More About Money Matters

GUIDANCE FROM PARAMAHANSA YOGANANDA

2012-10-02T21:43:00.000-07:00

"There is a world revolution going on. It will change the financial system. In the karmic firmament of America I see one beautiful sign: that no matter what the world goes through, she will be better off than most other countries. But America will experience widespread misery, suffering, and changes just the same....

I own nothing, yet I know that if I were hungry there would be thousands in the world who would feed me, because I have given to thousands. That same law will work for whoever thinks not of himself as the one who is going to starve, but of the other person in need....

There is enough money to blanket the world, and there is enough food to feed the world. Proper distribution is necessary. If men were not selfish, no one would be hungry or needy. Man should concentrate on brotherhood. Each one should live for all, loving everyone else as his own. I am sure that if anyone in Mt. Washington were going hungry, we would all get together and look after him. That community spirit must be lived by all people of all nations. "

~ "World Crisis" by Paramahansa Yogananda

Click Here to Order "World Crisis"

"Confronted by the present economic crisis, people all over the world are seeking understanding and direction in finding the best course forward for themselves and their families.

More than half a century ago, Paramahansa Yogananda described the changes that the world would go through as part of its transition into a higher, more spiritual age. While he did not give an exact timetable, he did offer a great deal of spiritual counsel and practical advice for dealing with these challenging times...." Read More....Paramahansa Yogananda’s Guidance For These Times of Economic Crisis

"Millions of people think that all wealth comes from banks, factories, and jobs, and through personal ability. Yet periodic great depressions prove that there are divine laws, aside from known physical laws, that govern the physical, mental, spiritual, and material phases of life. Strive every day to be healthy, wealthy, wise, and happy, not by taking away the health, wealth, and happiness of others, but by including their happiness and welfare in your own. The happiness of individuals, of family members, and of nations depends entirely upon the law of mutual cooperation or unselfishness, and on living up to this motto: 'Father, bless us, that we may remember Thee always. Let us not forget that all blessings flow from Thee.'"

~ Self-Realization Fellowship Lessons

"True happiness, lasting happiness, lies only in God, 'having whom no other gain is greater.' In Him is the only safety, the only shelter, the only escape from all our fears. You have no other security in the world, no other freedom. The only true freedom lies in God. So strive deeply to contact Him in meditation morning and night, as well as throughout the day in all work and duties you perform. Yoga teaches that where God is, there is no fear, no sorrow. The successful yogi can stand unshaken midst the crash of breaking worlds; he is secure in the realization: 'Lord, where I am, there Thou must come.'”

~ The Divine Romance

"Most of all I emphasize that you should get busy seeking God through meditation....Just beneath the shadows of this life is His wondrous Light. The universe is a vast temple of His presence. When you meditate, you will find doors opening to Him everywhere. When you have communion with Him, not all the ravages of the world can take away that Joy and Peace."

~ "World Crisis" by Paramahansa Yogananda

Creating Prosperity Consciousness

Selections From the Wisdom Legacy of

Paramahansa Yogananda

Excerpts from an article in the Spring 2009 issue of Self-Realization magazine.

“Creating Prosperity Consciousness:
Nine spiritual principles for activating the law of abundance
to supply your needs in good times and bad.”

Know That God’s Plan for the World Is Abundance and Joy. Abundance, material as well as spiritual, is a structural expression of rita, cosmic law or natural righteousness....

Every saint who has penetrated to the core of Reality has testified that a divine universal plan exists and that it is beautiful and full of joy.

According to the law of God and of Christian brotherhood, this earth was meant to provide the shelter and supply of all mankind; the wealth of mines and other resources was to be distributed equally to those performing equal labors. And God established the law of divine birthright: that all men and women are made in His image, hence are essentially divine; and that all nations are of one blood, being descendants of common parents, Adam and Eve.

If you believe in this fundamental relationship, if you feel love for all the world’s inhabitants as for your own family, recognizing no inner difference between any of the outwardly different nationalities, then you are establishing a legitimate astral right to your share of earth’s capital.

Those who seek prosperity for themselves alone are in the end bound to become poor, or to suffer from mental inharmony; but those who consider the whole world as their home, and who really care and work for group or world prosperity, activate astral forces that lead them ultimately to the place where they can find the individual prosperity that is legitimately theirs. This is a sure and secret law.

Whether one prospers is not dependent solely upon one’s creative ability, but also upon his past actions, and on his present efforts to activate the astral law of cause and effect. If mankind as a whole behaved unselfishly, the power of that law would distribute prosperity equally to all men, without exception. Those who by potent good thoughts and actions rouse this astral power to create positive prosperity succeed wherever they go, whether they are in prosperous or poverty-stricken environments.

Use the Law of Cause and Effect to Create Prosperity

All prosperity is measured out to man according to the law of cause and effect, which governs not only this life but all past lives. That is why intelligent people may be born poor or unhealthy, and a mentally mediocre person may be born healthy and wealthy. All men were originally sons of God made in His image having free choice and equal power of accomplishment. But by misuse of his God-given reason and will power, man has fallen under the control of the natural law of cause and effect of action (karma) and has thereby limited his freedom to make a success of life. A man’s success depends not only upon his intelligence and efficiency but upon the nature of his past actions.

However, there is a way to overcome the unfavorable results of past actions. The causes of failure must be destroyed and a new cause for success set in motion.

Contact the Superconscious Source of Success and Prosperity

The conscious mind alone cannot initiate a new cause that will bring positive success in any direction; but when the human mind attunes itself to God, in the state of superconsciousness, it can be sure of success; for the superconscious mind is in tune with the unlimited power of God, and is therefore able to create a new cause of success.

Absolute success signifies “the power to create at will what you need by developing your unlimited superconscious power.” This superconscious power can be awakened by knowing the definite technique of meditation, as taught by the God-realized masters of India. India has specialized in the art of controlling the mental machinery of the mind factory in order to produce prosperity, health, success, wisdom, and God-contact at any time, at will, and without limitation.

Western brothers and sisters need to learn that the mind is greater than its inventions. More time should be given to the art of controlling the mind in order to achieve scientifically all-round success. Less time should be given to acquiring products of the mind at the cost of neglecting the cultivation of the all-accomplishing, all-powerful mind itself....

Through meditation learn that money without health and peace is not success, and that peace and health without money for necessities do not make a complete or successful life. Follow the way taught by India: acquire superconsciousness and absolute control over the mind; then you can create at will whatever you need.

Exercise the Manifesting Power of Affirmation

All spiritual and material gifts flow from [God’s] boundless abundance. In order to receive His gifts you must eradicate from your mind all thoughts of limitation and poverty. Universal Mind is perfect and knows no lack; to reach that never-failing supply you must maintain a consciousness of abundance. Even when you do not know where the next dollar is coming from, you should refuse to be apprehensive. When you do your part and rely on God to do His, you will find that mysterious forces come to your aid and that your constructive wishes soon materialize. This confidence and consciousness of abundance are attained through meditation.

Affirmation: “God is my own inexhaustible Divine Bank. I am always rich, for I have access to the Cosmic Storehouse. I will go forth in perfect faith in the power of Omnipresent Good to bring me what I need at the time I need it.”

For More Information about Self Realization Fellowship

http://www.yogananda-srf.org/

HYPERINFLATION

2012-10-02T10:51:00.000-07:00

Hyperinflation

From Wikipedia, the free encyclopedia

For lungs filling with excessive air, see Hyperaeration.

Sweeping up the banknotes from the street after the Hungarian pengő was replaced in 1946.

Certain figures in this article use scientific notation for readability.

In economics, hyperinflation occurs when a country experiences very high and usually accelerating inflation. While the real values of the specific economic items generally stay the same in terms of relatively stable foreign currencies, in hyperinflationary conditions the general price level within a specific economy increases rapidly as the functional or internal currency, as opposed to a foreign currency. It loses its real value very quickly, normally at an accelerating rate.^[1]

Hyperinflation^[2] results from a rapid and continuing increase in the supply of money, which occurs when a government prints money or creates credits in bank accounts, instead of collecting taxes to fund government activities. The price increases that result from more government spending create a vicious circle, requiring ever growing amounts of money creation to fund government activities. Hence both monetary inflation and price inflation rapidly accelerate. Such rapidly increasing prices cause widespread unwillingness of the local population to hold the local currency as it rapidly loses its real value. Instead they quickly spend any money they receive, which rapidly increases the velocity of money flow, which in turn causes further acceleration in prices.^[3] Hyperinflation is often associated with wars or their aftermath, political or social upheavals, or other crises that make it difficult for the government to tax the population.

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[edit]Definitions

In 1956, Phillip Cagan wrote The Monetary Dynamics of Hyperinflation, generally regarded as the first serious study of hyperinflation and its effects. In it, he defined a hyperinflationary episode as starting in the month that the monthly inflation rate exceeds 50%, and it ending when the monthly inflation rate drops below 50% and stays that way for at least a year.^[4]Economists usually follow Cagan’s description that hyperinflation occurs when the monthly inflation rate exceeds 50%.^[5]

The International Accounting Standards Board does not establish an absolute rate at which hyperinflation is deemed to arise, but in International Accounting Standard 29 It lists factors that indicate the existence of hyperinflation:^[6]

The general population prefers to keep its wealth in non-monetary assets or in a relatively stable foreign currency. Amounts of local currency held are immediately invested to maintain purchasing power
The general population regards monetary amounts not in terms of the local currency but in terms of a relatively stable foreign currency. Prices may be quoted in that currency;
Sales and purchases on credit take place at prices that compensate for the expected loss of purchasing power during the credit period, even if the period is short;
Interest rates, wages, and prices are linked to a price index; and
The cumulative inflation rate over three years approaches, or exceeds, 100%.

The IASB´s definition is the generally accepted definition of hyperinflation in the accounting profession since April 1989 followed by all countries implementing International Financial Reporting Standards.

[edit]Causes

Hyperinflation occurs when there is a continuing (and often accelerating) rapid increase in the amount of money that is not supported by a corresponding growth in the output of goods and services. This results in an imbalance between the supply and demand for the money (including currency and bank deposits), causing rapid inflation. Very high inflation rates can result in a loss of confidence in the currency, similar to a bank run. Usually, the excessive money supply growth results from the government being either unable or unwilling to fully finance the government budget through taxation or borrowing, and instead it finances the government budget deficit through the printing of money.^[7]

As it allows a government to devalue their spending and displace (or avoid) a tax increase, governments have sometimes resorted to excessively loose monetary policy to meet their expenses. Inflation is effectively a regressive consumption tax,^[8] but less overt than levied taxes and therefore harder to understand by ordinary citizens. Inflation can obscure quantitative assessments of the true cost of living, as published price indices only look at data in retrospect, so may increase only months or years later. Monetary inflation can become hyperinflation if monetary authorities fail to fund increasing government expenses from taxes, government debt, cost cutting, or by other means, because either

during the time between recording or levying taxable transactions and collecting the taxes due, the value of the taxes collected falls in real value to a small fraction of the original taxes receivable; or
government debt issues fail to find buyers except at very deep discounts; or
a combination of the above.

Theories of hyperinflation generally look for a relationship between seigniorage and the inflation tax. In both Cagan's model and the neo-classical models, a tipping point occurs when the increase in money supply or the drop in the monetary base makes it impossible for a government to improve its financial position. Thus when fiat money is printed, government obligations that are not denominated in money increase in cost by more than the value of the money created.

From this, it might be wondered why any rational government would engage in actions that cause or continue hyperinflation. One reason for such actions is that often the alternative to hyperinflation is either depression or military defeat. The root cause is a matter of more dispute. In both classical economics and monetarism, it is always the result of the monetary authority irresponsibly borrowing money to pay all its expenses. These models focus on the unrestrained seigniorage of the monetary authority, and the gains from the inflation tax.

The price of gold in Germany, 1 January 1918 – 30 November 1923.

In neo-classical economic theory, hyperinflation is rooted in a deterioration of the monetary base, that is the confidence that there is a store of value which the currency will be able to command later. In this model, the perceived risk of holding currency rises dramatically, and sellers demand increasingly high premiums to accept the currency. This in turn leads to a greater fear that the currency will collapse, causing even higher premiums. One example of this is during periods of warfare, civil war, or intense internal conflict of other kinds: governments need to do whatever is necessary to continue fighting, since the alternative is defeat. Expenses cannot be cut significantly since the main outlay is armaments. Further, a civil war may make it difficult to raise taxes or to collect existing taxes. While in peacetime the deficit is financed by selling bonds, during a war it is typically difficult and expensive to borrow, especially if the war is going poorly for the government in question. The banking authorities, whether central or not, "monetize" the deficit, printing money to pay for the government's efforts to survive. The hyperinflation under the Chinese Nationalists from 1939 to 1945 is a classic example of a government printing money to pay civil war costs. By the end, currency was flown in over the Himalayas, and then old currency was flown out to be destroyed.

Hyperinflation is regarded as a complex phenomenon and one explanation may not be applicable to all cases. However, in both of these models, whether loss of confidence comes first, or central bank seigniorage, the other phase is ignited. In the case of rapid expansion of the money supply, prices rise rapidly in response to the increased supply of money relative to the supply of goods and services, and in the case of loss of confidence, the monetary authority responds to the risk premiums it has to pay by “running the printing presses.”

