Introduction

Focus of interest

• Extremes of macro instability
• In a non-experimental field outliers contain relevant information about the working of systems in less perturbed conditions

General approach

• Institutions and practices have evolved to make a division of labor in society too complex for typical human beings’ comprehension and control
• Money belongs to those institutions. By simplifying economic calculations and coordination reduces the cognitive demand of actual agents
• HI impairs the basic functioning of monetary institutions.

The economic environment becomes too difficult for people to handle calculation and coordination of long-term strategies

High inflation

• Notion with numerical connotations, but also association with decision- making patterns
• Behavioral definition: generalized reference to rates of price increases over monthly time intervals

Moderate: annual time frame

High: monthly time frame

Hyper: only few days

The causes of Inflation

Inflation certainly means always and everywhere a fall in the purchasing power of money over goods. But:

Behind a rise in the general price level stand the pricing decision of firms

• Nominal prices are typically decided by suppliers considering the evolution of production/sales costs
• Decisions to revise prices are motivated by market and policy signals that are at the end of other chains of causation

Building a complete model of economic and extra-economic determinants of inflation is out of reach.

• Necessary to decide which links to concentrate on
• How far to go in search for “deep explanations”? Nontrivial tradeoffs

The transmission of fiscal and monetary impulses to the price level is neither direct nor amenable to a straightforward description.

• That being said, typical features of high inflation economies are the difficulties faced by hard- pressed governments to finance their spending, and their dependence on central bank credit, with monetary policies behaving more or less passively as providers of seigniorage revenues to cover shortfalls in fiscal resources. In this setting, the changes in the fiscal balance and the dynamics of money demand, influenced in turn by inflationary expectations, occupy center stage.

The HI regime

Economic Performance

Under perfectly anticipated inflation, a high rate of price growth  would be predicted to have little effect on the performance of the economy

An as-if-legislated-in-advance tax on money balances (´a la Gesell money) will distort  individual choices as much as regular taxes. HI complicates substantially economic decisions

Policy behavior

Does not fit description of systematic sequence of actions perturbed by random innovations

Policy is made with more purpose than that. Thus, the problem is to know:

Who will be in charge?

What will they be trying to accomplish?

What economic theory they might believe in?

• Economic agents will strive to make sense of the future by drawing on their own experience to form their own views
• People are likely to differ in their expectations and in the underlying modes of analysis
• The rise in long-run relative to short-run uncertainty tends to strengthen flexibility preference
• In credit markets, the long end of the maturity structure may contract considerably: cortoplacismo
• In HI the ability to predict the frequent turnarounds in policy the private sector’s and to hedge against them becomes paramount to the success of firms
• The uncertainties associated with HI shape the relative prosperity of people with different skills. Financial experts seem to gain relative to engineers as real efficiency becomes less important

The finances of the Government

• Fiscal predicament is not just described by the amount of resources obtained from monetary emission and the inflation tax
• The key feature of HI economies is the unsystematic pressure for expenditures that are not feasible for the government to finance by ordinary legislated taxes
• There is no comprehensive working mechanism to arbitrate between the conflicting claims in a manner consistent with the resource constraint
• Once in HI, policy-makers will become absorbed in the day-to-day management of sundry claims without an overall design.
• Erratic inflation complicates fiscal budgeting. The door is open for various interest groups to present their contradictory demands one after the other as a matter of crucial importance

Living in High Inflation

Shoe-Leather costs

• The traditional analysis of expected inflation focuses on the transaction costs of moving in and out of monetary substitutes
• The shoe-leather history is a narrow view but it serves to stress that the movement out of money starts at the ‘store of value’ function
• In HI people will make great efforts to synchronize payments and receipts and to look for alternatives to the domestic money. However, it would appear that money retains its property as medium of routine exchanges even if its holding is taxed at very high rates
• In markets for high-cost items transactions become ‘dollarized’ regarding price denomination. Local money gets substituted further as inflation escalates
• The resulting erosion of real money demand reduces the efficacy of seigniorage as a revenue-generating instrument for the government

