 hectares of agricultural land per farm worker in even the late Eighties, before the emigrations of the Nineties. The average registered farm here is 10 times larger than in the Czech Republic, according to the World Bank.
Block that market
But the most important reasons for corporate dominance seem institutional. Under the land code, the collective could deny the individual’s claim for land and offer cash instead, Hendrix noted. The code justified such barriers to breakups of estates as protection of the environment.
The unequal distribution of land shares also led to corporate concentration. A 1994 decree of the Cabinet of Ministers permitted closed auctions of state farms to small groups of educated specialists. A presidential decree allowed farm directors of 20 years’ standing to receive a fifth of the capital shares, but this was dropped after public protest, according to the Food and Agriculture Organization. Under the 2003 land code, corporate farms could claim ownership to properties that they had rented, said the World Bank.
To some degree, this could have improved farming. Some collectives reorganized as limited partnerships. Healthy corporate farms in north Kazakhstan – especially grain operations that integrated several stages of production – took over bankrupt properties, said the World Bank. But this vertical integration stemmed from a government decision to let farms buy cheap shares in the enterprises that processed their products, according to the Food and Agriculture Organization. Such control of suppliers may give a farm undue power in the food market – power that it may exercise by restricting output in order to sustain high prices. Soft budget constraints on reorganized farms – politically powerful in their regions -- discouraged efficiency. In the mid-Nineties, large farms in Kazakhstan had about the same yield per hectare as small farms but incurred higher costs, said Hendrix. The farms had yet to replace their old machines.
A farmland market exists, barely. As of 2004, fewer than 5% of rural households and family farms had sold any land. Fewer than 5% of unregistered farms had bought land, and no corporate farm had done so. They rented from farm members, although it is not clear that the latter received payments, noted Swinnen and Vranken. Cash payments to unregistered farms averaged 500 tenge for a fifth of a hectare, estimated the World Bank. Generally, corporate farms paid in-kind rent to households. Nearly half of the farm workers received payment only in kind, according to a World Bank survey in 2000.
More than 70% of farms surveyed in recent years reported difficulties in renting in land, estimated Swinnen and Vranken. More than half of family farms, and 30% of corporate farms, said the main problem was identifying the authority in charge of land rents – a virtually unknown problem in other CIS countries surveyed. Among corporate farms, nearly 30% reported that they didn’t know if they could rent legally; 35% said they couldn’t find anyone to whom to rent.
The creaky operation of the land market is not the only problem. Of family farms surveyed, nearly two-thirds said they didn’t buy more land because they lacked farm tools. Finding spare parts was also troublesome. But such markets may fall into place if the main one – the land market – worked more smoothly. – Leon Taylor, tayloralmaty@gmail.com
Good reading
Kelley Cormier. Farm restructuring in Kazakhstan: An institutional economics approach. Michigan State University, Department of Agricultural Economics, Agricultural Economics Report 612. December 2001. http://www.aec.msu.edu/aecreports/aec612.pdf.
Yulia Dubovytskyx. Tseni vzyaly razgon. Delovoy Kazakhstan. February 11, 2011. Page 1.
Steven E. Hendrix. Legislative reform of property ownership in Kazakhstan, Development Policy Review 15: 159-171. 1997.
Zvi Lerman. The impact of land reform on rural household incomes in Transcaucasia and Central Asia. Hebrew University of Jerusalem, Center for Agricultural Economic Research and the Department of Agricultural Economics and Management. Discussion paper, 9.05, 2005. http://departments.agri.huji.ac.il/economics/lerman-vol.pdf
Zvi Lerman, Csaba Csaki, and Gershon Feder. Agriculture in transition: Land policies and evolving farm structures in post-Soviet countries. Lanham, Md.: Lexington Books. 2004. http://www.agri.huji.ac.il/%7Elermanzv/book/Ch1Heritage.pdf
Max Spoor and Oane Visser, The state of agrarian reform in the former Soviet Union. Europe-Asia Studies 53:6. 2001.
Johan F. M. Swinnen and Liesbet Vranken. The development of rural land markets in transition countries. The Food and Agriculture Organization of the United Nations. http://www.fao.org/regional/seur/events/landmark/docs/swinnen.pdf
United Nations Food and Agriculture Organization. A profile of Kazakhstan’s agricultural reforms. 1995. http://www.fao.org/docrep/v6800e/V6800E0h.htm#A%20profile%20of%20Kazakhstan's%20agricultural%20reforms
World Bank. Untitled book, chapter 3: The role of labor markets and safety nets. http://siteresources.worldbank.org/INTECA/Resources/ch3-poverty.pdf
World Bank. Emerging challenges of land rental markets: A review of available evidence for the Europe and Central Asia region. March 2006. http://siteresources.worldbank.org/INTECA/Resources/EmergingChallengesofLandRentalMarkets_FullReport.pdf
Thursday, February 10, 2011
Monetizing the debt for fun and profit
Does the government lend to itself?
Since 2000, the government of Kazakhstan usually has managed to rack up tidy little surpluses of up to 4.2% of the size of the economy (measured in gross domestic product, or GDP). But when Kazakhstani banks crashed in 2008-9, the government attempted (with some success) to spend its way out of recession. Consequently, it began spending more money than it was collecting in tax revenues. By 2011, this deficit may amount to more than 6% of GDP – judging from the budget approved by the legislature -- although the prime minister vows to reduce it to less than 3%.
Kazakhstan does not have a deficit overhang of Grecian dimensions. (In Greece, where the government spent as if there would be no tomorrow, the deficit in 2009 exceeded 15% of GDP, although the European Union ostensibly limits the deficit of a member nation to 3% of GDP.) Even so, a persistent deficit in Kazakhstan could raise the spectre of higher interest rates, since the government might compete with entrepreneurs for loans by bidding up the price of a tenge loaned – the rate of interest.
To surreptitiously avoid this appearance, the government can quietly borrow from itself. The central bank can buy the government’s bonds, thus holding down the interest rate that Astana must pay on this debt. Because these transactions are inconspicuous, public borrowing might look affordable.
Monetizing the debt is a time-honored trick. In Germany of 1923, the Reichsbank held 190 million trillion marks of bonds sold by the government, wrote Robert Hetzel. When it comes to public deficits, the central bank is often a co-conspirator.
Who does your banker favor?