Nevertheless the immense acceleration process that occurs during hyperinflation (such as during the German hyperinflation of 1922/23) still remains unclear and unpredictable. The transformation of an inflationary development into the hyperinflation has to be identified as a very complex phenomenon, which could be a further advanced research avenue of the complexity economics in conjunction with research areas like mass hysteria,bandwagon effect, social brain and mirror neurons.^[9]

[edit]Models

Since hyperinflation is visible as a monetary effect, models of hyperinflation center on the demand for money. Economists see both a rapid increase in the money supply and an increase in the velocity of money if the (monetary) inflating is not stopped. Either one, or both of these together are the root causes of inflation and hyperinflation. A dramatic increase in the velocity of money as the cause of hyperinflation is central to the "crisis of confidence" model of hyperinflation, where the risk premium that sellers demand for the paper currency over the nominal value grows rapidly. The second theory is that there is first a radical increase in the amount of circulating medium, which can be called the "monetary model" of hyperinflation. In either model, the second effect then follows from the first — either too little confidence forcing an increase in the money supply, or too much money destroying confidence.

In the confidence model, some event, or series of events, such as defeats in battle, or a run on stocks of the specie which back a currency, removes the belief that the authority issuing the money will remain solvent — whether a bank or a government. Because people do not want to hold notes which may become valueless, they want to spend them. Sellers, realizing that there is a higher risk for the currency, demand a greater and greater premium over the original value. Under this model, the method of ending hyperinflation is to change the backing of the currency, often by issuing a completely new one. War is one commonly cited cause of crisis of confidence, particularly losing in a war, as occurred during Napoleonic Vienna, and capital flight, sometimes because of “contagion” is another. In this view, the increase in the circulating medium is the result of the government attempting to buy time without coming to terms with the root cause of the lack of confidence itself.

In the monetary model, hyperinflation is a positive feedback cycle of rapid monetary expansion. It has the same cause as all other inflation: money-issuing bodies, central or otherwise, produce currency to pay spiralling costs, often from lax fiscal policy, or the mounting costs of warfare. When businesspeople perceive that the issuer is committed to a policy of rapid currency expansion, they mark up prices to cover the expected decay in the currency's value. The issuer must then accelerate its expansion to cover these prices, which pushes the currency value down even faster than before. According to this model the issuer cannot "win" and the only solution is to abruptly stop expanding the currency. Unfortunately, the end of expansion can cause a severe financial shock to those using the currency as expectations are suddenly adjusted. This policy, combined with reductions of pensions, wages, and government outlays, formed part of the Washington consensus of the 1990s.

Whatever the cause, hyperinflation involves both the supply and velocity of money. Which comes first is a matter of debate, and there may be no universal story that applies to all cases. But once the hyperinflation is established, the pattern of increasing the money stock, by whichever agencies are allowed to do so, is universal. Because this practice increases the supply of currency without any matching increase in demand for it, the price of the currency, that is the exchange rate, naturally falls relative to other currencies. Inflation becomes hyperinflation when the increase in money supply turns specific areas of pricing power into a general frenzy of spending quickly before money becomes worthless. The purchasing power of the currency drops so rapidly that holding cash for even a day is an unacceptable loss of purchasing power. As a result, no one holds currency, which increases the velocity of money, and worsens the crisis.

Because rapidly rising prices undermine the role of money as a store of value, people try to spend it on real goods or services as quickly as possible. Thus, the monetary model predicts that the velocity of money will increase as a result of an excessive increase in the money supply. At the point when money velocity and prices rapidly accelerate in a vicious circle, hyperinflation is out of control, because ordinary policy mechanisms, such as increasing reserve requirements, raising interest rates, or cutting government spending will be ineffective and be responded to by shifting away from the rapidly devalued money and towards other means of exchange.

During a period of hyperinflation, bank runs, loans for 24-hour periods, switching to alternate currencies, the return to use of gold or silver or even barter become common. Many of the people who hoard gold today expect hyperinflation, and are hedging against it by holding specie. There may also be extensive capital flight or flight to a “hard” currency such as the US dollar. This is sometimes met with capital controls, an idea which has swung from standard, to anathema, and back into semi-respectability. All of this constitutes an economy which is operating in an “abnormal” way, which may lead to decreases in real production. If so, that intensifies the hyperinflation, since it means that the amount of goods in "too much money chasing too few goods" formulation is also reduced. This is also part of the vicious circle of hyperinflation.

Once the vicious circle of hyperinflation has been ignited, dramatic policy means are almost always required, simply raising interest rates is insufficient. Bolivia, for example, underwent a period of hyperinflation in 1985, where prices increased 12,000% in the space of less than a year. The government raised the price of gasoline, which it had been selling at a huge loss to quiet popular discontent, and the hyperinflation came to a halt almost immediately, since it was able to bring in hard currency by selling its oil abroad. The crisis of confidence ended, and people returned deposits to banks. The German hyperinflation (1919-November 1923) was ended by producing a currency based on assets loaned against by banks, called the Rentenmark. Hyperinflation often ends when a civil conflict ends with one side winning. Although wage and price controls are sometimes used to control or prevent inflation, no episode of hyperinflation has been ended by the use of price controls alone. However, wage and price controls have sometimes been part of the mix of policies used to halt hyperinflation.

[edit]Effects

Hyperinflation effectively wipes out the purchasing power of private and public savings, distorts the economy in favor of the hoarding of real assets, causes the monetary base, whether specie or hard currency, to flee the country, and makes the afflicted area anathema to investment.

Enactment of price controls to prevent discounting the value of paper money relative to gold, silver, hard currency, or commodities, fail to force acceptance of a paper money which lacks intrinsic value. If the entity responsible for printing a currency promotes excessive money printing, with other factors contributing a reinforcing effect, hyperinflation usually continues. Hyperinflation is generally associated with paper money, which can easily be used to increase the money supply: add more zeros to the plates and print, or even stamp old notes with new numbers.^[10] Historically, there have been numerous episodes of hyperinflation in various countries followed by a return to "hard money". Older economies would revert to hard currency and barter when the circulating medium became excessively devalued, generally following a "run" on the store of value.

Much attention on hyperinflation naturally centers on the effect on savers whose investment become worthless. Academic economists seem not to have devoted much study on the (positive) effect on debtors. This may be due to the widespread perception that consistently saving a portion of one's income in monetary investments such as bonds or interest-bearing accounts is almost always a wise policy, and usually beneficial to the society of the savers. By contrast, incurring large or long-term debts (though sometimes unavoidable) is viewed as often resulting from irresponsibility or self-indulgence. Interest rate changes often cannot keep up with hyperinflation or even high inflation, certainly with contractually fixed interest rates. (For example, in the 1970s in the United Kingdom inflation reached 25% per annum, yet interest rates did not rise above 15% – and then only briefly – and many fixed interest rate loans existed). Contractually there is often no bar to a debtor clearing his long term debt with "hyperinflated-cash" nor could a lender simply somehow suspend the loan. "Early redemption penalties" were (and still are) often based on a penalty of x months of interest/payment; again no real bar to paying off what had been a large loan. In interwar Germany, for example, much private and corporate debt was effectively wiped out; certainly for those holding fixed interest rate loans.

[edit]Aftermath

Hyperinflation is ended with drastic remedies, such as imposing the shock therapy of slashing government expenditures or altering the currency basis. One form this may take isdollarization, the use of a foreign currency (not necessarily the U.S. dollar) as a national unit of currency. An example was dollarization in Ecuador, initiated in September 2000 in response to a 75% loss of value of the Ecuadorian sucre in early 2000.

Hyperinflation has always been a traumatic experience for the area which suffers it, and the next policy regime almost always enacts policies to prevent its recurrence. Often this means making the central bank very aggressive about maintaining price stability, as was the case with the German Bundesbank or moving to some hard basis of currency such as acurrency board. Many governments have enacted extremely stiff wage and price controls in the wake of hyperinflation but this does not prevent further inflating of the money supply by its central bank, and always leads to widespread shortages of consumer goods if the controls are rigidly enforced.

[edit]Currency

Germany, 1923: banknotes had lost so much value that they were used as wallpaper.

In countries experiencing hyperinflation, the central bank often prints money in larger and larger denominations as the smaller denomination notes become worthless. This can result in the production of some interesting banknotes, including those denominated in amounts of 1,000,000,000 or more.

By late 1923, the Weimar Republic of Germany was issuing two-trillion Mark banknotes and postage stamps with a face value of fifty billion Mark. The highest value banknote issued by the Weimar government's Reichsbank had a face value of 100 trillion Mark (100,000,000,000,000; 100 million million).^[11]^[12] At the height of the inflation, one US dollar was worth 4 trillion German marks. One of the firms printing these notes submitted an invoice for the work to the Reichsbank for 32,776,899,763,734,490,417.05 (3.28 × 10¹⁹, or 33quintillion) Marks.^[13]

The largest denomination banknote ever officially issued for circulation was in 1946 by the Hungarian National Bank for the amount of 100 quintillion pengő (100,000,000,000,000,000,000, or 10²⁰; 100 million million million) image. (There was even a banknote worth 10 times more, i.e. 10²¹ pengő, printed, but not issued image.) The banknotes however did not depict the numbers, "hundred million b.-pengő" ("hundred million trillion pengő") and "one milliard b.-pengő" were spelled out instead. This makes the 100,000,000,000,000Zimbabwean dollar banknotes the note with the greatest number of zeros shown.

The Post-World War II hyperinflation of Hungary held the record for the most extreme monthly inflation rate ever — 41,900,000,000,000,000% (4.19 × 10¹⁶% or 41.9 quadrillion percent) for July 1946, amounting to prices doubling every 15.3 hours. By comparison, recent figures (as of 14 November 2008) estimate Zimbabwe's annual inflation rate at 89.7 sextillion (10²¹) percent.,^[14]which corresponds to a monthly rate of 5473%, and a doubling time of about five days. In figures, that is 89,700,000,000,000,000,000,000%.

One way to avoid the use of large numbers is by declaring a new unit of currency (an example being, instead of 10,000,000,000 Dollars, a bank might set 1 new dollar = 1,000,000,000 old dollars, so the new note would read "10 new dollars.") An example of this would be Turkey's revaluation of the Lira on 1 January 2005, when the old Turkish lira(TRL) was converted to the New Turkish lira (TRY) at a rate of 1,000,000 old to 1 new Turkish Lira. While this does not lessen the actual value of a currency, it is called redenominationor revaluation and also happens over time in countries with standard inflation levels. During hyperinflation, currency inflation happens so quickly that bills reach large numbers before revaluation.

Some banknotes were stamped to indicate changes of denomination. This is because it would take too long to print new notes. By the time new notes were printed, they would be obsolete (that is, they would be of too low a denomination to be useful).

Metallic coins were rapid casualties of hyperinflation, as the scrap value of metal enormously exceeded the face value. Massive amounts of coinage were melted down, usually illicitly, and exported for hard currency.

Governments will often try to disguise the true rate of inflation through a variety of techniques. None of these actions addresses the root causes of inflation and they, if discovered, tend to further undermine trust in the currency, causing further increases in inflation. Price controls will generally result in shortages and hoarding and extremely high demand for the controlled goods, resulting in disruptions of supply chains. Products available to consumers may diminish or disappear as businesses no longer find it sufficiently profitable (or may be operating at a loss) to continue producing and/or distributing such goods at the legal prices, further exacerbating the shortages.

There are also issues with computerized money-handling systems. In Zimbabwe, during the hyperinflation of the Zimbabwe dollar, many automated teller machines and payment card machines struggled with arithmetic overflow errors as customers required many billions and trillions of dollars at one time.^[15]

[edit]Examples of hyperinflation

[edit]The Hanke-Krus Hyperinflation Table

The table to the right supplies, for the first time, a table that contains all 56 episodes of hyperinflation, including several which had previously gone unreported. The Hanke-Krus Hyperinflation Table is compiled in a systematic and uniform way. Most importantly, it meets the replicability test. It utilizes clean and consistent inflation metrics, indicates the start and end dates of each episode, identifies the month of peak hyperinflation, and signifies the currency that was in circulation, as well as the method used to calculate inflation rates.

[edit]Angola

Angola experienced high inflation from 1991 to 1995. It was a result of exchange restrictions following the introduction of the novo kwanza (AON) to replace the original kwanza (AOK) in 1990. At the first months of 1991, the highest denomination was 50 000 AON. By 1994, the highest denomination was 500 000 kwanzas. In the 1995 currency reform, the readjusted kwanza (AOR) replaced the novo kwanza at the ratio of 1 000 AON to 1 AOR, but hyperinflation continued as further denominations of up to 5 000 000 AOR were issued. In the 1999 currency reform, the kwanza (AOA) was reintroduced at the ratio of 1 million AOR to 1 AOA. Currently, the highest denomination banknote is 2 000 AOA and the overall impact of hyperinflation was 1 AOA = 1 billion AOK.

Start and End Date: Dec. 1994-Jan. 1997

Peak Month and Rate of Inflation: May 1996, 84.1%^[16]

[edit]Argentina

Argentina went through steady inflation from 1975 to 1991. At the beginning of 1975, the highest denomination was 1,000 pesos. In late 1976, the highest denomination was 5,000 pesos. In early 1979, the highest denomination was 10,000 pesos. By the end of 1981, the highest denomination was 1,000,000 pesos. In the 1983 currency reform, 1 peso argentino was exchanged for 10,000 pesos. In the 1985 currency reform, 1 austral was exchanged for 1,000 pesos argentinos. In the 1992 currency reform, 1 new peso was exchanged for 10,000 australes. The overall impact of hyperinflation: 1 (1992) peso = 100,000,000,000 pre-1983 pesos.

Start and End Date: May 1989- Mar. 1990

Peak Month and Rate of Inflation: Mar. 1990, 197%^[17]

[edit]Armenia

Armenia experience high inflation and hyperinflation from January 1992-December 1994. Its first episode of hyperinflation was due to the use of the Russian ruble after the dissolution of the Soviet Union. The second episode was due to an unstable Armenian dram.