Information gathering and utilization

Over a short time, an individual in HI may be able to guess (and act on) the results of policies and actions taken by the authorities

• Instead, it is impossible to know more than a few steps ahead what outcome may emerge from the collective decisions. The range of possibilities is simply too large
• The uncertainty is not that of a pre-determined game of chance. Individuals find themselves in a situation where the nature and the interpretation of valuable information may change at any time
• Public and private agents have to act on the basis that much less reliable information than in stable economies
• In HI people may engage in ‘speculation’ on the behavior of the economy in the near future but refuse to commit resources over longer horizons
• Actions that cannot be reversed for some time will be undertaken only reluctantly. Wealthier groups may move assets out of the country. Locals refuse to finance locals
• HI are associated with high ‘country risk’ and with intense capital flight
• Nominal and real instability dulls ‘animal spirits’ and channel them to non-productive applications

Contracting

Price instability clouds the images of the future based on which agents may base their decisions, and makes it harder to specify a mutually agreeable denominator for future payments

Transactors can adapt at several margins:

• They can write more complicated contracts
• Shorten the time horizon of commitments
• Refuse to enter into agreements

Argentine courts evolved a ‘doctrine of unforeseeability’: a party could obtain a revision of the contract if the adjustment variable showed large deviations from the presumable intention of parties

The added complexity of the economic scenario under HI gets reflected in the ‘thinning out’ of contractual markets

In not-so-extreme cases, large numbers of contracts end up being indexed to CPI

CPI indexation has desirable features in allowing parties to establish commitments ‘as if in real terms’. However, it has problems both with short term and long- term commitments

CPI indices report measurements with a lag. It makes little sense to index short contracts since the adjustment term would reflect price movements that took place before the contract was specified

For very long contracts the adjustment clause preserve the real values of payments if the inflation rate is not too different between the current period and the start of the contract, but not otherwise

Payments linked to the exchange rate are not subject to reporting lag, but face the problem of the ‘real’ variability of local incomes in terms of the unit of denomination

Menu of assets may tend to conform to a triple standard of deferred payments:

• Very short contracts remain (vanishingly) nominal
• Remaining agreements of longer terms may be linked to a price index or denominated in foreign currencies
• But no substitute for stability conditions

Current transactions

The economy retains some capacity to function over short periods

This residual property results from the survival of business practices that still provide some order to market for everyday products:

• Offer to sell in a more or less customary way
• Maintain prices in domestic currency posted for some time

Price indexation, formal or informal; “inertia”, in both directions

As HI becomes entrenched and gains in intensity the system ‘loses memory’ so that current information loses relevance to anticipate future conditions

Segmentation of markets becomes ubiquitous and the ‘law of one price’ often fails over short distances

Price instability makes comparison shopping much more difficult. Learning the price of a good does not tell a consumer much if her information about the prices of similar goods have almost certainly changed in the meantime

Price competition becomes less effective to attract buyers. Also, firms tend to base increasingly their cost calculations on prospective values. Likely implication of higher mark-ups and lower real wages

Over the brink: ‘Closed for the lack of prices’

Inflation causes the inter-temporal structure of markets to shrink, starting at the long end

• In hyperinflation even the spot markets are threatened

The movement into hyper has been observed to happen as a sudden phase transition

•  Alarming news can precipitate a rush into foreign currencies

As the risk grows of prices suddenly accelerating, wage-setting schemes that extrapolate past price trends becomes less acceptable to labor

• When this anchor lets go one of the remaining links between past and current prices is lost
• Plans are calculated on a daily basis. Uncertainty over restocking costs and the growing irrelevance of consumer search induce firms to raise markups and, in the limit, to just stop selling

The signs posted in shops during some hyperinflations (‘Closed for the lack of prices’ or ‘Closed for revision of prices’) reveal in a striking way how even routine trades get deeply disrupted when people are deprived of signposts about the real outcome of transactions

Hyperinflations cannot be sustained for long. When a society has reached this extreme, the alternatives become stark; Stabilize or else!