At the moment, net claims of the National Bank of Kazakhstan on the central government are negative, and the gross value of its government securities generally does not exceed 6 billion tenge. But as of December, net claims of commercial banks on the central government were nearly 400 billion tenge, the equal of more than 5% of their reserves, according to raw data from the National Bank. Claims on public nonfinancial institutions were more than twice as much – over 800 billion tenge (equaling more than 11% of reserves). This, of course, could not possibly have anything to do with the fact that since 2008 the government has become a major owner of large commercial banks.
Curiously, commercial bank loans to local governments – the oblasts and the cities – were less than 6 billion tenge, equaling just one-tenth of one percent of reserves. One would have thought that the banks would take more interest in the condition of their localities. Then again, we have a new owner.
All told, commercial bank loans to the public sector in Kazakhstan were easily more than half as much as their loans to households. To some extent, banks would rather finance the government than a local youth’s education.
Financial gumshoes
How can we tell whether we really can afford the public borrowing? By looking at the market rate of interest. This has two components.
One is the “real” interest rate, which reflects the real return to capital (that is, the return in terms of purchasing power). If people expect a proposed auto-assembly plant to earn 5 cents of profit per dollar spent on construction, then the entrepreneur is willing to pay up to 5 cents of interest to borrow a dollar for building.
The second component reflects the expected rate of inflation, since the lender wants to be compensated for any loss of purchasing power in his funds that is due to higher prices. When prices are twice as high, a tenge will buy only half as much. (Or less. In Argentina, a woman purchased a plane ticket to Lebanon in 1988 – only to find that the refund in 2001 would buy only an alarm clock, reported the Wall Street Journal.)
At present, the annual rate of inflation in Kazakhstan is about 8%. The creditor who lends a dollar for a year can expect to get back a dollar in 2012 that buys 8% less of goods than it would today. To offset this expected loss, the creditor will demand 8 cents of interest.
The expected rate of inflation may seem an evanescent idea. But for many long-term rates of interest -- such as on 30-year home mortgages a few years ago in the United States -- inflationary expectations make up the bulk of the rate. Before 2008, Americans expected prices to rise more and more sharply over time.
The market rate of interest sums the real rate of interest and the expected rate of inflation. The long-run real rate of return to capital per year in Kazakhstan is (very) roughly 8% to 10%, judging from the trend rate of economic growth. The expected rate of annual inflation may be 8%. Thus a typical interest rate on creditworthy corporate loans may be 16% or 18% over the long run.
Government borrowing may affect either component. If the government competes away resources from the private sector, then borrowers will have to propose more profitable projects than before in order to get funds. This increases the real rate of return to capital. Also, new government spending pressures prices upward when the economy already is producing at full capacity. Thus it increases the expected rate of inflation.
At present, the deficit does not have an overwhelming impact on private interest rates. The rate on short-term bank loans of tenge fell from 16.6% in 2008 to 16% in 2009, with rates continuing to fall into 2010, according to the National Bank. The rate on interbank loans rose from 4.67% in 2007 to 6.75% in 2009, but that probably reflected the growing riskiness of banking. All this notwithstanding, in any sustained recovery, one should consider whether government borrowing may contribute to inflation.
This examination would be simpler if we had a simple way to measure expected inflation.
In the United States, you can estimate this expectation by looking at the difference in rates between Treasury bonds that compensate you for inflation (on top of their usual yields) and Treasury bonds that don't. At present, a Treasury security maturing in five years yields .31% per year. That is, the bond would pay you 31 cents for every $100 that you spent on it, and it would also compensate for inflation on top of that. An ordinary Treasury bond maturing in five years yields 2.29% per year, according to data from the Federal Reserve. This suggests that people expected an average of 2.29% – .31% = 1.98% inflation per year until 2016.
Over the short run, this forecasting tool does pretty well: One can use the interest rates on one- to six-month Treasury bills to forecast inflation a month ahead in a way that is statistically reliable, noted economist Stephen Smith. The government of Kazakhstan may wish to give a thought or three to introducing inflation-indexed securities of its own. -- Leon Taylor, tayloralmaty@gmail.com
Good reading
Central Asia & Caucasus Business Weekly. Untitled article on Kazakhstani deficits. October 26, 2010 http://business.highbeam.com/436263/article-1G1-241679918/interfax-central-asia-amp-caucasus-business-weekly
Robert L. Hetzel. German monetary history in the first half of the twentieth century. Economic Quarterly. Federal Reserve Bank of Richmond. Winter 2002, pages 1-35. http://www.richmondfed.org/publications/research/economic_quarterly/2002/winter/pdf/hetzel.pdf
David Luhnow. For Argentina, no panacea in the dollar. Wall Street Journal. December 4, 2001. Page A12.
Stephen D. Smith. What do asset prices tell us about the future? Economic Review. Federal Reserve Bank of Atlanta. Third quarter 1999. http://www.frbatlanta.org/filelegacydocs/smith.pdf
Since 2000, the government of Kazakhstan usually has managed to rack up tidy little surpluses of up to 4.2% of the size of the economy (measured in gross domestic product, or GDP). But when Kazakhstani banks crashed in 2008-9, the government attempted (with some success) to spend its way out of recession. Consequently, it began spending more money than it was collecting in tax revenues. By 2011, this deficit may amount to more than 6% of GDP – judging from the budget approved by the legislature -- although the prime minister vows to reduce it to less than 3%.
Kazakhstan does not have a deficit overhang of Grecian dimensions. (In Greece, where the government spent as if there would be no tomorrow, the deficit in 2009 exceeded 15% of GDP, although the European Union ostensibly limits the deficit of a member nation to 3% of GDP.) Even so, a persistent deficit in Kazakhstan could raise the spectre of higher interest rates, since the government might compete with entrepreneurs for loans by bidding up the price of a tenge loaned – the rate of interest.
To surreptitiously avoid this appearance, the government can quietly borrow from itself. The central bank can buy the government’s bonds, thus holding down the interest rate that Astana must pay on this debt. Because these transactions are inconspicuous, public borrowing might look affordable.
Monetizing the debt is a time-honored trick. In Germany of 1923, the Reichsbank held 190 million trillion marks of bonds sold by the government, wrote Robert Hetzel. When it comes to public deficits, the central bank is often a co-conspirator.
Who does your banker favor?