(1) Start and End Date: Jan. 1992- Feb. 1993

(1) Peak Month and Rate of Inflation: Jan. 1992, 73.1%

(2) Start and End Date: Oct. 1993- Dec. 1994

(2) Peak Month and Rate of Inflation: Nov. 1993, 438%^[18]

[edit]Austria

In 1922, inflation in Austria reached 1426%, and from 1914 to January 1923, the consumer price index rose by a factor of 11836, with the highest banknote in denominations of 500,000 krones.^[19]

Start and End Date: Oct. 1921- Sep. 1922

Peak Month and Rate of Inflation: Aug. 1922, 129%^[20]

[edit]Azerbaijan

Azerbaijan experienced inflation from January 1992 until December 1994. It first circulated the Russian Ruble until August 1992 when it introduced the Azerbaijani manat.

Start and End Date: Jan. 1991- Dec. 1994

Peak Month and Rate of Inflation: Jan. 1992, 118%^[21]

[edit]Belarus

Belarus experienced steady inflation from 1994 to 2002. In 1993, the highest denomination was 5,000 rublei. By 1999, it was 5,000,000 rublei. In the 2000 currency reform, the ruble was replaced by the new ruble at an exchange rate of 1 new ruble = 1,000 old rublei. The highest denomination in 2008 was 100,000 rublei, equal to 100,000,000 pre-2000 rublei.

(1) Start and End Date: Jan. 1992- Feb. 1992

(1) Peak Month and Rate of Inflation: Jan. 1992, 159%

(2) Start and End Date: Aug. 1994- Aug. 1994

(2) Peak Month and Rate of Inflation: Aug. 1994, 53.4%^[22]

[edit]Bolivia

Bolivia experienced its worst inflation between 1984 and 1986. Before 1984, the highest denomination was 1,000 Bolivian pesos. By 1985, the highest denomination was 10 million Bolivian pesos. In 1985, a Bolivian note for 1 million pesos was worth 55 cents in US dollars, one-thousandth of its exchange value of $5,000 less than three years previously.^[23] In the 1987 currency reform, the Peso Boliviano was replaced by the Boliviano at a rate of 1,000,000 : 1.

Start and End Date: Apr. 1984- Sep. 1985

Peak Month and Rate of Inflation: Feb. 1985, 183%^[24]

[edit]Bosnia and Herzegovina

Bosnia and Herzegovina went through its worst inflation in 1992. In 1992, the highest denomination was 1,000 dinara. By 1993, the highest denomination was 100,000,000 dinara. In the Republika Srpska, the highest denomination was 10,000 dinara in 1992 and 10,000,000,000 dinara in 1993. 50,000,000,000 dinara notes were also printed in 1993 but never issued.

Start and End Date: Apr. 1992- Jun. 1993

Peak Month and Rate of Inflation: Jun. 1992, 322%^[25]

[edit]Brazil

Main article: Hyperinflation in Brazil

From 1967–1994, the base currency unit was shifted seven times to adjust for inflation in the final years of the Brazilian military dictatorship era. A 1967 cruzeiro was, in 1994, worth less than one trillionth of a US cent, after adjusting for multiple devaluations and note changes. In that same year, inflation reached a record 2,075.8%. A new currency called real was adopted in 1994, and hyperinflation was eventually brought under control.^[26] The real was also the currency in use until 1942; 1 (current) real is the equivalent of 2,750,000,000,000,000,000 of Brazil's first currency (called réis in Portuguese).

Start and End Date: Dec. 1989- Mar. 1990

Peak Month and Rate of Inflation: Mar. 1990, 82.4%^[27]

[edit]Bulgaria

Bulgaria experience hyperinflation only in the month of February 1997. However, it had high inflation for many years proceeding this episode. In order to curb inflation, Bulgaria implemented a [currency board] in July of that year. Inflation subsequently dropped almost immediately.

Start and End Date: Feb. 1997- Feb. 1997

Peak Month and Rate of Inflation: Feb. 1997, 123%^[28]

[edit]Chile

In 1973, Chile had experienced hyperinflation that had hit 700 percent, at a time when the country, under high protectionist barriers, had no foreign reserves, and GDP was falling.^[29]However, due to the miracle of Chile in the 1980s, Chile turned it's market around, bringing about a free society.

Start and End Date: Oct. 1973- Oct. 1973

Peak Month and Rate of Inflation: Oct. 1973, 87.6%^[30]

[edit]China

As the first user of fiat currency, China has had an early history of troubles caused by hyperinflation. The Yuan Dynasty printed huge amounts of fiat paper money to fund their wars, and the resulting hyperinflation, coupled with other factors, led to its demise at the hands of a revolution. The Republic of China went through the worst inflation 1948–49. In 1947, the highest denomination was 50,000 yuan. By mid-1948, the highest denomination was 180,000,000 yuan. The 1948 currency reform replaced the yuan by the gold yuan at an exchange rate of 1 gold yuan = 3,000,000 yuan. In less than a year, the highest denomination was 10,000,000 gold yuan. In the final days of the civil war, the Silver Yuan was briefly introduced at the rate of 500,000,000 Gold Yuan. Meanwhile the highest denomination issued by a regional bank was 6,000,000,000 yuan (issued by Xinjiang Provincial Bank in 1949). After the renminbi was instituted by the new communist government, hyperinflation ceased with a revaluation of 1:10,000 old Renminbi in 1955. The overall impact of inflation was 1 Renminbi = 15,000,000,000,000,000,000 pre-1948 yuan.

(1) Start and End Date: Jul. 1943- Aug. 1945

(1) Peak Month and Rate of Inflation: Jun. 1945, 302%

(2) Start and End Date: Oct. 1947- Mid. May 1949

(2) Peak Month and Rate of Inflation: Apr. 5070%^[31]

[edit]Estonia

Estonia experienced hyperinflation as a result of using the Russian ruble after the fall of the Soviet Union. However, it was the first post-Soviet union country to implement a currency reform by installing a currency board. It began circulation of the Estonian kroon in April of 1992, ridding the country of high inflation.

Start and End Date: Jan. 1992- Feb. 1992

Peak Month and Rate of Inflation: Jan. 1992, 87.2%^[32]

[edit]France

During the French Revolution, the National Assembly issued bonds backed by seized church property called Assignats. These evolved into fiat legal tender money, were overprinted and caused hyperinflation. Napoleon replaced them with the franc in 1803, at which time the assignats were basically worthless Despite the fact that the assignat is normally considered to be the currency of this time, it was actually the mandat the experienced the peak month of hyperinflation.

Start and End Date: May 1795- Nov. 1796

Peak Month and Rate of Inflation: Mid-Aug. 1796, 304%^[33]

[edit]Free City of Danzig

Danzig went through its worst inflation in 1923. In 1922, the highest denomination was 1,000 Mark. By 1923, the highest denomination was 10,000,000,000 Mark.

Start and End Date: Aug. 1922- Mid. Oct. 1923

Peak Month and Rate of Inflation: Sep. 1923, 2437%^[34]

[edit]Georgia

Georgia went through its worst inflation in 1994. In 1993, the highest denomination was 100,000 coupons [kuponi]. By 1994, the highest denomination was 1,000,000 coupons. In the 1995 currency reform, a new currency, the lari, was introduced with 1 lari exchanged for 1,000,000 coupons.

(1) Start and End Date: Mar. 1922- Apr. 1992

(1) Peak Month and Rate of Inflation: Mar. 1992, 198%

(2) Start and End Date: Sep. 1993- Sep. 1994

(2) Peak Month and Rate of Inflation: Sep. 1994, 211%^[35]

[edit]Germany

Main article: Hyperinflation in the Weimar Republic

Germany went through its worst inflation in 1923. In 1922, the highest denomination was 50,000 Mark. By 1923, the highest denomination was 100,000,000,000,000 Mark. In December 1923 the exchange rate was 4,200,000,000,000 Marks to 1 US dollar.^[36] In 1923, the rate of inflation hit 3.25 × 10⁶ percent per month (prices double every two days). Beginning on 20 November 1923, 1,000,000,000,000 old Marks were exchanged for 1 Rentenmark so that 4.2 Rentenmarks were worth 1 US dollar, exactly the same rate the Mark had in 1914.^[36]

(1) Start and End Date: Jan. 1920- Jan. 1920

(1) Peak Month and Rate of Inflation: Jan. 1920, 56.9%

(2) Start and End Date: Aug. 1922- Dec. 1923

(2) Peak Month and Rate of Inflation: Nov. 1923, 29,525%^[37]

[edit]Greece

Main article: Hyperinflation in Greece

Greece went through its worst inflation in 1944. In 1942, the highest denomination was 50,000 drachmai. By 1944, the highest denomination was 100,000,000,000 drachmai. In the 1944 currency reform, 1 new drachma was exchanged for 50,000,000,000 drachmai. Another currency reform in 1953 replaced the drachma at an exchange rate of 1 new drachma = 1,000 old drachmai. The overall impact of hyperinflation: 1 (1953) drachma = 50,000,000,000,000 pre 1944 drachmai. The Greek monthly inflation rate reached 8.5 billion percent in October 1944.

Start and End Date: May 1941- Dec. 1945

Peak Month and Rate of Inflation: Nov. 1944, 13,800%^[38]

[edit]Hungary, 1923–24

[edit]Hungary, 1945–46

Main article: Hungarian pengő hyperinflation

Hungary went through the worst inflation ever recorded between the end of 1945 and July 1946. In 1944, the highest denomination was 1,000 pengő. By the end of 1945, it was 10,000,000 pengő. The highest denomination in mid-1946 was 100,000,000,000,000,000,000 pengő. A special currency the adópengő – or tax pengő – was created for tax and postal payments.^[40] The value of the adópengő was adjusted each day, by radio announcement. On 1 January 1946 one adópengő equaled one pengő. By late July, one adópengő equaled 2,000,000,000,000,000,000,000 or 2×10²¹ pengő. When the pengő was replaced in August 1946 by the forint, the total value of all Hungarian banknotes in circulation amounted to ¹/_1,000 of one US dollar.^[41] It is the most severe known incident of inflation recorded, peaking at 1.3 × 10¹⁶ percent per month (prices double every 15 hours).^[42] The overall impact of hyperinflation: On 18 August 1946, 400,000 or 4×10²⁹ (four hundredquadrilliard on the long scale used in Hungary; four hundred octillion on short scale) pengő became 1 forint.

Start and End Date: Aug. 1945- Jul. 1946

Peak Month and Rate of Inflation:Jul. 1946, 41.9 quintillion percent^[43]

[edit]Kazakhstan

Kazakhstan experienced two episodes of hyperinflation. The first was in 1992. A feature that most post-Soviet Union countries experienced. The second episode was in November 1993 with the implementation of the Kazakhstani tenge.

(1) Start and End Date: Jan. 1992- Jan. 1992

(1) Peak Month and Rate of Inflation: Jan. 1992, 141%

(2) Start and End Date: Nov. 1993- Nov. 1993

(2) Peak Month and Rate of Inflation: 55.5% ^[44]

[edit]Kyrgyzstan

Kyrgyzstan experienced hyperinflation in Jan. 1992 following the dissolution of the Soviet Union.

Start and End Date: Jan. 1992- Jan. 1992

Peak Month and Rate of Inflation: Jan. 1992, 157%^[45]

[edit]Krajina

The Republic of Serbian Krajina went through its worst inflation in 1993. In 1992, the highest denomination was 50,000 dinara. By 1993, the highest denomination was 50,000,000,000 dinara. Note that this unrecognized country was reincorporated into Croatia in 1995.

[edit]North Korea

North Korea most likely experienced hyperinflation from December 2009- mid-January 2011. Based on the price of rice, North Korea's hyperinflation peaked in mid-January 2010, but according to black market exchange-rate data, and calculations base on purchasing power parity, North Korea experienced it's peak month of inflation in early March 2010. However, this data is unofficial and therefore, must be given a degree of caution.^[46]

[edit]Nicaragua

Nicaragua went through the worst inflation from 1986 to 1990. From 1943 to April 1971, one US dollar equalled 7 córdobas. From April 1971-early 1978, one US dollar was worth 10 córdobas. In early 1986, the highest denomination was 10,000 córdobas. By 1987, it was 1,000,000 córdobas. In the 1988 currency reform, 1 new córdoba was exchanged for 10,000 old córdobas. The highest denomination in 1990 was 100,000,000 new córdobas. In the 1991 currency reform, 1 new córdoba was exchanged for 5,000,000 old córdobas. The overall impact of hyperinflation: 1 (1991) córdoba = 50,000,000,000 pre-1988 córdobas.

Start and End Date: Jun. 1986- Mar. 1991

Peak Month and Rate of Inflation: Mar. 1991, 261%^[47]

[edit]Peru

Peru experienced its worst inflation from 1988–1990. In the 1985 currency reform, 1 inti was exchanged for 1,000 soles. In 1986, the highest denomination was 1,000 intis. But in September 1988, monthly inflation went to 114%. In August 1990, monthly inflation was 397%. The highest denomination was 5,000,000 intis by 1991. In the 1991 currency reform, 1 nuevo sol was exchanged for 1,000,000 intis. The overall impact of hyperinflation: 1 nuevo sol = 1,000,000,000 (old) soles.

(1) Start and End Date: Sep. 1988- Sep. 1988

(1) Peak Month and Rate of Inflation: Sep. 1988, 114%

(2) Start and End Date: Jul. 1990- Aug. 1990

(2) Peak Month and Rate of Inflation: Aug. 1990, 397% ^[48]

[edit]Philippines

The Japanese government occupying the Philippines during the World War II issued fiat currencies for general circulation. The Japanese-sponsored Second Philippine Republicgovernment led by Jose P. Laurel at the same time outlawed possession of other currencies, most especially "guerilla money." The fiat money was dubbed "Mickey Mouse Money" because it is similar to play money and is next to worthless. Survivors of the war often tell tales of bringing suitcase or bayong (native bags made of woven coconut or buri leaf strips) overflowing with Japanese-issued bills. In the early times, 75 Mickey Mouse pesos could buy one duck egg.^[49] In 1944, a box of matches cost more than 100 Mickey Mouse pesos.^[50]

In 1942, the highest denomination available was 10 pesos. Before the end of the war, because of inflation, the Japanese government was forced to issue 100, 500 and 1000 peso notes.

