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.