At the moment, net claims of the National Bank of Kazakhstan on the central government are negative, and the gross value of its government securities generally does not exceed 6 billion tenge. But as of December, net claims of commercial banks on the central government were nearly 400 billion tenge, the equal of more than 5% of their reserves, according to raw data from the National Bank. Claims on public nonfinancial institutions were more than twice as much – over 800 billion tenge (equaling more than 11% of reserves). This, of course, could not possibly have anything to do with the fact that since 2008 the government has become a major owner of large commercial banks.
Curiously, commercial bank loans to local governments – the oblasts and the cities – were less than 6 billion tenge, equaling just one-tenth of one percent of reserves. One would have thought that the banks would take more interest in the condition of their localities. Then again, we have a new owner.
All told, commercial bank loans to the public sector in Kazakhstan were easily more than half as much as their loans to households. To some extent, banks would rather finance the government than a local youth’s education.
Financial gumshoes
How can we tell whether we really can afford the public borrowing? By looking at the market rate of interest. This has two components.
One is the “real” interest rate, which reflects the real return to capital (that is, the return in terms of purchasing power). If people expect a proposed auto-assembly plant to earn 5 cents of profit per dollar spent on construction, then the entrepreneur is willing to pay up to 5 cents of interest to borrow a dollar for building.
The second component reflects the expected rate of inflation, since the lender wants to be compensated for any loss of purchasing power in his funds that is due to higher prices. When prices are twice as high, a tenge will buy only half as much. (Or less. In Argentina, a woman purchased a plane ticket to Lebanon in 1988 – only to find that the refund in 2001 would buy only an alarm clock, reported the Wall Street Journal.)
At present, the annual rate of inflation in Kazakhstan is about 8%. The creditor who lends a dollar for a year can expect to get back a dollar in 2012 that buys 8% less of goods than it would today. To offset this expected loss, the creditor will demand 8 cents of interest.
The expected rate of inflation may seem an evanescent idea. But for many long-term rates of interest -- such as on 30-year home mortgages a few years ago in the United States -- inflationary expectations make up the bulk of the rate. Before 2008, Americans expected prices to rise more and more sharply over time.
The market rate of interest sums the real rate of interest and the expected rate of inflation. The long-run real rate of return to capital per year in Kazakhstan is (very) roughly 8% to 10%, judging from the trend rate of economic growth. The expected rate of annual inflation may be 8%. Thus a typical interest rate on creditworthy corporate loans may be 16% or 18% over the long run.
Government borrowing may affect either component. If the government competes away resources from the private sector, then borrowers will have to propose more profitable projects than before in order to get funds. This increases the real rate of return to capital. Also, new government spending pressures prices upward when the economy already is producing at full capacity. Thus it increases the expected rate of inflation.
At present, the deficit does not have an overwhelming impact on private interest rates. The rate on short-term bank loans of tenge fell from 16.6% in 2008 to 16% in 2009, with rates continuing to fall into 2010, according to the National Bank. The rate on interbank loans rose from 4.67% in 2007 to 6.75% in 2009, but that probably reflected the growing riskiness of banking. All this notwithstanding, in any sustained recovery, one should consider whether government borrowing may contribute to inflation.
This examination would be simpler if we had a simple way to measure expected inflation.
In the United States, you can estimate this expectation by looking at the difference in rates between Treasury bonds that compensate you for inflation (on top of their usual yields) and Treasury bonds that don't. At present, a Treasury security maturing in five years yields .31% per year. That is, the bond would pay you 31 cents for every $100 that you spent on it, and it would also compensate for inflation on top of that. An ordinary Treasury bond maturing in five years yields 2.29% per year, according to data from the Federal Reserve. This suggests that people expected an average of 2.29% – .31% = 1.98% inflation per year until 2016.
Over the short run, this forecasting tool does pretty well: One can use the interest rates on one- to six-month Treasury bills to forecast inflation a month ahead in a way that is statistically reliable, noted economist Stephen Smith. The government of Kazakhstan may wish to give a thought or three to introducing inflation-indexed securities of its own. -- Leon Taylor, tayloralmaty@gmail.com
Good reading
Central Asia & Caucasus Business Weekly. Untitled article on Kazakhstani deficits. October 26, 2010 http://business.highbeam.com/436263/article-1G1-241679918/interfax-central-asia-amp-caucasus-business-weekly
Robert L. Hetzel. German monetary history in the first half of the twentieth century. Economic Quarterly. Federal Reserve Bank of Richmond. Winter 2002, pages 1-35. http://www.richmondfed.org/publications/research/economic_quarterly/2002/winter/pdf/hetzel.pdf
David Luhnow. For Argentina, no panacea in the dollar. Wall Street Journal. December 4, 2001. Page A12.
Stephen D. Smith. What do asset prices tell us about the future? Economic Review. Federal Reserve Bank of Atlanta. Third quarter 1999. http://www.frbatlanta.org/filelegacydocs/smith.pdf
Thursday, February 3, 2011
Should the National Bank of Kazakhstan use a money rule?
Here’s a nightmare: The Kazakhstani economy in the early 90s. Monthly rates of consumer inflation were as high as 3,300% in the summer of ’94, estimates the National Bank of Kazakhstan.
Post-Soviet nations had printed rubles sans the oversight that Moscow had exercised in the days of the USSR. Each nation in the former Soviet bloc could pass along, to its neighbors, the costs of inflating its own supply of money, since the inflation reduced the value of the money received by foreigners. So each nation printed too much money. Result: Regional hyperinflation. Kazakhstan’s transition to the tenge in 1993 proved rocky.
By comparison to the early 90s, Kazakhstan no longer has a problem with prices. Even so, in the ongoing recovery, the price level has fluctuated quite a bit, tripling in one six-year stretch. Annual consumer inflation has never fallen below 5%, according to Kazakhstan’s central bank.
This sort of persistent inflation, like the hyperinflation of 1994-5, is the fault of the National Bank of Kazakhstan, which is supposed to manage the supply of tenge. Some events, like a labor strike or a bad harvest, can create inflation temporarily by raising production costs, compelling firms to raise prices. But the only cause of continued inflation is an ever-increasing supply of money. When it grows more rapidly than output, it provides more and more currency units per output unit. Prices must rise.
Fooling all of the workers some of the time
In 1968, the Nobel laureate Milton Friedman explained why a central bank tended to print too much money. The bank wants low inflation and low unemployment, but if it has to choose, then it may well prefer the latter.
In Friedman’s vision, the economy usually produces as much as it comfortably can – a level of output called “full employment.” The unemployment rate corresponding to this output is “natural.” To lower the unemployment rate below the natural rate, the bank must over-stimulate production. To do this, it seeks to raise the price level above what people expect, so that the real wage – the cost of a labor hour – falls below what workers think it is.