Start and End Date: Jan. 1944- Dec. 1944

Peak Month and Rate of Inflation: Jan. 1944, 60%^[51]

[edit]Poland, 1923–1924

After Poland’s independence in 1918, the country soon began experiencing extreme inflation. By 1921, prices had already risen 251 times above those of 1914, but in the following three years they rose by 988,223%^[52] with a peak rate in late 1923 of prices doubling every nineteen and a half days.^[53] At independence there was 8 marek per US dollar, but by 1923 the exchange rate was 6,375,000 marek (mkp) for 1 US dollar. The highest denomination was 10,000,000 mkp. In the 1924 currency reform there was a new currency introduced: 1 zloty = 1,800,000 mkp.

Start and End Date: Jan. 1923- Jan. 1924

Peak Month and Rate of Inflation: Nov. 1923, 275%^[54]

[edit]Poland, 1989–1990

Poland experienced a second hyperinflation between 1989 and 1990. The highest denomination in 1989 was 200,000 zlotych. It was 1,000,000 zlotych in 1991 and 2,000,000 zlotych in 1992; the exchange rate was 9500 zlotych for 1 US dollar in January 1990 and 19600 zlotych at the end of August 1992. In the 1994 currency reform, 1 new zloty was exchanged for 10,000 old zlotych and 1 US$ exchange rate was ca. 2.5 zlotych (new).

Start and End Date: Oct. 1989- Jan. 1990

Peak Month and Rate of Inflation: Jan. 1990, 77.3%^[55]

[edit]Republika Srpska

Republika Srpska was a breakaway region of Bosnia. As with Krajina, it pegged its currency, the Republika Srpska dinar, to that of Yugoslavia. Their bills were almost the same as Krajina's, but they issued fewer and did not issue currency after 1993.

Start and End Date: Apr. 1992- Jan. 1994

Peak Month and Rate of Inflation: Jan. 1994, 297 million percent^[56]

[edit]Soviet Union / Russian Federation

Main article: Hyperinflation in early Soviet Russia. See also: Soviet ruble.

Between 1921 and 1922, inflation in the Soviet Union reached 213%.

In 1992, the first year of the post-Soviet economic reform, inflation levels went up to 2,520%. In 1993, the annual rate was 840%, and in 1994, 224%. The ruble devalued from about 40 r/$ in 1991 to about 5,000 r/$ in late 1997. In 1998, a denominated ruble was introduced at the exchange rate of 1 new ruble = 1,000 pre-1998 rubles. In the second half of the same year, ruble fell to about 30 r/$ as a result of financial crisis^[57].

(1) Start and End Date: Jan. 1922- Feb. 1924

(1) Peak Month and Rate of Inflation: Feb. 1924

(2) Start and End Date: Jan. 1992- Jan. 1992, 212%

(2) Peak Month and Rate of Inflation: Jan. 1992, 245% ^[58]

[edit]Taiwan

As the Chinese Civil War reached its peak, Taiwan also suffered from the hyperinflation that has ravaged China in late 1940s. Highest denomination issued was a 1,000,000 DollarBearer's Cheque. Inflation was finally brought under control at introduction of New Taiwan Dollar in 15 June 1949 at rate of 40,000 old Dollar = 1 New Dollar

[[Image:100000-Kupon-1994-front.jpg|thumb|right|200px|A 100,000 Ukrainian karbovantsi (used between 1992 and 1996). In 1996, it was taken out of circulation, and was replaced by the Hryvnya at an exchange rate of 100,000 karbovantsi = 1 Hryvnya (approx. USD 0.50 at that time, about USD 0.20 as of 2007).

(1) Start and End Date: Aug. 1945- Sep. 1945

(1) Peak Month and Rate of Inflation: Aug. 1945, 399%

(2) Start and End Date: Feb. 1947- Feb. 1947

(2) Peak Month and Rate of Inflation: Feb. 1947, 50.8%

(3) Start and End Date: Oct. 1948- May 1949

(3) Peak Month and Rate of Inflation: October. 1948 399%^[59]

[edit]Takjikistan

Takjikistan experienced two episodes of hyperinflation. One episode following the break-up of the Soviet Union that lasted longer than many of it's neighboring countries. The second episode was in 1995 following the circulation of their new ruble.

(1) Start and End Date: Jan. 1992- Oct. 1993

(1) Peak Month and Rate of Inflation: Jan. 1992, 201%

(2) Start and End Date: Oct. 1995- Nov. 1995

(2) Peak Month and Rate of Inflation: Nov. 1995, 65.2%^[60]

[edit]Turkmenistan

Turkmenistan experience two episodes of hyperinflation as well. Similar to Takjikistan it experienced one episode in 1992 and one in 1995 following the introduction of it's currency the manat.

(1) Start and End Date: Jan. 1992- Nov. 1993

(1) Peak Month and Rate of Inflation: Nov. 1993, 429%

(2) Start and End Date: Nov. 1995- Jan. 1996

(2) Peak Month and Rate of Inflation: Jan. 1996, 62.5%^[61]

[edit]Ukraine

Ukraine experienced its worst inflation between 1992 and 1994. In 1992, the Ukrainian karbovanets was introduced, which was exchanged with the defunct Soviet ruble at a rate of 1 UAK = 1 SUR. Before 1993, the highest denomination was 1,000 karbovantsiv. By 1995, it was 1,000,000 karbovantsiv. In 1996, during the transition to the Hryvnya and the subsequent phase out of the karbovanets, the exchange rate was 100,000 UAK = 1 UAH. By some estimates, inflation for the entire calendar year of 1993 was 10,000% or higher, with retail prices reaching over 100 times their pre-1993 level by the end of the year.^[62]

Start and End Date:Jan. 1992- Nov. 1994

Peak Month and Rate of Inflation: Jan. 1992, 285%^[63]

[edit]Uzebekistan

Like many of the post-Soviet Union countries, Uzebekistan also experienced hyperinflation following the dissolution of the Soviet Union in 1992.

Start and End Date: Jan. 1992- Feb. 1992

Peak Month and Rate of Inflation: Jan. 1992, 118%^[64]

[edit]Yugoslavia

[[Image:500000000000 dinars.jpg|thumb|right|200px|A 500 billion Yugoslav dinar banknote c. 1993, the largest nominal value ever officially printed in Yugoslavia, the final result of hyperinflation.]] Yugoslavia went through a period of hyperinflation and subsequent currency reforms from 1989–1994. The highest denomination in 1988 was 50,000 dinars. By 1989 it was 2,000,000 dinars. In the 1990 currency reform, 1 new dinar was exchanged for 10,000 old dinars. In the 1992 currency reform, 1 new dinar was exchanged for 10 old dinars. The highest denomination in 1992 was 50,000 dinars. By 1993, it was 10,000,000,000 dinars. In the 1993 currency reform, 1 new dinar was exchanged for 1,000,000 old dinars. However, before the year was over, the highest denomination was 500,000,000,000 dinars. In the 1994 currency reform, 1 new dinar was exchanged for 1,000,000,000 old dinars. In another currency reform a month later, 1 novi dinar was exchanged for 13 million dinars (1 novi dinar = 1 German mark at the time of exchange). The overall impact of hyperinflation: 1 novi dinar = 1 × 10²⁷~1.3 × 10²⁷ pre 1990 dinars. Yugoslavia's rate of inflation hit 5 × 10¹⁵ percent cumulative inflation over the time period 1 October 1993 and 24 January 1994.

(1) Start and End Date: Sept. 1989- Dec. 1989

(1) Peak Month and Rate of Inflation: Dec 1989, 59.7%

(2) Start and End Date: Apr. 1992- Jan. 1994

(2) Peak Month and Rate of Inflation: Jan. 1994, 313 billion percent^[65]

[edit]Zaire (now the Democratic Republic of the Congo)

Zaire went through a period of inflation between 1989 and 1996. In 1988, the highest denomination was 5,000 zaires. By 1992, it was 5,000,000 zaires. In the 1993 currency reform, 1 nouveau zaire was exchanged for 3,000,000 old zaires. The highest denomination in 1996 was 1,000,000 nouveaux zaires. In 1997, Zaire was renamed the Congo Democratic Republic and changed its currency to francs. 1 franc was exchanged for 100,000 nouveaux zaires. One post-1997 franc was equivalent to 3 × 10¹¹ pre 1989 zaires.

(1) Start and End Date: Nov. 1993- Sep. 1994

(1) Peak Month and Rate of Inflation: Nov. 1993, 250%

(2) Start and End Date: Oct. 1991- Sep. 1992

(2) Peak Month and Rate of Inflation: Nov. 1992, 114%

(3) Start and End Date: Aug. 1998- Aug. 1998

(3) Peak Month and Rate of Inflation: 78.5% ^[66]

[edit]Zimbabwe

Main article: Hyperinflation in Zimbabwe

The 100 trillion Zimbabwean dollar banknote (10¹⁴ dollars), equal to 10²⁷ pre-2006 dollars

Hyperinflation in Zimbabwe was one of the few instances that resulted in the abandonment of the local currency. At independence in 1980, the Zimbabwe dollar (ZWD) was worth about USD 1.25. Afterwards, however, rampant inflation and the collapse of the economy severely devalued the currency. Inflation was steady before Robert Mugabe in 1998 began a program of land reforms that primarily focused on taking land from white farmers and redistributing those properties and assets to black farmers, which sent food production and revenues from export of food plummeting.^[67]^[68]^[69] The result was that to pay its expenditures Mugabe’s government and Gideon Gono’s Reserve Bank printed more and more notes with higher face values.

Hyperinflation began early in the 21st-century, reaching 624% in 2004. It fell back to low triple digits before surging to a new high of 1,730% in 2006. The Reserve Bank of Zimbabwe revalued on 1 August 2006 at a ratio of 1 000 ZWD to each second dollar (ZWN), but year-to-year inflation rose by June 2007 to 11,000% (versus an earlier estimate of 9,000%). Larger denominations were progressively issued:

5 May: banknotes or "bearer cheques" for the value of ZWN 100 million and ZWN 250 million.^[70]
15 May: new bearer cheques with a value of ZWN 500 million (then equivalent to about USD 2.50).^[71]
20 May: a new series of notes (“agro cheques”) in denominations of $5 billion, $25 billion and $50 billion.
21 July: “agro cheque” for $100 billion.^[72]

Inflation by 16 July officially surged to 2,200,000%^[73] with some analysts estimating figures surpassing 9,000,000 percent.^[74] As of 22 July 2008 the value of the ZWN fell to approximately 688 billion per 1 USD, or 688 trillion pre-August 2006 Zimbabwean dollars.^[75]

Date of redenomination	Currency code	Value
1 August 2006	ZWN	1 000 ZWD
1 August 2008	ZWR	10¹⁰ ZWN = 10¹³ ZWD
2 February 2009	ZWL	10¹² ZWR = 10²² ZWN = 10²⁵ ZWD

On 1 August 2008, the Zimbabwe dollar was redenominated at the ratio of 10¹⁰ ZWN to each third dollar (ZWR).^[76] On 19 August 2008, official figures announced for June estimated the inflation over 11,250,000%.^[77] Zimbabwe's annual inflation was 231,000,000% in July^[78](prices doubling every 17.3 days). For periods after July 2008, no official inflation statistics were released. Prof. Steve H. Hanke overcame the problem by estimating inflation rates after July 2008 and publishing the Hanke Hyperinflation Index for Zimbabwe.^[79] Prof. Hanke’s HHIZ measure indicated that the inflation peaked at an annual rate of 89.7 sextillion percent (89,700,000,000,000,000,000,000%) in mid-November 2008. The peak monthly rate was 79.6 billion percent, which is equivalent to a 98% daily rate, or around 7× 10¹⁰⁸ percent yearly rate. At that rate, prices were doubling every 24.7 hours. Note that many of these figures should be considered mostly theoretic, since the hyperinflation did not proceed at that rate a whole year.^[80]

At its November 2008 peak, Zimbabwe's rate of inflation approached, but failed to surpass, Hungary's July 1946 world record.^[80] On 2 February 2009, the dollar was redenominated for the fourth time at the ratio of 10¹² ZWR to 1 ZWL, only three weeks after the $100 trillion banknote was issued on 16 January,^[81]^[82] but hyperinflation waned by then as official inflation rates in USD were announced and foreign transactions were legalised,^[80] and on 12 April the dollar was abandoned in favour of using only foreign currencies. The overall impact of hyperinflation was 1 ZWL = 10²⁵ ZWD.

Start and End Date: Mar. 2007- Mid-Nov. 2008

Peak Month and Rate of Inflation:Mid-Nov. 2008, 7.96 billion percent^[83]

[edit]Examples of high inflation

Some countries experienced very high inflation, but did not reach hyperinflation, as defined as a monthly inflation rate of 50% per month.

[edit]Iraq

Between 1987 and 1995 the Iraqi Dinar went from an official value of 0.306 Dinars/USD (or $3.26 USD per dinar, though the black market rate is thought to have been substantially lower) to 3000 Dinars/USD due to government printing of 10s of trillions of dinars starting with a base of only 10s of billions. That equates to approximately 315% inflation per year averaged over that eight year period. ^[84]

[edit]Mexico

In spite of the Oil Crisis of the late 1970s (Mexico is a producer and exporter), and due to excessive social spending, Mexico defaulted on its external debt in 1982. As a result, the country suffered a severe case of capital flight and several years of hyperinflation and peso devaluation. On 1 January 1993, Mexico created a new currency, the nuevo peso ("new peso", or MXN), which chopped 3 zeros off the old peso, an inflation rate of 10,000% over the several years of the crisis. (One new peso was equal to 1000 of the obsolete MXP pesos).

