However, not all inflation is hyperinflation. Of course, there are people who fear that any inflation, if left alone, would escalate into a hyperinflation. For example, in the early 2000s, Mr Masaru Hayami, the governor of the central bank of Japan, famously refused to ease money supply on the ground that he was worried about the possibility of a hyperinflation – despite the fact that his country was at the time actually in the middle of a deflation (falling prices). But there is actually no evidence that this is inevitable – or even likely. No one would argue that hyperinflation is desirable, or even acceptable, but it is highly questionable whether all inflation is a bad thing, whatever the rate is.
Since the 1980s, free-market economists have managed to convince the rest of the world that economic stability, which they define as very low (ideally zero) inflation, should be attained at all costs, since inflation is bad for the economy. The target inflation rate they recommended has been something like 1–3 per cent, as suggested by Stanley Fischer, a former economics professor at MIT and the chief economist of the IMF between 1994 and 2001.[1]
However, there is actually no evidence that, at low levels, inflation is bad for the economy. For example, even studies done by some free-market economists associated with institutions such as the University of Chicago or the IMF suggest that, below 8–10 per cent, inflation has no relationship with a country’s economic growth rate.[2] Some other studies would even put the threshold higher – 20 per cent or even 40 per cent.[3]
The experiences of individual countries also suggest that fairly high inflation is compatible with rapid economic growth. During the 1960s and 70s, Brazil had an average inflation rate of 42 per cent but was one of the fastest-growing economies in the world, with its per capita income growing at 4.5 per cent a year. During the same period, per capita income in South Korea was growing at 7 per cent per year, despite having an annual average rate of inflation of nearly 20 per cent, which was actually higher than that found in many Latin American countries at the time.[4]
Moreover, there is evidence that excessive anti-inflationary policies can actually be harmful for the economy. Since 1996, when Brazil – having gone through a traumatic phase of rapid inflation, although not quite of hyperinflationary magnitude – started to control inflation by raising real interest rates (nominal interest rates minus the rate of inflation) to some of the highest levels in the world (10–12 per cent per year), its inflation fell to 7.1 per cent per year but its economic growth also suffered, with a per capita income growth rate of only 1.3 per cent per year. South Africa has also had a similar experience since 1994, when it started giving inflation control top priority and jacked up interest rates to the Brazilian levels mentioned above.
Why is this? It is because the policies that are aimed to reduce inflation actually reduce investment and thus economic growth, if taken too far. Free-market economists often try to justify their highly hawkish attitude towards inflation by arguing that economic stability encourages savings and investment, which in turn encourage economic growth. So, in trying to argue that macroeconomic stability, defined in terms of low inflation, was a key factor in the rapid growth of the East Asian economies (a proposition that does not actually apply to South Korea, as seen above), the World Bank argues in its 1993 report: ‘Macroeconomic stability encourages long-term planning and private investment and, through its impact on real interest rates and the real value of financial assets, helped to increase financial savings.’ However, the truth of the matter is that policies that are needed to bring down inflation to a very low – low single-digit – level discourage investment.
Real interest rates of 8, 10 or 12 per cent mean that potential investors would not find non-financial investments attractive, as few such investments bring profit rates higher than 7 per cent.[5] In this case, the only profitable investment is in high-risk, high-return financial assets. Even though financial investments can drive growth for a while, such growth cannot be sustained, as those investments have to be ultimately backed up by viable long-term investments in real sector activities, as so vividly shown by the 2008 financial crisis (see Thing 22).
So, free-market economists have deliberately taken advantage of people’s justified fears of hyperinflation in order to push for excessive anti-inflationary policies, which do more harm than good. This is bad enough, but it is worse than that. Anti-inflationary policies have not only harmed investment and growth but they have failed to achieve their supposed aim – that is, enhancing economic stability.
Since the 1980s, but especially since the 1990s, inflation control has been at the top of policy agendas in many countries. Countries were urged to check government spending, so that budget deficits would not fuel inflation. They were also encouraged to give political independence to the central bank, so that it could raise interest rates to high levels, if necessary against popular protests, which politicians would not be able to resist.
