An inconvenient number

Kazakhstan’s central bank, the National Bank, has long maintained that inflation here has chiefly a “non-monetary character”, reported a business weekly, Panorama. 

There’s only one problem with the Bank’s claim: It’s probably wrong.  In Kazakhstan, the simple correlation between the supply of tenge (chiefly cash and checkable accounts) and average consumer prices exceeds .97.  That is, the correlation here between money and prices is positive and virtually perfect:  It tells us that more money is almost always associated with higher prices.  The increase in average prices is, of course, inflation.

Correlation need not imply causation; for example, money and prices in Kazakhstan may each relate to a third factor rather than directly to each other.  But in general, “inflation is almost always the result of rapid growth in the money supply” because “no other factor is likely to lead to persistent increases in the price level”, writes a well-known monetary economist, David Romer. 

Consider the impact of two likely factors -- output and the interest rate. 

In principle, a decrease in output could raise prices, since we would be spending the same amount of money as before but on fewer goods.  But statistical estimates indicate that output would have to fall by half if it is to double prices, Romer writes.  Such a large change in output is unrealistic. 

Similarly, an increase in the interest rate could induce people to buy interest-bearing assets, bidding up their prices and thus creating inflation.  But interest rates would have to rise by a factor of 32 if they are to double prices.  That’s almost inconceivable. 

On the other hand, doubling the money supply over a few years – which is what a doubling of prices would require – is rather common.  Just ask the Bank of Japan.

Lots of factors – ranging from earthquakes to elections -- can spark a one-time rise in prices.  But a sustained rise almost always has one cause only:  The central bank, in effect, is revving up the printing presses.  --Leon Taylor, tayloralmaty@gmail.com

Notes

1. The money supply considered here is M1, called "narrow money" because it is quite liquid. 
2. “Average consumer prices” refers to the consumer price level. 
3. The simple correlation coefficient gauges the direction and strength of the relationship between two variables.  The coefficient varies from -1 to 1, where values close to -1 indicate a strong, negative relationship; values close to 1, a strong, positive relationship; and values close to 0, a weak relationship or none.  To estimate the coefficient, I used the Bank’s monthly data for the period from 2000 through 2011.

References

Drozd, Nikolai.  Sytuatsyu na valutnom rinke udalos’ uspokoyt s bolswym trudom.  Panorama.  August 9, 2013.

Romer, David.  Advanced macroeconomics.  McGraw-Hill Irwin.  Third edition. 2006.