[edit]Roman Egypt

In Roman Egypt, where the best documentation on pricing has survived, a measure of wheat which sold for 200 drachmae in 276 AD increased to more than 2,000,000 drachmae in 334 AD, roughly 1,000,000% inflation in a span of 58-years.^[85]

Although the price increased by a factor of 10,000 over 58 years, the annual rate of inflation was only 17.2% compounded. This can be shown by the sum: R = (1 + 0.172)^58. Inflation but not hyperinflation.

[edit]Romania

Romania experienced hyperinflation in the 1990s. The highest denomination in 1990 was 100 lei and in 1998 was 100,000 lei. By 2000 it was 500,000 lei. In early 2005 it was 1,000,000 lei. In July 2005 the leu was replaced by the new leu at 10,000 old lei = 1 new leu. Inflation in 2005 was 9%. [2] In July 2005 the highest denomination became 500 lei (= 5,000,000 old lei).

[edit]United States

During the Revolutionary War, when the Continental Congress authorized the printing of paper currency called continental currency, the monthly inflation rate reached a peak of 47 percent in November 1779 (Bernholz 2003: 48). These notes depreciated rapidly, giving rise to the expression "not worth a continental."

A second close encounter occurred during the U.S. Civil War, between January 1861 and April 1865, the Lerner Commodity Price Index of leading cities in the eastern Confederacy states increased from 100 to over 9,000.^[86] As the Civil War dragged on, the Confederate dollar had less and less value, until it was almost worthless by the last few months of the war. Similarly, the Union government inflated its greenbacks, with the monthly rate peaking at 40 percent in March 1864 (Bernholz 2003: 107).^[87]

[edit]Worst hyperinflations in world history

Highest monthly inflation rates in history^[87]
Country	Currency name	Month with highest inflation rate	Highest monthly inflation rate	Equivalent daily inflation rate	Time required for prices to double
Hungary	Hungarian pengő	July 1946	4.19 × 10¹⁶ %	207.19%	15 hours
Zimbabwe	Zimbabwe dollar	November 2008	7.96 × 10¹⁰ %	98.01%	24.7 hours
Yugoslavia	Yugoslav dinar	January 1994	3.13 × 10⁸ %	64.63%	1.4 days
Republika Srpska	Republika Srpska dinar	January 1994	297,000,000%	64.3%	1.4 days
Germany	German Papiermark	October 1923	29,500%	20.87%	3.7 days
Greece	Greek drachma	October 1944	13,800%	17.84%	4.3 days

[edit]Units of inflation

Inflation rate is usually measured in percent per year. It can also be measured in percent per month or in price doubling time.

Example of inflation rates and units When first bought, an item cost 1 currency unit. Later, the price rose...

Old price

New price 1 year later

New price 10 years later

New price 100 years later

(Annual) inflation [%]

Monthly
inflation
[%]

Price
doubling
time
[years]

Zero add time [years]

.0001

.001

.01

0.01

.0008

6931

23028

.001

.01

.11

0.1

.00833

693

2300

.003

.03

.35

0.3

.0250

231

769

.01

.10

.70

.0830

231

.03

.34

.247

77.9

.59

13800

.797

.27

24.1

1024

1.27 × 10³⁰

100

.95

3.32

10¹⁰

10¹⁰⁰

900

0	.301 (3⅔ months)

8.20 × 10¹⁴

1.37 × 10¹⁴⁹

3000

0	.202 (2½ months)

0.671 (8 months)

10¹²

10¹²⁰

10^1,200

10¹⁴

900

0	.0251 (9 days)

0.0833 (1 month)

1.67 × 10⁷³

1.69 × 10⁷³²

1.87 × 10^7,322

1.67 × 10⁷⁵

1.26 × 10⁸

0	.00411 (36 hours)

0.0137 (5 days)

1.05 × 10^2,637

1.69 × 10^26,370

1.89 × 10^263,702

1.05 × 10^2,639

5.65 × 10²²¹

0	.000114 (1 hour)

0.000379(3.3 hours)

Often, at redenominations, three zeroes are cut from the bills. It can be read from the table that if the (annual) inflation is for example 100%, it takes 3.32 years to produce one more zero on the price tags, or 3 × 3.32 = 9.96 years to produce three zeroes. Thus can one expect a redenomination to take place about 9.96 years after the currency was introduced.

[edit]See also

[edit]References

^ O’Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 341, 404.ISBN 0-13-063085-3.
^ Where's the Hyperinflation?, Forbes.com, 2012
^ Parsson, Jens (1974). Dying of Money (Chapter 17: Velocity). Boston, MA: Wellspring Press. pp. 112-119.
^ Phillip Cagan, The Monetary Dynamics of Hyperinflation, in Milton Friedman (Editor), Studies in the Quantity Theory of Money, Chicago: University of Chicago Press (1956).
^ Ragan, Christopher; Lipsey, Richard (2008). Macroeconomics. Toronto, Ontario, Canada: Pearson Education Canada. p. 645. ISBN 0-558-05845-0.
^ "IAS 29 — Financial Reporting in Hyperinflationary Economies". IASB. Retrieved 2012-04-10.
^ Hyperinflation: causes, cures Bernard Mufute, 2003-10-02, “Hyperinflation has its root cause in money growth, which is not supported by growth in the output of goods and services. Usually the excessive money supply growth is caused by financing of the government budget deficit through the printing of money.”
^http://www.ssc.uwo.ca/economics/econref/workingpapers/researchreports/wp2000/wp2000_1.pdf
^ Wolfgang Chr. Fischer (Editor), German Hyperinflation 1922/23 – A Law and Economics Approach, Eul Verlag, Köln, Germany 2010, p.124
^ http://blogs.wsj.com/marketbeat/2008/03/06/jefferson-county-memories/Jefferson County Miracles, Wall Street Journal, March 6, 2008.
^ 1 billion in the German long scale = 1000 milliard = 1 trillion US scale.
^ Values of the most important German Banknotes of the Inflation Period from 1920 – 1923
^ The Penniless Billionaires, Max Shapiro, New York Times Book Co., 1980, page 203, ISBN 0-8129-0923-2 Shipiro comments: "Of course, one must not forget the 5 pfennig!"
^ Hanke, Steve H. (17 November 2008). "New Hyperinflation Index (HHIZ) Puts Zimbabwe Inflation at 89.7 sextillion percent". The Cato Institute. Retrieved 17 November 2008.
^ Tran, Mark (31 July 2008). "Zimbabwe knocks 10 zeros off currency amid world's highest inflation". The Guardian (London).
^ IMF. ‘International Financial Statistics (IFS)’, Washington, D.C.: International Monetary Fund, accessed October 2009. http://elibrary-data.imf.org/.
^ IMF. ‘International Financial Statistics (IFS)’, Washington, D.C.: International Monetary Fund, accessed October 2009. http://elibrary-data.imf.org/.
^ IMF. ‘International Financial Statistics (IFS)’, Washington, D.C.: International Monetary Fund, accessed October 2009.http://elibrary-data.imf.org/.
^ http://www.fee.org/pdf/the-freeman/0604RMEbeling.pdf
^ Sargent, T. J. (1986) Rational Expectations and Inflation, New York: Harper & Row.
^ IMF. ‘International Financial Statistics (IFS)’, Washington, D.C.: International Monetary Fund, accessed April 2012. http://elibrary-data.imf.org/.
^ 29. World Bank. (1994) Statistical Handbook: States of the Former USSR, Washington, D.C.: World Bank.
^ Weatherford, Jack (1997). The History of Money. Three Rivers Press. p. 194.ISBN 0-609-80172-4.
^ IMF. ‘International Financial Statistics (IFS)’, Washington, D.C.: International Monetary Fund, accessed October 2009. http://elibrary-data.imf.org/.
^ Kreso, S. (1997) Novac Bosne i Hercegovine: Od BHD do Novog Novca BiH, Sarajevo: Jez.
^ How Brazil Beat Hyperinflation, by Leslie Evans
^ IMF. ‘International Financial Statistics (IFS)’, Washington, D.C.: International Monetary Fund, accessed October 2009. http://elibrary-data.imf.org/.
^ IMF. ‘International Financial Statistics (IFS)’, Washington, D.C.: International Monetary Fund, accessed October 2009. http://elibrary-data.imf.org/.
^ Manfred Bräuchle. "Applied Theory: The Reforms in Chile". HTML version
^ IMF. (1973-1974) ‘International Financial Statistics (IFS’), Washington, D.C.: International Monetary Fund.
^ Chang, K. (1958) The Inflationary Spiral, The Experience in China, 1939-1950, New York: The Technology Press of Massachusetts Institute of Technology and John Wiley and Sons.
^ World Bank. (1993) Statistical Handbook: States of the Former USSR, Washington, D.C.: World Bank.
^ White, E.N. (1991) ‘Measuring the French Revolution's Inflation: the Tableaux de depreciation,’ Histoire & Mesure, 6 (3): 245 – 274.
^ Sargent, T. J. (1986) Rational Expectations and Inflation, New York: Harper & Row.
^ Wang, J.Y. (1999) ‘The Georgian Hyperinflation and Stabilization’, working paper, International Monetary Fund, May, 99/65.
^ ^a ^b Bresciani-Turroni, page 335
^ Sargent, T. J. (1986) Rational Expectations and Inflation, New York: Harper & Row.
^ Makinen, G. E. (1986) ‘The Greek Hyperinflation and Stabilization of 1943–1946’, Journal of Economic History, 46 (3): 795–805.
^ Sargent, T.J. (1981) ‘The Ends of Four Big Inflations’, working paper, Federal Reserve Bank of Minneapolis, 158.
^ Hungary: Postal history – Hyperinflation (part 2)
^ Judt, Tony (2006). Postwar: A History of Europe Since 1945. Penguin. p. 87.ISBN 0-14-303775-7.
^ Zimbabwe hyperinflation 'will set world record within six weeks' Zimbabwe Situation 2008-11-14
^ Nogaro, B. (1948) ‘Hungary’s Recent Monetary Crisis and Its Theoretical Meaning’, American Economic Review, 38 (4): 526–42.
^ World Bank. (1994) Statistical Handbook: States of the Former USSR, Washington, D.C.: World Bank.
^ World Bank. (1994) Statistical Handbook: States of the Former USSR, Washington, D.C.: World Bank.
^ http://www.dailynk.com/english/market.php
^ IMF. ‘International Financial Statistics (IFS)’, Washington, D.C.: International Monetary Fund, accessed November 2011. http://elibrary-data.imf.org/.
^ IMF. ‘International Financial Statistics (IFS)’, Washington, D.C.: International Monetary Fund, accessed November 2011. http://elibrary-data.imf.org/.
^ Barbara A. Noe (7 August 2005). "A Return to Wartime Philippines". Los Angeles Times. Retrieved 2006-11-16.^{[dead link]}
^ Agoncillo, Teodoro A. & Guerrero, Milagros C., History of the Filipino People, 1986, R.P. Garcia Publishing Company, Quezon City, Philippines
^ Hartendorp, A. (1958) History of Industry and Trade of the Philippines, Manila: American Chamber of Commerce on the Philippines, Inc.
^ [1]
^ Hyperinflation: Mugabe Versus Milosević
^ Sargent, T.J. (1981) ‘The Ends of Four Big Inflations’, working paper, Federal Reserve Bank of Minneapolis, 158.
^ IMF. ‘International Financial Statistics (IFS)’, Washington, D.C.: International Monetary Fund, accessed October 2009. http://elibrary-data.imf.org/.
^ Vilendecic, S. (2008) Banking in Republika Srpska in the late XX and early XXI century, Banja Luka: Besjeda.
^ Statistics on Inflation Levels in Russia, International Monetary Fund, 2012.
^ World Bank. (1993) Statistical Handbook: States of the Former USSR, Washington, D.C.: World Bank.
^ Liu, F.C. (1970) Essays on Monetary Development in Taiwan, Taipei, Taiwan: China Committee for Publication Aid and Prize Awards.
^ World Bank. (1996) Statistical Handbook: States of the Former USSR, Washington, D.C.: World Bank.
^ World Bank. (1996) Statistical Handbook: States of the Former USSR, Washington, D.C.: World Bank.
^ Yuriy Skolotiany, The past and the future of Ukrainian national currency, Interview with Anatoliy Halchynsky, Mirror Weekly, #33(612), 2—8 September 2006
^ World Bank. (1994) Statistical Handbook: States of the Former USSR, Washington, D.C.: World Bank.
^ World Bank. (1994) Statistical Handbook: States of the Former USSR, Washington, D.C.: World Bank.
^ Rostowski, J. (1998) Macroeconomics Instability in Post-Communist Countries, New York: Carendon Press.
^ IMF. ‘International Financial Statistics (IFS)’, Washington, D.C.: International Monetary Fund, accessed October 2009. http://elibrary-data.imf.org/.
^ Land reform in Zimbabwe
^ Zimbabwe famine
^ Greenspan, Alan. The Age of Turbulence: Adventures in a New World. New York: The Penguin Press. 2007. Page 339.
^ Zimbabwe issues 250 mn dollar banknote to tackle price spiral- International Business-News-The Economic Times
^ BBC NEWS: Zimbabwe bank issues $500m note
^ http://uk.news.yahoo.com/afp/20080719/tbs-zimbabwe-economy-inflation-5268574.html
^ "Zimbabwe inflation at 2,200,000%". BBC News. 16 July 2008. Retrieved 26 March 2010.
^ http://www.thezimbabweindependent.com/index.php?option=com_content&view=article&id=20637:inflation-gallops-ahead&catid=28:zimbabwe%20business%20stories&Itemid=59
^ http://www.zimbabweanequities.com/
^ Reuters. http://africa.reuters.com/business/news/usnBAN034008.html.
^ "Zimbabwe inflation rockets higher". BBC News. 19 August 2008. Retrieved 26 March 2010.
^ http://news.yahoo.com/s/afp/20081009/wl_africa_afp/zimbabweeconomyinflation
^ Steve H. Hanke, "New Hyperinflation Index (HHIZ) Puts Zimbabwe Inflation at 89.7 Sextillion Percent.” Washington, D.C.: Cato Institute. (Retrieved 17 November 2008) (http://www.cato.org/zimbabwe)
^ ^a ^b ^c Steve H. Hanke and Alex K. F. Kwok, "On the Measurement of Zimbabwe’s Hyperinflation." Cato Journal, Vol. 29, No. 2 (Spring/Summer 2009). (http://www.cato.org/pubs/journal/cj29n2/cj29n2-8.pdf)
^ http://www.africasia.com/services/news/newsitem.php?area=africa&item=090116063500.qczog3x4.php
^ Zimbabwe dollar sheds 12 zeros, BBC News, 2009-02-02, retrieved 2008-02-02
^ Hanke, S. H. and Kwok, A. K. F. (2009) ‘On the Measurement of Zimbabwe’s Hyperinflation’, Cato Journal, 29 (2): 353-64.
^ History page at the Central Bank of Iraq http://cbi.iq/index.php?pid=History
^ http://www.businessinsider.com/7-gasoline-thanks-ben-2012-4
^ Money and Finance in the Confederate States of America, Marc Weidenmier, Claremont McKenna College
^ ^a ^b http://www.cato.org/pubs/journal/cj29n2/cj29n2-8.pdf