The struggle took time, but the beast called inflation has been tamed in the majority of countries in recent years. According to the IMF data, between 1990 and 2008, average inflation rate fell in 97 out of 162 countries, compared to the rates in the 1970s and 80s. The fight against inflation was particularly successful in the rich countries: inflation fell in all of them. Average inflation for the OECD countries (most of which are rich, although not all rich countries belong to the OECD) fell from 7.9 per cent to 2.6 per cent between the two periods (70s–80s vs. 90s–00s). The world, especially if you live in a rich country, has become more stable – or has it?
The fact is that the world has become more stable only if we regard low inflation as the sole indicator of economic stability, but it has notbecome more stable in the way most of us experience it.
One sense in which the world has become more unstable during the last three decades of free-market dominance and strong anti-inflationary policies is the increased frequency and extent of financial crises. According to a study by Kenneth Rogoff, a former chief economist of the IMF and now a professor at Harvard University, and Carmen Reinhart, a professor at the University of Maryland, virtually no country was in banking crisis between the end of the Second World War and the mid 1970s, when the world was much more unstable than today, when measured by inflation. Between the mid 1970s and the late 1980s, when inflation accelerated in many countries, the proportion of countries with banking crises rose to 5–10 per cent, weighted by their share of world income, seemingly confirming the inflation-centric view of the world. However, the proportion of countries with banking crises shot up to around 20 per cent in the mid 1990s, when we are supposed to have finally tamed the beast called inflation and attained the elusive goal of economic stability. The ratio then briefly fell to zero for a few years in the mid 2000s, but went up again to 35 per cent following the 2008 global financial crisis (and is likely to rise even further at the time of writing, that is, early 2010).[6]
Another sense in which the world has become more unstable during the last three decades is that job insecurity has increased for many people during this period. Job security has always been low in developing countries, but the share of insecure jobs in the so-called ‘informal sector’ – the collection of unregistered firms which do not pay taxes or observe laws, including those providing job security – has increased in many developing countries during the period, due to premature trade liberalization that destroyed a lot of secure ‘formal’ jobs in their industries. In the rich countries, job insecurity increased during the 1980s too, due to rising (compared to the 1950s–70s) unemployment, which was in large part a result of restrictive macroeconomic policies that put inflation control above everything else. Since the 1990s, unemployment has fallen, but job insecurity has still risen, compared to the pre-1980s period.
2
A study by Robert Barro, a leading free-market economist, concludes that moderate inflation (10–20 per cent) has low negative effects on growth, and that, below 10 per cent, inflation has no effect at all. See R. Barro, ‘Inflation and growth’,
3
See: M. Bruno, ‘Does inflation really lower growth?’,
4
In the 1960s, Korea’s inflation rate was much higher than that of five Latin American countries (Venezuela, Bolivia, Mexico, Peru and Colombia) and not much lower than that of Argentina. In the 1970s, the Korean inflation rate was higher than that found in Venezuela, Ecuador and Mexico, and not much lower than that of Colombia and Bolivia. The information is from A. Singh, ‘How did East Asia grow so fast? – Slow progress towards an analytical consensus’, 1995, UNCTAD Discussion Paper, no. 97, table 8.
5
There are many different ways to calculate profit rates, but the relevant concept here is returns on assets. According to S. Claessens, S. Djankov and L. Lang, ‘Corporate growth, financing, and risks in the decades before East Asia’s financial crisis’, 1998, Policy Research Working Paper, no. 2017, World Bank, Washington, DC, fig. 1, the returns on assets in forty-six developed and developing countries during 1988–96 ranged between 3.3 per cent (Austria) and 9.8 per cent (Thailand). The ratio ranged between 4 per cent and 7 per cent in forty of the forty-six countries; it was below 4 per cent in three countries and above 7 per cent in three countries. Another World Bank study puts the average profit rate for non-financial firms in ‘emerging market’ economies (middle-income countries) during the 1990s (1992–2001) at an even lower level of 3.1 per cent (net income/assets). See S. Mohapatra, D. Ratha and P. Suttle, ‘Corporate financing patterns and performance in emerging markets’, mimeo., March 2003,World Bank, Washington, DC.
6
C. Reinhart and K. Rogoff,