(The “real wage” expresses the purchasing power of the wage. A higher price level reduces the amount of output that a given wage can buy, diminishing its purchasing power. If prices double, then a wage of 10,000 tenge will buy only half as much as before.)
To raise the price level surreptitiously, the central bank prints money. Producers respond to the cut in wages by hiring more workers, thus increasing output. Workers will provide this additional labor because they don’t realize that their real wage has fallen. Once they do realize this, they will demand higher wages, to pay for the higher prices of the goods that they buy. To pay for the increase in wages, producers will raise output prices throughout the economy. The price level will rise, choking off aggregate demand. The fall in spending will force firms to lay off workers and curtail production until output returns to the full-employment level. Friedman does not explain why workers are slower than producers to discern the initial fall in real wages.
Money rules
What, if anything, should we do about excess in the money supply? Some economists – monetarists and New Classical economists -- argue that the National Bank should adopt a “money rule” that limits either the rate of inflation or the supply of money. For example, the Bank could declare that it would no longer tolerate rates of inflation higher than 2% or lower than 0% (that is, the Bank would not permit deflation). Such a rule would build the confidence of consumers and investors in the national economy. So they would continue to spend and invest even when an external shock, such as a bad harvest, reduced output for a while. The result would be a more stable business cycle – shorter, milder recessions.
The trouble with a money rule is that the National Bank must convince people that it will adhere to it. Otherwise, the rule won’t work. Since the rate of inflation has never fallen below 5% in Kazakhstan, people would have trouble believing that the Bank would now hold it below 2%. The Bank would have to demonstrate its determination, by withdrawing enough money from the economy – enough units of currency per unit of output -- to bring down the rate of inflation. In the short run, this withdrawal probably would reduce spending and create unemployment. If the Bank is not willing to risk a recession, then it might as well not even bring up the subject of a money rule. And so we continue to muddle along.
Scarce knowledge
Supporters of a money rule contend that we don’t know enough about Kazakhstan’s economy to fine-tune the supply of tenge to its daily needs. The National Bank seems to accept this argument. At one time, it used complex computer models, simultaneously solving many equations, in order to forecast economic conditions. Now it appears to rely more than before on back-of-the-envelope models. A money rule would be consistent with such simplicity.
Economist Robert Lucas, a Nobel laureate, points out that the parameters in large computer models are calibrated using past data. But what is relevant to forecasts is how people behave today, not how they behaved in the past. When they draw up their spending plans, they use all the information available to them, not just past information. A central bank acting on a model based on past data is like a general who keeps fighting the last war.
For example, the bank’s model might assume that a consumer spends 60 tenge of every 100 received. This assumption is based on what consumers used to do. But the economy is different now. If people expect a recession, then they may start now to build up a rainy-day fund, by saving more of their income. Today, they spend just 40 tenge of every 100 – and save the other 60. This decision is based on economic expectations. These, in turn, are based on today’s headlines, not on yesterday’s spending.
Do money rules work?
The central banks of New Zealand, the United Kingdom, Sweden and Canada have targeted inflation, with some success. In New Zealand, the Parliament could strip the governor of the central bank of his job if he did not keep inflation between 0 and 3 percent, noted Bennett McCallum. Canada’s economy settled down after the central bank stopped targeting the money supply – which had not stopped inflation – and decided to reduce inflation directly, in 1991, wrote Ben Bernanke (now chairman of the Federal Reserve) and Frederic Mishkin. In Europe, the Bundesbank and the Banque de France provoked recessions so that they could stabilize their prices for the new European Monetary Union, wrote Robert Hetzel. Other countries that have targeted inflation include Australia and Israel, as well as Finland and Spain under their old central banks, according to Bernanke and Mishkin.
Typically, countries target a sort of consumer price index, usually excluding food and energy prices as too volatile to express underlying inflation, wrote Bernanke and Mishkin. When oil prices rose, the Bank of Canada ignored them when calculating inflation, wrote David Dodge.
At the moment, inflation is not a problem. Although bank reserves skyrocketed in the United States after 2008, the commercial banks there have yet to dole out most of this money to borrowers. Since no one is spending the vault cash, it doesn’t push up prices.
But according to monetarists, the time to worry about inflation is before it happens. As a famous joke has it, the job of the central bank is to take away the punch bowl before the party begins to swing. Is the National Bank of Kazakhstan allowing itself enough time to confiscate the good stuff? – Leon Taylor, tayloralmaty@gmail.com
Good reading
Ben S. Bernanke and Frederic S. Mishkin. Inflation targeting: A new framework for monetary policy? Journal of Economic Perspectives. Spring 1997. Analyzes the policies of various central banks.
David A. Dodge. Untitled remarks. Economic Review. Federal Reserve Bank of Kansas City. Fourth quarter 2002. About Canada’s central banking.
Milton Friedman. The role of monetary policy. American Economic Review 58: 1-17. May 1968. Readable and influential.
Robert L. Hetzel. German monetary history in the second half of the twentieth century. Economic Quarterly. Federal Reserve Bank of Richmond.
Juliet Johnson. A fistful of rubles: The rise and fall of the Russian banking system. Ithaca, New York: Cornell University Press. 2000. Discusses the early years of post-Soviet banking.
Mankiw, N. Gregory. Macroeconomics. New York: Worth Publishers. Fourth edition, 2011. Chapter 15 analyzes policy rules.
Bennett T. McCallum. Recent developments in monetary policy analysis: The roles of theory and evidence. Economic Quarterly. Federal Reserve Bank of Richmond. Winter 2002. Discusses New Zealand’s central bank.
Post-Soviet nations had printed rubles sans the oversight that Moscow had exercised in the days of the USSR. Each nation in the former Soviet bloc could pass along, to its neighbors, the costs of inflating its own supply of money, since the inflation reduced the value of the money received by foreigners. So each nation printed too much money. Result: Regional hyperinflation. Kazakhstan’s transition to the tenge in 1993 proved rocky.
By comparison to the early 90s, Kazakhstan no longer has a problem with prices. Even so, in the ongoing recovery, the price level has fluctuated quite a bit, tripling in one six-year stretch. Annual consumer inflation has never fallen below 5%, according to Kazakhstan’s central bank.