[edit]Further reading

Costantino Bresciani-Turroni, The Economics of Inflation (English transl.). Northampton, England: Augustus Kelly Publishers, 1937,http://mises.org/books/economicsofinflation.pdf on the German 1919–1923 inflation.
Shun-Hsin Chou, The Chinese Inflation 1937–1949, New York, Columbia University Press, 1963, Library of Congress Cat. 62-18260.
Andrew Dickson White, Fiat Money Inflation in France, Caxton Printers, Idaho, 1969. a popular description of the 1789–1799 inflation.
Steve H. Hanke, “Zimbabwe: From Hyperinflation to Growth.” Development Policy Analysis No. 6. Washington, D.C.: Cato Institute, Center for Global Liberty and Prosperity. (June 25, 2008) (http://www.cato.org/pubs/dpa/dpa6.pdf)
Steve H. Hanke and Alex K. F. Kwok, "On the Measurement of Zimbabwe’s Hyperinflation." Cato Journal, Vol. 29, No. 2 (Spring/Summer 2009). (http://www.cato.org/pubs/journal/cj29n2/cj29n2-8.pdf)
Wolfgang Chr. Fischer (Editor), "German Hyperinflation 1922/23 – A Law and Economics Approach", Eul Verlag, Köln, Germany 2010.

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INFLATION

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Inflation

From Wikipedia, the free encyclopedia

This article is about a rise in the general price level. For the expansion of the early universe, see Inflation (cosmology). For other uses, see Inflation (disambiguation).

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v t e

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.^[1] When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy.^[2]^[3] A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.^[4]

Inflation's effects on an economy are various and can be simultaneously positive and negative. Negative effects of inflation include a decrease in the real value of money and other monetary items over time, uncertainty over future inflation which may discourage investment and savings, and if inflation is rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future. Positive effects include ensuring that central banks can adjust nominal interest rates (intended to mitigate recessions),^[5] and encouraging investment in non-monetary capital projects.

Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply.^[6] Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities, as well as to growth in the money supply. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth.^[7]^[8]

Today, most economists favor a low, steady rate of inflation.^[9] Low (as opposed to zero or negative) inflation reduces the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduces the risk that a liquidity trap prevents monetary policy from stabilizing the economy.^[10] The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control monetary policy through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements.^[11]

[edit]History

Annual inflation rates in the United States from 1666 to 2004.

Increases in the quantity of money or in the overall money supply (or debasement of the means of exchange) have occurred in many different societies throughout history, changing with different forms of money used.^[12]^[13] For instance, when gold was used as currency, the government could collect gold coins, melt them down, mix them with other metals such a silver, copper or lead, and reissue them at the same nominal value. By diluting the gold with other metals, the government could issue more coins without also needing to increase the amount of gold used to make them. When the cost of each coin is lowered in this way, the government profits from an increase in seigniorage.^[14] This practice would increase the money supply but at the same time the relative value of each coin would be lowered. As the relative value of the coins becomes lower, consumers would need to give more coins in exchange for the same goods and services as before. These goods and services would experience a price increase as the value of each coin is reduced.^[15]

Historically, infusions of gold or silver into an economy also led to inflation. From the second half of the 15th century to the first half of the 17th, Western Europe experienced a major inflationary cycle referred to as the "price revolution",^[16]^[17] with prices on average rising perhaps sixfold over 150 years. This was largely caused by the sudden influx of gold and silver from the New World into Habsburg Spain.^[18] The silver spread throughout a previously cash-starved Europe and caused widespread inflation.^[19]^[20] Demographic factors also contributed to upward pressure on prices, with European population growth after depopulation caused by the Black Death pandemic.

By the nineteenth century, economists categorized three separate factors that cause a rise or fall in the price of goods: a change in the value or production costs of the good, a change in the price of money which then was usually a fluctuation in the commodity price of the metallic content in the currency, and currency depreciation resulting from an increased supply of currency relative to the quantity of redeemable metal backing the currency. Following the proliferation of private banknote currency printed during the American Civil War, the term "inflation" started to appear as a direct reference to the currency depreciation that occurred as the quantity of redeemable banknotes outstripped the quantity of metal available for their redemption. At that time, the term inflation referred to the devaluation of the currency, and not to a rise in the price of goods.^[21]

This relationship between the over-supply of banknotes and a resulting depreciation in their value was noted by earlier classical economists such as David Hume and David Ricardo, who would go on to examine and debate what effect a currency devaluation (later termed monetary inflation) has on the price of goods (later termed price inflation, and eventually justinflation).^[22]

The adoption of fiat currency (paper money) by many countries, from the 18th century onwards, made much larger variations in the supply of money possible. Since then, huge increases in the supply of paper money have taken place in a number of countries, producing hyperinflations – episodes of extreme inflation rates much higher than those observed in earlier periods of commodity money. The hyperinflation in the Weimar Republic of Germany is a notable example.

[edit]Related definitions

The term "inflation" originally referred to increases in the amount of money in circulation, and some economists still use the word in this way. However, most economists today use the term "inflation" to refer to a rise in the price level. An increase in the money supply may be called monetary inflation, to distinguish it from rising prices, which may also for clarity be called 'price inflation'.^[23] Economists generally agree that in the long run, inflation is caused by increases in the money supply.^[24]

Other economic concepts related to inflation include: deflation – a fall in the general price level; disinflation – a decrease in the rate of inflation; hyperinflation – an out-of-control inflationary spiral; stagflation – a combination of inflation, slow economic growth and high unemployment; and reflation – an attempt to raise the general level of prices to counteract deflationary pressures.

Since there are many possible measures of the price level, there are many possible measures of price inflation. Most frequently, the term "inflation" refers to a rise in a broad price index representing the overall price level for goods and services in the economy. The Consumer Price Index (CPI), the Personal Consumption Expenditures Price Index (PCEPI) and the GDP deflatorare some examples of broad price indices. However, "inflation" may also be used to describe a rising price level within a narrower set of assets, goods or services within the economy, such as commodities (including food, fuel, metals), financial assets(such as stocks, bonds and real estate), services (such as entertainment and health care), or labor. The Reuters-CRB Index(CCI), the Producer Price Index, and Employment Cost Index (ECI) are examples of narrow price indices used to measure price inflation in particular sectors of the economy. Core inflation is a measure of inflation for a subset of consumer prices that excludes food and energy prices, which rise and fall more than other prices in the short term. The Federal Reserve Board pays particular attention to the core inflation rate to get a better estimate of long-term future inflation trends overall.^[25]

[edit]Measures

CPI inflation (year-on-year) in the United States from 1914 to 2010.

Inflation is usually estimated by calculating the inflation rateof a price index, usually the Consumer Price Index.^[26] The Consumer Price Index measures prices of a selection of goods and services purchased by a "typical consumer".^[4]The inflation rate is the percentage rate of change of a price index over time.

For instance, in January 2007, the U.S. Consumer Price Index was 202.416, and in January 2008 it was 211.080. The formula for calculating the annual percentage rate inflation in the CPI over the course of 2007 is

The resulting inflation rate for the CPI in this one year period is 4.28%, meaning the general level of prices for typical U.S. consumers rose by approximately four percent in 2007.^[27]

Other widely used price indices for calculating price inflation include the following:

Producer price indices (PPIs) which measures average changes in prices received by domestic producers for their output. This differs from the CPI in that price subsidization, profits, and taxes may cause the amount received by the producer to differ from what the consumer paid. There is also typically a delay between an increase in the PPI and any eventual increase in the CPI. Producer price index measures the pressure being put on producers by the costs of their raw materials. This could be "passed on" to consumers, or it could be absorbed by profits, or offset by increasing productivity. In India and the United States, an earlier version of the PPI was called the Wholesale Price Index.
Commodity price indices, which measure the price of a selection of commodities. In the present commodity price indices are weighted by the relative importance of the components to the "all in" cost of an employee.
Core price indices: because food and oil prices can change quickly due to changes in supply and demand conditions in the food and oil markets, it can be difficult to detect the long run trend in price levels when those prices are included. Therefore most statistical agencies also report a measure of 'core inflation', which removes the most volatile components (such as food and oil) from a broad price index like the CPI. Because core inflation is less affected by short run supply and demand conditions in specific markets, central banks rely on it to better measure the inflationary impact of current monetary policy.

Other common measures of inflation are:

GDP deflator is a measure of the price of all the goods and services included in gross domestic product (GDP). The US Commerce Department publishes a deflator series for US GDP, defined as its nominal GDP measure divided by its real GDP measure.
Regional inflation The Bureau of Labor Statistics breaks down CPI-U calculations down to different regions of the US.
Historical inflation Before collecting consistent econometric data became standard for governments, and for the purpose of comparing absolute, rather than relative standards of living, various economists have calculated imputed inflation figures. Most inflation data before the early 20th century is imputed based on the known costs of goods, rather than compiled at the time. It is also used to adjust for the differences in real standard of living for the presence of technology.
Asset price inflation is an undue increase in the prices of real or financial assets, such as stock (equity) and real estate. While there is no widely accepted index of this type, some central bankers have suggested that it would be better to aim at stabilizing a wider general price level inflation measure that includes some asset prices, instead of stabilizing CPI or core inflation only. The reason is that by raising interest rates when stock prices or real estate prices rise, and lowering them when these asset prices fall, central banks might be more successful in avoiding bubbles and crashes in asset prices.^{[dubious – discuss]}

[edit]Issues in measuring

Measuring inflation in an economy requires objective means of differentiating changes in nominal prices on a common set of goods and services, and distinguishing them from those price shifts resulting from changes in value such as volume, quality, or performance. For example, if the price of a 10 oz. can of corn changes from $0.90 to $1.00 over the course of a year, with no change in quality, then this price difference represents inflation. This single price change would not, however, represent general inflation in an overall economy. To measure overall inflation, the price change of a large "basket" of representative goods and services is measured. This is the purpose of a price index, which is the combined price of a "basket" of many goods and services. The combined price is the sum of the weighted average prices of items in the "basket". A weighted price is calculated by multiplying the unit price of an item to the number of those items the average consumer purchases. Weighted pricing is a necessary means to measuring the impact of individual unit price changes on the economy's overall inflation. The Consumer Price Index, for example, uses data collected by surveying households to determine what proportion of the typical consumer's overall spending is spent on specific goods and services, and weights the average prices of those items accordingly. Those weighted average prices are combined to calculate the overall price. To better relate price changes over time, indexes typically choose a "base year" price and assign it a value of 100. Index prices in subsequent years are then expressed in relation to the base year price.^[11] While comparing inflation measures for various periods one has to take into consideration the base effect as well.

Inflation measures are often modified over time, either for the relative weight of goods in the basket, or in the way in which goods and services from the present are compared with goods and services from the past. Over time, adjustments are made to the type of goods and services selected in order to reflect changes in the sorts of goods and services purchased by 'typical consumers'. New products may be introduced, older products disappear, the quality of existing products may change, and consumer preferences can shift. Both the sorts of goods and services which are included in the "basket" and the weighted price used in inflation measures will be changed over time in order to keep pace with the changing marketplace.^{[citation needed]}

Inflation numbers are often seasonally adjusted in order to differentiate expected cyclical cost shifts. For example, home heating costs are expected to rise in colder months, and seasonal adjustments are often used when measuring for inflation to compensate for cyclical spikes in energy or fuel demand. Inflation numbers may be averaged or otherwise subjected to statistical techniques in order to remove statistical noise and volatility of individual prices.^{[citation needed]}

When looking at inflation, economic institutions may focus only on certain kinds of prices, or special indices, such as the core inflation index which is used by central banks to formulate monetary policy.^{[citation needed]}

Most inflation indices are calculated from weighted averages of selected price changes. This necessarily introduces distortion, and can lead to legitimate disputes about what the true inflation rate is. This problem can be overcome by including all available price changes in the calculation, and then choosing the median value.^[28]

[edit]Effects

[edit]General

An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when the general level of prices rises, each monetary unit buys fewer goods and services. The effect of inflation is not distributed evenly in the economy, and as a consequence there are hidden costs to some and benefits to others from this decrease in the purchasing power of money. For example, with inflation, lenders or depositors who are paid a fixed rate of interest on loans or deposits will lose purchasing power from their interest earnings, while their borrowers benefit. Individuals or institutions with cash assets will experience a decline in the purchasing power of their holdings. Increases in payments to workers and pensioners often lag behind inflation, especially for those with fixed payments. Increases in the price level (inflation) erode the real value of money (the functional currency) and other items with an underlying monetary nature.

Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real" interest rate as the inflation rate rises. The real interest on a loan is the nominal rate minus the inflation rate.The formula R = N-I approximates the correct answer as long as both the nominal interest rate and the inflation rate are small. The correct equation is r = n/i where r, n and i are expressed as ratios (e.g. 1.2 for +20%, 0.8 for −20%). As an example, when the inflation rate is 3%, a loan with a nominal interest rate of 5% would have a real interest rate of approximately 2%. Any unexpected increase in the inflation rate would decrease the real interest rate. Banks and other lenders adjust for this inflation risk either by including an inflation risk premium to fixed interest rate loans, or lending at an adjustable rate.

[edit]Negative

High or unpredictable inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation.^[11] Uncertainty about the future purchasing power of money discourages investment and saving.^[29] And inflation can impose hidden tax increases, as inflated earnings push taxpayers into higher income tax rates unless the tax brackets are indexed to inflation.

With high inflation, purchasing power is redistributed from those on fixed nominal incomes, such as some pensioners whose pensions are not indexed to the price level, towards those with variable incomes whose earnings may better keep pace with the inflation.^[11] This redistribution of purchasing power will also occur between international trading partners. Where fixedexchange rates are imposed, higher inflation in one economy than another will cause the first economy's exports to become more expensive and affect the balance of trade. There can also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation.

Cost-push inflation: High inflation can prompt employees to demand rapid wage increases, to keep up with consumer prices. In the cost-push theory of inflation, rising wages in turn can help fuel inflation. In the case of collective bargaining, wage growth will be set as a function of inflationary expectations, which will be higher when inflation is high. This can cause a wage spiral.^[30] In a sense, inflation begets further inflationary expectations, which beget further inflation.

Hoarding: People buy durable and/or non-perishable commodities and other goods as stores of wealth, to avoid the losses expected from the declining purchasing power of money, creating shortages of the hoarded goods.

Social unrest and revolts: Inflation can lead to massive demonstrations and revolutions. For example, inflation and in particular food inflation is considered as one of the main reasons that caused the 2010–2011 Tunisian revolution^[31] and the 2011 Egyptian revolution,^[32] according to many observators including Robert Zoellick,^[33] president of the World Bank. Tunisian presidentZine El Abidine Ben Ali was ousted, Egyptian President Hosni Mubarak was also ousted after only 18 days of demonstrations, and protests soon spread in many countries of North Africa and Middle East.

Hyperinflation: If inflation gets totally out of control (in the upward direction), it can grossly interfere with the normal workings of the economy, hurting its ability to supply goods. Hyperinflation can lead to the abandonment of the use of the country's currency, leading to the inefficiencies of barter.

Allocative efficiency: A change in the supply or demand for a good will normally cause its relative price to change, signaling to buyers and sellers that they should re-allocate resources in response to the new market conditions. But when prices are constantly changing due to inflation, price changes due to genuine relative price signals are difficult to distinguish from price changes due to general inflation, so agents are slow to respond to them. The result is a loss of allocative efficiency.

Shoe leather cost: High inflation increases the opportunity cost of holding cash balances and can induce people to hold a greater portion of their assets in interest paying accounts. However, since cash is still needed in order to carry out transactions this means that more "trips to the bank" are necessary in order to make withdrawals, proverbially wearing out the "shoe leather" with each trip.

Menu costs: With high inflation, firms must change their prices often in order to keep up with economy-wide changes. But often changing prices is itself a costly activity whether explicitly, as with the need to print new menus, or implicitly.

Business cycles: According to the Austrian Business Cycle Theory, inflation sets off the business cycle. Austrian economists hold this to be the most damaging effect of inflation. According to Austrian theory, artificially low interest rates and the associated increase in the money supply lead to reckless, speculative borrowing, resulting in clusters of malinvestments, which eventually have to be liquidated as they become unsustainable.^[34]

[edit]Positive

Labor-market adjustments: Nominal wages are slow to adjust downwards. This can lead to prolonged disequilibrium and high unemployment in the labor market. Since inflation allows real wages to fall even if nominal wages are kept constant, moderate inflation enables labor markets to reach equilibrium faster.^[35]

Room to maneuver: The primary tools for controlling the money supply are the ability to set the discount rate, the rate at which banks can borrow from the central bank, and open market operations, which are the central bank's interventions into the bonds market with the aim of affecting the nominal interest rate. If an economy finds itself in a recession with already low, or even zero, nominal interest rates, then the bank cannot cut these rates further (since negative nominal interest rates are impossible) in order to stimulate the economy – this situation is known as a liquidity trap. A moderate level of inflation tends to ensure that nominal interest rates stay sufficiently above zero so that if the need arises the bank can cut the nominal interest rate.^{[citation needed]}

Mundell–Tobin effect: The Nobel laureate Robert Mundell noted that moderate inflation would induce savers to substitute lending for some money holding as a means to finance future spending. That substitution would cause market clearing real interest rates to fall.^[36]The lower real rate of interest would induce more borrowing to finance investment. In a similar vein, Nobel laureate James Tobin noted that such inflation would cause businesses to substitute investment in physical capital (plant, equipment, and inventories) for money balances in their asset portfolios. That substitution would mean choosing the making of investments with lower rates of real return. (The rates of return are lower because the investments with higher rates of return were already being made before.)^[37] The two related effects are known as the Mundell–Tobin effect. Unless the economy is already overinvesting according to models of economic growth theory, that extra investment resulting from the effect would be seen as positive.

Instability with Deflation: Economist S.C. Tsaing noted that once substantial deflation is expected, two important effects will appear; both a result of money holding substituting for lending as a vehicle for saving.^[38] The first was that continually falling prices and the resulting incentive to hoard money will cause instability resulting from the likely increasing fear, while money hoards grow in value, that the value of those hoards are at risk, as people realize that a movement to trade those money hoards for real goods and assets will quickly drive those prices up. Any movement to spend those hoards "once started would become a tremendous avalanche, which could rampage for a long time before it would spend itself."^[39] Thus, a regime of long-term deflation is likely to be interrupted by periodic spikes of rapid inflation and consequent real economic disruptions. Moderate and stable inflation would avoid such a seesawing of price movements.

Financial Market Inefficiency with Deflation: The second effect noted by Tsaing is that when savers have substituted money holding for lending on financial markets, the role of those markets in channeling savings into investment is undermined. With nominal interest rates driven to zero, or near zero, from the competition with a high return money asset, there would be no price mechanism in whatever is left of those markets. With financial markets effectively euthanized, the remaining goods and physical asset prices would move in perverse directions. For example, an increased desire to save could not push interest rates further down (and thereby stimulate investment) but would instead cause additional money hoarding, driving consumer prices further down and making investment in consumer goods production thereby less attractive. Moderate inflation, once its expectation is incorporated into nominal interest rates, would give those interest rates room to go both up and down in response to shifting investment opportunities, or savers' preferences, and thus allow financial markets to function in a more normal fashion.

[edit]Causes

The Bank of England, central bank of the United Kingdom, monitors causes and attempts to control inflation.

Historically, a great deal of economic literature was concerned with the question of what causes inflation and what effect it has. There were different schools of thought as to the causes of inflation. Most can be divided into two broad areas: quality theories of inflation and quantity theories of inflation. The quality theory of inflation rests on the expectation of a seller accepting currency to be able to exchange that currency at a later time for goods that are desirable as a buyer. The quantity theory of inflation rests on the quantity equation of money, that relates the money supply, its velocity, and the nominal value of exchanges. Adam Smith and David Hume proposed a quantity theory of inflation for money, and a quality theory of inflation for production.^{[citation needed]}

Currently, the quantity theory of money is widely accepted as an accurate model of inflation in the long run. Consequently, there is now broad agreement among economists that in the long run, the inflation rate is essentially dependent on the growth rate of money supply. However, in the short and medium term inflation may be affected by supply and demand pressures in the economy, and influenced by the relative elasticity of wages, prices and interest rates.^[24] The question of whether the short-term effects last long enough to be important is the central topic of debate between monetarist and Keynesian economists. In monetarism prices and wages adjust quickly enough to make other factors merely marginal behavior on a general trend-line. In the Keynesian view, prices and wages adjust at different rates, and these differences have enough effects on real output to be "long term" in the view of people in an economy.

[edit]Keynesian view

Keynesian economic theory proposes that changes in money supply do not directly affect prices, and that visible inflation is the result of pressures in the economy expressing themselves in prices.

There are three major types of inflation, as part of what Robert J. Gordon calls the "triangle model":^[40]

Demand-pull inflation is caused by increases in aggregate demand due to increased private and government spending, etc. Demand inflation is constructive to a faster rate of economic growth since the excess demand and favourable market conditions will stimulate investment and expansion.
Cost-push inflation, also called "supply shock inflation," is caused by a drop in aggregate supply (potential output). This may be due to natural disasters, or increased prices of inputs. For example, a sudden decrease in the supply of oil, leading to increased oil prices, can cause cost-push inflation. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices. Another example stems from unexpectedly high Insured Losses, either legitimate (catastrophes) or fraudulent (which might be particularly prevalent in times of recession).^{[citation needed]}
Built-in inflation is induced by adaptive expectations, and is often linked to the "price/wage spiral". It involves workers trying to keep their wages up with prices (above the rate of inflation), and firms passing these higher labor costs on to their customers as higher prices, leading to a 'vicious circle'. Built-in inflation reflects events in the past, and so might be seen as hangover inflation.

Demand-pull theory states that the rate of inflation accelerates whenever aggregate demand is increased beyond the ability of the economy to produce (its potential output). Hence, any factor that increases aggregate demand can cause inflation.^[41]However, in the long run, aggregate demand can be held above productive capacity only by increasing the quantity of money in circulation faster than the real growth rate of the economy. Another (although much less common) cause can be a rapid decline in the demand for money, as happened in Europe during the Black Death, or in the Japanese occupied territories just before the defeat of Japan in 1945.

The effect of money on inflation is most obvious when governments finance spending in a crisis, such as a civil war, by printing money excessively. This sometimes leads to hyperinflation, a condition where prices can double in a month or less. Money supply is also thought to play a major role in determining moderate levels of inflation, although there are differences of opinion on how important it is. For example, Monetarist economists believe that the link is very strong; Keynesian economists, by contrast, typically emphasize the role of aggregate demand in the economy rather than the money supply in determining inflation. That is, for Keynesians, the money supply is only one determinant of aggregate demand.

Some Keynesian economists also disagree with the notion that central banks fully control the money supply, arguing that central banks have little control, since the money supply adapts to the demand for bank credit issued by commercial banks. This is known as the theory of endogenous money, and has been advocated strongly by post-Keynesians as far back as the 1960s. It has today become a central focus of Taylor rule advocates. This position is not universally accepted – banks create money by making loans, but the aggregate volume of these loans diminishes as real interest rates increase. Thus, central banks can influence the money supply by making money cheaper or more expensive, thus increasing or decreasing its production.

A fundamental concept in inflation analysis is the relationship between inflation and unemployment, called the Phillips curve. This model suggests that there is a trade-off between price stability and employment. Therefore, some level of inflation could be considered desirable in order to minimize unemployment. The Phillips curve model described the U.S. experience well in the 1960s but failed to describe the combination of rising inflation and economic stagnation (sometimes referred to as stagflation) experienced in the 1970s.

Thus, modern macroeconomics describes inflation using a Phillips curve that shifts (so the trade-off between inflation and unemployment changes) because of such matters as supply shocks and inflation becoming built into the normal workings of the economy. The former refers to such events as the oil shocks of the 1970s, while the latter refers to the price/wage spiral andinflationary expectations implying that the economy "normally" suffers from inflation. Thus, the Phillips curve represents only the demand-pull component of the triangle model.

Another concept of note is the potential output (sometimes called the "natural gross domestic product"), a level of GDP, where the economy is at its optimal level of production given institutional and natural constraints. (This level of output corresponds to the Non-Accelerating Inflation Rate of Unemployment, NAIRU, or the "natural" rate of unemployment or the full-employment unemployment rate.) If GDP exceeds its potential (and unemployment is below the NAIRU), the theory says that inflation willaccelerate as suppliers increase their prices and built-in inflation worsens. If GDP falls below its potential level (and unemployment is above the NAIRU), inflation will decelerate as suppliers attempt to fill excess capacity, cutting prices and undermining built-in inflation.^[42]

However, one problem with this theory for policy-making purposes is that the exact level of potential output (and of the NAIRU) is generally unknown and tends to change over time. Inflation also seems to act in an asymmetric way, rising more quickly than it falls. Worse, it can change because of policy: for example, high unemployment under British Prime Minister Margaret Thatchermight have led to a rise in the NAIRU (and a fall in potential) because many of the unemployed found themselves as structurally unemployed (also see unemployment), unable to find jobs that fit their skills. A rise in structural unemployment implies that a smaller percentage of the labor force can find jobs at the NAIRU, where the economy avoids crossing the threshold into the realm of accelerating inflation.

[edit]Monetarist view

Inflation is closely related to growth in money supply (using the M2 definition) over the long run.

For more details on this topic, see Monetarism.

