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BOHANON & STYRING: Venezuela offers lessons in dangers of inflation

February 27, 2016

Economic AnalysisVenezuela just landed 37 jumbo jets packed with a commodity vital to that country’s economy. No, it wasn’t food, medicine or disposable diapers—though all those necessities do happen to be in short supply in that inflation-wracked, price-controlled, government-directed economy. The 747s were loaded with bank notes. Seems inflation is so rampant, the country’s combined printing presses can’t keep up with the demand for paper bolivars. The South American nation’s inflation rate was 181 percent last year.

Inflation is a sustained and persistent increase in the general level of prices. In the United States, we don’t have much inflation right now, but, historically, governments have conjured up inflation as a way to raise revenue and repudiate debts.

Note that real inflation has two components. First, prices in general increase. Your grocer’s stamping a 10-cent price hike on a can of green beans isn’t inflation. Prices act as the economy’s signaling mechanism. In a normally functioning market economy, some prices will always be going up while other prices are dropping. That’s how we signal to one another that we want more of this or less of that. To get real inflation, all, or nearly all, prices must be rising.

Second, this increase in prices must be sustained. A short burst of price increases is possible if money velocity (how often money changes hands in a given time period) increases abruptly. When the Korean War began, people remembered World War II rationing. Fearing a repeat, they scrambled to buy things. Prices rose, but the increases abated once the initial panic buying ran its course.

Milton Friedman put it succinctly when he said inflation is always and everywhere a “monetary phenomenon.” To get those sustained increases in overall prices, central banks have to systematically and continually increase the money supply. Right now, we have little inflation in the United States because, although our Federal Reserve has expanded the monetary base, U.S. banks have been sitting on those excess reserves. If U.S. banks ever do start lending out those reserves, subsequent expansion of the money supply could give the U.S. an inflationary episode.

One has to be a baby boomer or older to remember the Great Inflation. It peaked in March 1980 when prices were rising at an annual rate of 14.8 percent. Home mortgage rates peaked at 18.5 percent in October 1981 and unemployment peaked at 10.8 percent in December 1982. It wasn’t pretty. We hope it doesn’t happen again.•

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Bohanon is a professor of economics at Ball State University. Styring is an economist and independent researcher. Both also blog at INforefront.com. Send comments to ibjedit@ibj.com.

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