This sort of persistent inflation, like the hyperinflation of 1994-5, is the fault of the National Bank of Kazakhstan, which is supposed to manage the supply of tenge. Some events, like a labor strike or a bad harvest, can create inflation temporarily by raising production costs, compelling firms to raise prices. But the only cause of continued inflation is an ever-increasing supply of money. When it grows more rapidly than output, it provides more and more currency units per output unit. Prices must rise.
Fooling all of the workers some of the time
In 1968, the Nobel laureate Milton Friedman explained why a central bank tended to print too much money. The bank wants low inflation and low unemployment, but if it has to choose, then it may well prefer the latter.
In Friedman’s vision, the economy usually produces as much as it comfortably can – a level of output called “full employment.” The unemployment rate corresponding to this output is “natural.” To lower the unemployment rate below the natural rate, the bank must over-stimulate production. To do this, it seeks to raise the price level above what people expect, so that the real wage – the cost of a labor hour – falls below what workers think it is.
(The “real wage” expresses the purchasing power of the wage. A higher price level reduces the amount of output that a given wage can buy, diminishing its purchasing power. If prices double, then a wage of 10,000 tenge will buy only half as much as before.)
To raise the price level surreptitiously, the central bank prints money. Producers respond to the cut in wages by hiring more workers, thus increasing output. Workers will provide this additional labor because they don’t realize that their real wage has fallen. Once they do realize this, they will demand higher wages, to pay for the higher prices of the goods that they buy. To pay for the increase in wages, producers will raise output prices throughout the economy. The price level will rise, choking off aggregate demand. The fall in spending will force firms to lay off workers and curtail production until output returns to the full-employment level. Friedman does not explain why workers are slower than producers to discern the initial fall in real wages.
Money rules
What, if anything, should we do about excess in the money supply? Some economists – monetarists and New Classical economists -- argue that the National Bank should adopt a “money rule” that limits either the rate of inflation or the supply of money. For example, the Bank could declare that it would no longer tolerate rates of inflation higher than 2% or lower than 0% (that is, the Bank would not permit deflation). Such a rule would build the confidence of consumers and investors in the national economy. So they would continue to spend and invest even when an external shock, such as a bad harvest, reduced output for a while. The result would be a more stable business cycle – shorter, milder recessions.
The trouble with a money rule is that the National Bank must convince people that it will adhere to it. Otherwise, the rule won’t work. Since the rate of inflation has never fallen below 5% in Kazakhstan, people would have trouble believing that the Bank would now hold it below 2%. The Bank would have to demonstrate its determination, by withdrawing enough money from the economy – enough units of currency per unit of output -- to bring down the rate of inflation. In the short run, this withdrawal probably would reduce spending and create unemployment. If the Bank is not willing to risk a recession, then it might as well not even bring up the subject of a money rule. And so we continue to muddle along.
Scarce knowledge
Supporters of a money rule contend that we don’t know enough about Kazakhstan’s economy to fine-tune the supply of tenge to its daily needs. The National Bank seems to accept this argument. At one time, it used complex computer models, simultaneously solving many equations, in order to forecast economic conditions. Now it appears to rely more than before on back-of-the-envelope models. A money rule would be consistent with such simplicity.
Economist Robert Lucas, a Nobel laureate, points out that the parameters in large computer models are calibrated using past data. But what is relevant to forecasts is how people behave today, not how they behaved in the past. When they draw up their spending plans, they use all the information available to them, not just past information. A central bank acting on a model based on past data is like a general who keeps fighting the last war.
For example, the bank’s model might assume that a consumer spends 60 tenge of every 100 received. This assumption is based on what consumers used to do. But the economy is different now. If people expect a recession, then they may start now to build up a rainy-day fund, by saving more of their income. Today, they spend just 40 tenge of every 100 – and save the other 60. This decision is based on economic expectations. These, in turn, are based on today’s headlines, not on yesterday’s spending.
Do money rules work?
The central banks of New Zealand, the United Kingdom, Sweden and Canada have targeted inflation, with some success. In New Zealand, the Parliament could strip the governor of the central bank of his job if he did not keep inflation between 0 and 3 percent, noted Bennett McCallum. Canada’s economy settled down after the central bank stopped targeting the money supply – which had not stopped inflation – and decided to reduce inflation directly, in 1991, wrote Ben Bernanke (now chairman of the Federal Reserve) and Frederic Mishkin. In Europe, the Bundesbank and the Banque de France provoked recessions so that they could stabilize their prices for the new European Monetary Union, wrote Robert Hetzel. Other countries that have targeted inflation include Australia and Israel, as well as Finland and Spain under their old central banks, according to Bernanke and Mishkin.
Typically, countries target a sort of consumer price index, usually excluding food and energy prices as too volatile to express underlying inflation, wrote Bernanke and Mishkin. When oil prices rose, the Bank of Canada ignored them when calculating inflation, wrote David Dodge.
At the moment, inflation is not a problem. Although bank reserves skyrocketed in the United States after 2008, the commercial banks there have yet to dole out most of this money to borrowers. Since no one is spending the vault cash, it doesn’t push up prices.
But according to monetarists, the time to worry about inflation is before it happens. As a famous joke has it, the job of the central bank is to take away the punch bowl before the party begins to swing. Is the National Bank of Kazakhstan allowing itself enough time to confiscate the good stuff? – Leon Taylor, tayloralmaty@gmail.com
Good reading
Ben S. Bernanke and Frederic S. Mishkin. Inflation targeting: A new framework for monetary policy? Journal of Economic Perspectives. Spring 1997. Analyzes the policies of various central banks.
David A. Dodge. Untitled remarks. Economic Review. Federal Reserve Bank of Kansas City. Fourth quarter 2002. About Canada’s central banking.
Milton Friedman. The role of monetary policy. American Economic Review 58: 1-17. May 1968. Readable and influential.
Robert L. Hetzel. German monetary history in the second half of the twentieth century. Economic Quarterly. Federal Reserve Bank of Richmond.
Juliet Johnson. A fistful of rubles: The rise and fall of the Russian banking system. Ithaca, New York: Cornell University Press. 2000. Discusses the early years of post-Soviet banking.
Mankiw, N. Gregory. Macroeconomics. New York: Worth Publishers. Fourth edition, 2011. Chapter 15 analyzes policy rules.
Bennett T. McCallum. Recent developments in monetary policy analysis: The roles of theory and evidence. Economic Quarterly. Federal Reserve Bank of Richmond. Winter 2002. Discusses New Zealand’s central bank.
Tuesday, February 1, 2011
Who cares about inflation?
Quietly, the supply of tenge has been rising more rapidly than has Kazakhstani output. This may presage a general rise in prices – inflation. The number of tenge in cash, checkable accounts, and small savings accounts – economists call this supply M2 – has doubled since early 2008, according to data from the National Bank of Kazakhstan.
At the moment, we haven’t noticed this excess supply of money, because people aren’t spending it. But with oil prices rising, Kazakhstan’s economy is on the threshold of another strong recovery. Sometime in the next few years, production here may increase to the point where no excess capacity in the economy remains. When that happens, additional spending must drive up prices, since the economy won’t be able to produce any more than it already does. As a result, the annual rate of inflation in Kazakhstan, now under 7%, may spike – just as it did in 2008, when consumer prices rose 17%. So maybe this is the right time to ask: Who cares about inflation?
Few studies in Kazakhstan have addressed this question. But the work in the United States indicates that the public may worry more about inflation than do economists. In surveys, Americans typically named inflation as a more serious problem than unemployment, although they were not willing to accept higher unemployment in exchange for lower inflation, wrote Rebecca Hellerstein. Maybe that’s because unemployment has never affected more than a tenth of the labor force since the Great Depression, while inflation affects us all.
Americans particularly worry about inflation when it rises above 5 or 6 percent, because they believe that prices will rise before their wages do, Hellerstein noted. When the rate rose above 10 percent in the Seventies, Americans named inflation as “public enemy number one.” President Gerald Ford crusaded to “whip inflation now” (WIN for short; Ford lost the 1976 presidential election, anyway).
You could argue that the American experience does not pertain to Kazakhstan, since the United States has never seen a rate of inflation anywhere near 3,000% (which Kazakhstan suffered in 1994). But it’s reasonable to think that if Americans worry about a 5% rate of inflation, then so will people in Kazakhstan, where annual inflation has never been below 5% ever since the country became independent in 1991.
Hyperactive prices
In other countries, hyperinflation (in which prices rise by more than 100% per year) has left the public chary of even moderate inflation. The Brazilians have an historical fear of inflation, for good reason. A good with a price of $1 in 1912 would have had a price of $1,000 trillion in the Nineties, noted Gerald Dwyer Jr. and R.W. Hafer. Before it adopted the euro, Germany avidly fought inflation of the deutschmark, because it remembered the hyperinflation of 1923 that helped bring Hitler to power.
You would think that the National Bank of Kazakhstan, which manages the supply of tenge, would make moderating inflation a top priority, if only to placate a public that remembers 1994. In fact, the Bank’s stance toward inflation does not seem as clear as it did in 2004, when it said its main job was to stabilize prices.
Germany in the 1920s provides a vivid example of what can happen when the central bank ignores rising rates of inflation. Robert Hetzel and Thomas Sargent have analyzed the incident separately.
Germany had entered World War I thinking that the war would be short, as had been the Franco-Prussian War a few decades earlier. So the Germans tried to finance WWI by borrowing (in particular, by issuing bonds); Germany had no income tax to help pay for the war. By the 1918 armistice, the Reich’s debt was half of national wealth. On top of that, the Allies demanded 132 billion gold marks; at the time, the total currency in Germany was 6 billion marks.
Until 1922, Germany struggled with the reparations, paying a tenth of its national income. Finally it decided to print money. The Reichsbank engaged nearly 1,800 printing presses.
Prices rose nearly a trillion-fold. In Berlin, a loaf of bread in 1923 cost 428 billion marks, or 71 billion times more than Germany’s total currency before World War I. A kilogram of butter cost almost 6 trillion marks.
Eventually Germany fixed the exchange rate at 4.2 trillion marks to the dollar. It brought the hyperinflation to a sudden end in 1924 by limiting increases in the money supply.
Meanwhile, hyperinflation had broken down the rule of law. “Lenin was certainly right,” Keynes had written in 1919. “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.” When the government set the price of bread at 140 billion marks, crowds raided stores and attacked Jews. Hyperinflation paved the way, 10 years later, for the Nazis. Hitler promised to hold down retail prices. That, he smirked, was what his storm troopers were for.
Nothing so drastic is likely to occur in Kazakhstan, where the government is more stable than the Weimar regime was in 1920s Germany. Even so, we might do well to remember that steep rates of inflation entail a political cost. – Leon Taylor, tayloralmaty@gmail.com
Good reading
Gerald P. Dwyer Jr. and R.W. Hafer. Are money growth and inflation still related? Economic Review. Federal Reserve Bank of Atlanta. Second quarter 1999, pages 32-43. http://www.frbatlanta.org/filelegacydocs/dwyhaf.pdf Discusses the Brazilian experience.
Rebecca Hellerstein. The impact of inflation. Regional Review. Federal Reserve Bank of Boston. Winter 1997. http://www.bos.frb.org/economic/nerr/rr1997/winter/hell97_1.htm Reviews surveys of Americans concerning inflation.
Robert L. Hetzel. German monetary history in the first half of the twentieth century. Economic Quarterly. Federal Reserve Bank of Richmond. Winter 2002, pages 1-35. http://www.richmondfed.org/publications/research/economic_quarterly/2002/winter/pdf/hetzel.pdf
John Maynard Keynes. Economic consequences of the peace. London: Macmillan. 1919. A famous analysis of reparations and inflation.
National Bank of Kazakhstan. Overview of the monetary police of the National Bank of Kazakhstan. October 2004. www.nationalbank.kz . States the Bank’s anti-inflation policy at that time.
Thomas J. Sargent. The ends of four big inflations. Federal Reserve Bank of Minneapolis Working Paper No. 158. May 1981. http://www.minneapolisfed.org/research/WP/WP158.pdf . Explains how Germany ended hyperinflation.
At the moment, we haven’t noticed this excess supply of money, because people aren’t spending it. But with oil prices rising, Kazakhstan’s economy is on the threshold of another strong recovery. Sometime in the next few years, production here may increase to the point where no excess capacity in the economy remains. When that happens, additional spending must drive up prices, since the economy won’t be able to produce any more than it already does. As a result, the annual rate of inflation in Kazakhstan, now under 7%, may spike – just as it did in 2008, when consumer prices rose 17%. So maybe this is the right time to ask: Who cares about inflation?
Few studies in Kazakhstan have addressed this question. But the work in the United States indicates that the public may worry more about inflation than do economists. In surveys, Americans typically named inflation as a more serious problem than unemployment, although they were not willing to accept higher unemployment in exchange for lower inflation, wrote Rebecca Hellerstein. Maybe that’s because unemployment has never affected more than a tenth of the labor force since the Great Depression, while inflation affects us all.
Americans particularly worry about inflation when it rises above 5 or 6 percent, because they believe that prices will rise before their wages do, Hellerstein noted. When the rate rose above 10 percent in the Seventies, Americans named inflation as “public enemy number one.” President Gerald Ford crusaded to “whip inflation now” (WIN for short; Ford lost the 1976 presidential election, anyway).
You could argue that the American experience does not pertain to Kazakhstan, since the United States has never seen a rate of inflation anywhere near 3,000% (which Kazakhstan suffered in 1994). But it’s reasonable to think that if Americans worry about a 5% rate of inflation, then so will people in Kazakhstan, where annual inflation has never been below 5% ever since the country became independent in 1991.
Hyperactive prices
In other countries, hyperinflation (in which prices rise by more than 100% per year) has left the public chary of even moderate inflation. The Brazilians have an historical fear of inflation, for good reason. A good with a price of $1 in 1912 would have had a price of $1,000 trillion in the Nineties, noted Gerald Dwyer Jr. and R.W. Hafer. Before it adopted the euro, Germany avidly fought inflation of the deutschmark, because it remembered the hyperinflation of 1923 that helped bring Hitler to power.
You would think that the National Bank of Kazakhstan, which manages the supply of tenge, would make moderating inflation a top priority, if only to placate a public that remembers 1994. In fact, the Bank’s stance toward inflation does not seem as clear as it did in 2004, when it said its main job was to stabilize prices.
Germany in the 1920s provides a vivid example of what can happen when the central bank ignores rising rates of inflation. Robert Hetzel and Thomas Sargent have analyzed the incident separately.
Germany had entered World War I thinking that the war would be short, as had been the Franco-Prussian War a few decades earlier. So the Germans tried to finance WWI by borrowing (in particular, by issuing bonds); Germany had no income tax to help pay for the war. By the 1918 armistice, the Reich’s debt was half of national wealth. On top of that, the Allies demanded 132 billion gold marks; at the time, the total currency in Germany was 6 billion marks.
Until 1922, Germany struggled with the reparations, paying a tenth of its national income. Finally it decided to print money. The Reichsbank engaged nearly 1,800 printing presses.
Prices rose nearly a trillion-fold. In Berlin, a loaf of bread in 1923 cost 428 billion marks, or 71 billion times more than Germany’s total currency before World War I. A kilogram of butter cost almost 6 trillion marks.
Eventually Germany fixed the exchange rate at 4.2 trillion marks to the dollar. It brought the hyperinflation to a sudden end in 1924 by limiting increases in the money supply.
Meanwhile, hyperinflation had broken down the rule of law. “Lenin was certainly right,” Keynes had written in 1919. “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.” When the government set the price of bread at 140 billion marks, crowds raided stores and attacked Jews. Hyperinflation paved the way, 10 years later, for the Nazis. Hitler promised to hold down retail prices. That, he smirked, was what his storm troopers were for.
Nothing so drastic is likely to occur in Kazakhstan, where the government is more stable than the Weimar regime was in 1920s Germany. Even so, we might do well to remember that steep rates of inflation entail a political cost. – Leon Taylor, tayloralmaty@gmail.com
Good reading
Gerald P. Dwyer Jr. and R.W. Hafer. Are money growth and inflation still related? Economic Review. Federal Reserve Bank of Atlanta. Second quarter 1999, pages 32-43. http://www.frbatlanta.org/filelegacydocs/dwyhaf.pdf Discusses the Brazilian experience.
Rebecca Hellerstein. The impact of inflation. Regional Review. Federal Reserve Bank of Boston. Winter 1997. http://www.bos.frb.org/economic/nerr/rr1997/winter/hell97_1.htm Reviews surveys of Americans concerning inflation.
Robert L. Hetzel. German monetary history in the first half of the twentieth century. Economic Quarterly. Federal Reserve Bank of Richmond. Winter 2002, pages 1-35. http://www.richmondfed.org/publications/research/economic_quarterly/2002/winter/pdf/hetzel.pdf
John Maynard Keynes. Economic consequences of the peace. London: Macmillan. 1919. A famous analysis of reparations and inflation.
National Bank of Kazakhstan. Overview of the monetary police of the National Bank of Kazakhstan. October 2004. www.nationalbank.kz . States the Bank’s anti-inflation policy at that time.
Thomas J. Sargent. The ends of four big inflations. Federal Reserve Bank of Minneapolis Working Paper No. 158. May 1981. http://www.minneapolisfed.org/research/WP/WP158.pdf . Explains how Germany ended hyperinflation.
A snapshot of Kazakhstan’s economy
Smile for the camera...
Since independence in 1991, Kazakhstan has been in one long business cycle, according to World Bank data. Annual output fell 60% until after the crash of the Russian ruble in 1998. Then output recovered, in tandem with rising oil prices. Some private estimates assert that Kazakhstan was in a mild recession in 2008-09, due to collapsing banks and falling oil prices. World Bank data indicate that income stagnated in those years but did not fall significantly.
Real wages in Kazakhstan have risen 7.5% per year since 2003, according to raw data from the government's statistical agency. At that rate, the worker's purchasing power would more than double every decade. Wages in Almaty and Astana are 40% higher than the national average, but the urban wage premium has been diminishing.
The unemployment rate has been dropping slowly for more than three years (Note 1). The rate was 7.3% for 2007 and 6.6% for both 2008 and 2009. The first half of 2010 improved upon that of 2009: The rate dropped from 6.9% to 6.2% in the first quarter and from 6.7% to 5.8% in the second.
What is most visible in the unemployment rate is not its sectoral decline but its strong seasonality. The rate is highest in the first quarter of each year, probably because of winter.
Most striking is the steep decline in unemployment among youths aged 15 to 24. Winter unemployment of youth fell by nearly half from 2007 to 2010, from 11% to 6.1%.
Over the long haul
The economy’s capacity to produce may be growing. The “long-term” rate of unemployment – referring to those who have looked futilely for work for a year -- is falling more sharply than is the general rate. The long-term rate reflects the difficulty of matching workers to jobs (“structural” unemployment), so the allocation of labor may be improving.
If indeed labor is becoming more mobile in Kazakhstan, then we should see a decrease in the dispersion of unemployment rates across oblasts and cities over time. Workers unemployed in one region would have an easier time than before of finding work in another region. As it happens, one measure of dispersion in unemployment rates across oblasts and cities – the standard deviation -- has fallen by more than two-thirds since 2003, with most of the decline occurring before the 2008-2009 slowdown of the national economy.
As the economy becomes more efficient, the relative importance of short-term unemployment grows apace. It accounted for nearly two-thirds of all unemployment by early 2010.
Most short-term unemployment – which has comprised about 4% of the labor force since 2007 – probably arises either from the business cycle or from economic “friction.” Sources of friction include logistical delays in beginning a job as well as short searches for better jobs. As a matter of fact, the rate of short-term unemployment has been relatively stable across phases of the business cycle. Since early 2007, it has varied only from 3.6% to 4.2%, with most values clustering around 3.9% (Note 2). This indicates that most short-term unemployment may be frictional. The government may want to take a closer look at the short-run labor market.
Urban doldrums
Kazakhstan’s major cities, Almaty and Astana, have not recovered from the 2008-09 slowdown as fully as has the nation. The unemployment rate in Almaty was one-sixth higher than the national rate in 2009 – and this ratio has been increasing steadily since 2003.
Unemployment rates are also higher in Astana than in the nation, and the trend since 2003 has not been in Astana’s favor. Perhaps migrants to the two cities are over-estimating their chances of employment there.
Wage trends also indicate a sluggish recovery in the cities. While real wages remain higher in Almaty and Astana than for the entire nation, the urban wage premium is diminishing. For Almaty, the premium has fallen from nearly 50% in 2007 to 40% in early 2010.
In most years since 2003, real wages have been higher in Astana than in Almaty. Is the government becoming a more lucrative sector of the economy than are finance and education? – Leon Taylor, tayloralmaty@gmail.com
Notes
1. The source of GDP data is the World Bank (www.worldbank.org). All other raw data are from the statistical agency of Kazakhstan (www.stat.kz).
Government data for monthly wages that are ostensibly real, from 2003 through 2010, suggest an annual rate of increase of 16.4% over that period, but the statistical agency has apparently confused nominal wages for real wages.
2. One measure of dispersion in a given variable is the ratio of the standard deviation to the mean. This measure is .04 for the rate of total unemployment, .071 for the rate of long-term unemployment, and just .018 for the rate of short-term unemployment.
Since independence in 1991, Kazakhstan has been in one long business cycle, according to World Bank data. Annual output fell 60% until after the crash of the Russian ruble in 1998. Then output recovered, in tandem with rising oil prices. Some private estimates assert that Kazakhstan was in a mild recession in 2008-09, due to collapsing banks and falling oil prices. World Bank data indicate that income stagnated in those years but did not fall significantly.
Real wages in Kazakhstan have risen 7.5% per year since 2003, according to raw data from the government's statistical agency. At that rate, the worker's purchasing power would more than double every decade. Wages in Almaty and Astana are 40% higher than the national average, but the urban wage premium has been diminishing.
The unemployment rate has been dropping slowly for more than three years (Note 1). The rate was 7.3% for 2007 and 6.6% for both 2008 and 2009. The first half of 2010 improved upon that of 2009: The rate dropped from 6.9% to 6.2% in the first quarter and from 6.7% to 5.8% in the second.
What is most visible in the unemployment rate is not its sectoral decline but its strong seasonality. The rate is highest in the first quarter of each year, probably because of winter.
Most striking is the steep decline in unemployment among youths aged 15 to 24. Winter unemployment of youth fell by nearly half from 2007 to 2010, from 11% to 6.1%.
Over the long haul
The economy’s capacity to produce may be growing. The “long-term” rate of unemployment – referring to those who have looked futilely for work for a year -- is falling more sharply than is the general rate. The long-term rate reflects the difficulty of matching workers to jobs (“structural” unemployment), so the allocation of labor may be improving.
If indeed labor is becoming more mobile in Kazakhstan, then we should see a decrease in the dispersion of unemployment rates across oblasts and cities over time. Workers unemployed in one region would have an easier time than before of finding work in another region. As it happens, one measure of dispersion in unemployment rates across oblasts and cities – the standard deviation -- has fallen by more than two-thirds since 2003, with most of the decline occurring before the 2008-2009 slowdown of the national economy.
As the economy becomes more efficient, the relative importance of short-term unemployment grows apace. It accounted for nearly two-thirds of all unemployment by early 2010.
Most short-term unemployment – which has comprised about 4% of the labor force since 2007 – probably arises either from the business cycle or from economic “friction.” Sources of friction include logistical delays in beginning a job as well as short searches for better jobs. As a matter of fact, the rate of short-term unemployment has been relatively stable across phases of the business cycle. Since early 2007, it has varied only from 3.6% to 4.2%, with most values clustering around 3.9% (Note 2). This indicates that most short-term unemployment may be frictional. The government may want to take a closer look at the short-run labor market.
Urban doldrums
Kazakhstan’s major cities, Almaty and Astana, have not recovered from the 2008-09 slowdown as fully as has the nation. The unemployment rate in Almaty was one-sixth higher than the national rate in 2009 – and this ratio has been increasing steadily since 2003.
Unemployment rates are also higher in Astana than in the nation, and the trend since 2003 has not been in Astana’s favor. Perhaps migrants to the two cities are over-estimating their chances of employment there.
Wage trends also indicate a sluggish recovery in the cities. While real wages remain higher in Almaty and Astana than for the entire nation, the urban wage premium is diminishing. For Almaty, the premium has fallen from nearly 50% in 2007 to 40% in early 2010.
In most years since 2003, real wages have been higher in Astana than in Almaty. Is the government becoming a more lucrative sector of the economy than are finance and education? – Leon Taylor, tayloralmaty@gmail.com
Notes
1. The source of GDP data is the World Bank (www.worldbank.org). All other raw data are from the statistical agency of Kazakhstan (www.stat.kz).
Government data for monthly wages that are ostensibly real, from 2003 through 2010, suggest an annual rate of increase of 16.4% over that period, but the statistical agency has apparently confused nominal wages for real wages.
2. One measure of dispersion in a given variable is the ratio of the standard deviation to the mean. This measure is .04 for the rate of total unemployment, .071 for the rate of long-term unemployment, and just .018 for the rate of short-term unemployment.
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