Monetarists believe the most significant factor influencing inflation or deflation is how fast the money supply grows or shrinks. They consider fiscal policy, or government spending and taxation, as ineffective in controlling inflation.^[43]According to the famous monetarist economist Milton Friedman, "Inflation is always and everywhere a monetary phenomenon."^[44] Some monetarists, however, will qualify this by making an exception for very short-term circumstances.

Monetarists assert that the empirical study of monetary history shows that inflation has always been a monetary phenomenon. The quantity theory of money, simply stated, says that any change in the amount of money in a system will change the price level. This theory begins with the equation of exchange:

where

is the nominal quantity of money.

is the velocity of money in final expenditures;

is the general price level;

is an index of the real value of final expenditures;

In this formula, the general price level is related to the level of real economic activity (Q), the quantity of money (M) and the velocity of money (V). The formula is an identity because the velocity of money (V) is defined to be the ratio of final nominal expenditure () to the quantity of money (M).

Monetarists assume that the velocity of money is unaffected by monetary policy (at least in the long run), and the real value of output is determined in the long run by the productive capacity of the economy. Under these assumptions, the primary driver of the change in the general price level is changes in the quantity of money. With exogenous velocity (that is, velocity being determined externally and not being influenced by monetary policy), the money supply determines the value of nominal output (which equals final expenditure) in the short run. In practice, velocity is not exogenous in the short run, and so the formula does not necessarily imply a stable short-run relationship between the money supply and nominal output. However, in the long run, changes in velocity are assumed to be determined by the evolution of the payments mechanism. If velocity is relatively unaffected by monetary policy, the long-run rate of increase in prices (the inflation rate) is equal to the long run growth rate of the money supply plus the exogenous long-run rate of velocity growth minus the long run growth rate of real output.^[7]

[edit]Unemployment

A connection between inflation and unemployment has been drawn since the emergence of large scale unemployment in the 19th century, and connections continue to be drawn today. In Marxian economics, the unemployed serve as a reserve army of labour, which restrain wage inflation. In the 20th century, similar concepts in Keynesian economics include the NAIRU (Non-Accelerating Inflation Rate of Unemployment) and the Phillips curve.

[edit]Rational expectations theory

For more details on this topic, see Rational expectations theory.

Rational expectations theory holds that economic actors look rationally into the future when trying to maximize their well-being, and do not respond solely to immediate opportunity costs and pressures. In this view, while generally grounded in monetarism, future expectations and strategies are important for inflation as well.

A core assertion of rational expectations theory is that actors will seek to "head off" central-bank decisions by acting in ways that fulfill predictions of higher inflation. This means that central banks must establish their credibility in fighting inflation, or economic actors will make bets that the central bank will expand the money supply rapidly enough to prevent recession, even at the expense of exacerbating inflation. Thus, if a central bank has a reputation as being "soft" on inflation, when it announces a new policy of fighting inflation with restrictive monetary growth economic agents will not believe that the policy will persist; their inflationary expectations will remain high, and so will inflation. On the other hand, if the central bank has a reputation of being "tough" on inflation, then such a policy announcement will be believed and inflationary expectations will come down rapidly, thus allowing inflation itself to come down rapidly with minimal economic disruption.

[edit]Austrian view

For more details on this topic, see The Austrian view of inflation and monetary inflation

The Austrian School asserts that inflation is an increase in the money supply, rising prices are merely consequences and this semantic difference is important in defining inflation.^[45] Austrians stress that inflation affects prices in various degree, i.e. that prices rise more sharply in some sectors than in other sectors of the economy. The reason for the disparity is that excess money will be concentrated to certain sectors, such as housing, stocks or health care. Because of this disparity, Austrians argue that the aggregate price level can be very misleading when observing the effects of inflation. Austrian economists measure inflation by calculating the growth of new units of money that are available for immediate use in exchange, that have been created over time.^[46]^[47]^[48]

[edit]Real bills doctrine

Main article: Real bills doctrine

Within the context of a fixed specie basis for money, one important controversy was between the quantity theory of money and the real bills doctrine (RBD). Within this context, quantity theory applies to the level of fractional reserve accounting allowed against specie, generally gold, held by a bank. Currency and banking schools of economics argue the RBD, that banks should also be able to issue currency against bills of trading, which is "real bills" that they buy from merchants. This theory was important in the 19th century in debates between "Banking" and "Currency" schools of monetary soundness, and in the formation of theFederal Reserve. In the wake of the collapse of the international gold standard post 1913, and the move towards deficit financing of government, RBD has remained a minor topic, primarily of interest in limited contexts, such as currency boards. It is generally held in ill repute today, with Frederic Mishkin, a governor of the Federal Reserve going so far as to say it had been "completely discredited."

The debate between currency, or quantity theory, and banking schools in Britain during the 19th century prefigures current questions about the credibility of money in the present. In the 19th century the banking school had greater influence in policy in the United States and Great Britain, while the currency school had more influence "on the continent", that is in non-British countries, particularly in the Latin Monetary Union and the earlier Scandinavia monetary union.

[edit]Anti-classical or backing theory

Another issue associated with classical political economy is the anti-classical hypothesis of money, or "backing theory". The backing theory argues that the value of money is determined by the assets and liabilities of the issuing agency.^[49] Unlike the Quantity Theory of classical political economy, the backing theory argues that issuing authorities can issue money without causing inflation so long as the money issuer has sufficient assets to cover redemptions. There are very few backing theorists, making quantity theory the dominant theory explaining inflation.^{[citation needed]}

[edit]Controlling inflation

A variety of policies have been used to control inflation.

[edit]Monetary policy

The U.S. effective federal funds ratecharted over fifty years.

Main article: Monetary policy

Today the primary tool for controlling inflation is monetary policy. Most central banks are tasked with keeping their inter-bank lending rates at low levels, normally to a target rate around 2% to 3% per annum, and within a targeted low inflation range, somewhere from about 2% to 6% per annum. A low positive inflation is usually targeted, as deflationary conditions are seen as dangerous for the health of the economy.

There are a number of methods that have been suggested to control inflation.Central banks such as the U.S. Federal Reserve can affect inflation to a significant extent through setting interest rates and through other operations. High interest rates and slow growth of the money supply are the traditional ways through which central banks fight or prevent inflation, though they have different approaches. For instance, some follow a symmetrical inflation target while others only control inflation when it rises above a target, whether express or implied.

Monetarists emphasize keeping the growth rate of money steady, and using monetary policy to control inflation (increasing interest rates, slowing the rise in the money supply). Keynesians emphasize reducing aggregate demand during economic expansions and increasing demand during recessions to keep inflation stable. Control of aggregate demand can be achieved using both monetary policy and fiscal policy (increased taxation or reduced government spending to reduce demand).

[edit]Fixed exchange rates

Main article: Fixed exchange rate

Under a fixed exchange rate currency regime, a country's currency is tied in value to another single currency or to a basket of other currencies (or sometimes to another measure of value, such as gold). A fixed exchange rate is usually used to stabilize the value of a currency, vis-a-vis the currency it is pegged to. It can also be used as a means to control inflation. However, as the value of the reference currency rises and falls, so does the currency pegged to it. This essentially means that the inflation rate in the fixed exchange rate country is determined by the inflation rate of the country the currency is pegged to. In addition, a fixed exchange rate prevents a government from using domestic monetary policy in order to achieve macroeconomic stability.

Under the Bretton Woods agreement, most countries around the world had currencies that were fixed to the US dollar. This limited inflation in those countries, but also exposed them to the danger of speculative attacks. After the Bretton Woods agreement broke down in the early 1970s, countries gradually turned to floating exchange rates. However, in the later part of the 20th century, some countries reverted to a fixed exchange rate as part of an attempt to control inflation. This policy of using a fixed exchange rate to control inflation was used in many countries in South America in the later part of the 20th century (e.g.Argentina (1991–2002), Bolivia, Brazil, and Chile).

[edit]Gold standard

Main article: Gold standard

Under a gold standard, paper notes are convertible into pre-set, fixed quantities of gold.

The gold standard is a monetary system in which a region's common media of exchange are paper notes that are normally freely convertible into pre-set, fixed quantities of gold. The standard specifies how the gold backing would be implemented, including the amount of specie per currency unit. The currency itself has no innate value, but is accepted by traders because it can be redeemed for the equivalent specie. A U.S. silver certificate, for example, could be redeemed for an actual piece of silver.

The gold standard was partially abandoned via the international adoption of the Bretton Woods System. Under this system all other major currencies were tied at fixed rates to the dollar, which itself was tied to gold at the rate of $35 per ounce. The Bretton Woods system broke down in 1971, causing most countries to switch to fiat money – money backed only by the laws of the country.

According to Lawrence H. White, an F. A. Hayek Professor of Economic History “who values the Austrian tradition”^[50], economies based on the gold standard rarely experience inflation above 2 percent annually.^[51] However, historically, the U.S. saw inflation over 2% several times and a higher peak of inflation under the gold standard when compared to inflation after the gold standard.^[52] Under a gold standard, the long term rate of inflation (or deflation) would be determined by the growth rate of the supply of gold relative to total output.^[53] Critics argue that this will cause arbitrary fluctuations in the inflation rate, and that monetary policy would essentially be determined by gold mining.^[54]^[55]

[edit]Wage and price controls

Main article: Incomes policies

Another method attempted in the past have been wage and price controls ("incomes policies"). Wage and price controls have been successful in wartime environments in combination with rationing. However, their use in other contexts is far more mixed. Notable failures of their use include the 1972 imposition of wage and price controls by Richard Nixon. More successful examples include the Prices and Incomes Accord in Australia and the Wassenaar Agreement in the Netherlands.

In general wage and price controls are regarded as a temporary and exceptional measure, only effective when coupled with policies designed to reduce the underlying causes of inflation during the wage and price control regime, for example, winning the war being fought. They often have perverse effects, due to the distorted signals they send to the market. Artificially low prices often cause rationing and shortages and discourage future investment, resulting in yet further shortages. The usual economic analysis is that any product or service that is under-priced is overconsumed. For example, if the official price of bread is too low, there will be too little bread at official prices, and too little investment in bread making by the market to satisfy future needs, thereby exacerbating the problem in the long term.

Temporary controls may complement a recession as a way to fight inflation: the controls make the recession more efficient as a way to fight inflation (reducing the need to increase unemployment), while the recession prevents the kinds of distortions that controls cause when demand is high. However, in general the advice of economists is not to impose price controls but to liberalize prices by assuming that the economy will adjust and abandon unprofitable economic activity. The lower activity will place fewer demands on whatever commodities were driving inflation, whether labor or resources, and inflation will fall with total economic output. This often produces a severe recession, as productive capacity is reallocated and is thus often very unpopular with the people whose livelihoods are destroyed (see creative destruction).

[edit]Cost-of-living allowance

For more details on this topic, see Cost of living.

The real purchasing-power of fixed payments is eroded by inflation unless they are inflation-adjusted to keep their real values constant. In many countries, employment contracts, pension benefits, and government entitlements (such as social security) are tied to a cost-of-living index, typically to the consumer price index.^[56] A cost-of-living allowance (COLA) adjusts salaries based on changes in a cost-of-living index. Salaries are typically adjusted annually in low inflation economies. During hyperinflation they are adjusted more often.^[56] They may also be tied to a cost-of-living index that varies by geographic location if the employee moves.

Annual escalation clauses in employment contracts can specify retroactive or future percentage increases in worker pay which are not tied to any index. These negotiated increases in pay are colloquially referred to as cost-of-living adjustments or cost-of-living increases because of their similarity to increases tied to externally determined indexes. Many economists and compensation analysts consider the idea of predetermined future "cost of living increases" to be misleading for two reasons: (1) For most recent periods in the industrialized world, average wages have increased faster than most calculated cost-of-living indexes, reflecting the influence of rising productivity and worker bargaining power rather than simply living costs, and (2) most cost-of-living indexes are not forward-looking, but instead compare current or historical data.^{citation required}

[edit]See also

[edit]Notes

^ See:
- Wyplosz & Burda 1997 (Glossary);
- Blanchard 2000 (Glossary)
- Barro 1997 (Glossary)
- Abel & Bernanke 1995 (Glossary)
^ Why price stability?, Central Bank of Iceland, Accessed on September 11, 2008.
^ Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting, New York: Harcourt Brace Javonovich, Inc. Page 429. “The Measuring Unit principle: The unit of measure in accounting shall be the base money unit of the most relevant currency. This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.”
^ ^a ^b Mankiw 2002, pp. 22–32
^ Mankiw 2002, pp. 238–255
^ Robert Barro and Vittorio Grilli (1994), European Macroeconomics, Ch. 8, p. 139, Fig. 8.1. Macmillan, ISBN 0-333-57764-7.
^ ^a ^b Mankiw 2002, pp. 81–107
^ Abel & Bernanke 2005, pp. 266–269
^ Hummel, Jeffrey Rogers. "Death and Taxes, Including Inflation: the Public versus Economists" (January 2007).[1]p.56
^ "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others" Lars E.O. Svensson, Journal of Economic Perspectives, Volume 17, Issue 4 Fall 2003, p145-166
^ ^a ^b ^c ^d Taylor, Timothy (2008). Principles of Economics. Freeload Press. ISBN 1-930789-05-X.
^ Dobson, Roger (January 27, 2002). "How Alexander caused a great Babylon inflation". The Independent. Archived from the original on April 12, 2010. Retrieved April 12, 2010
^ Harl, Kenneth W. (June 19, 1996). Coinage in the Roman Economy, 300 B.C. to A.D. 700. Baltimore: The Johns Hopkins University Press. ISBN 0-8018-5291-9
^ "Annual Report (2006), Royal Canadian Mint, p. 4". Mint.ca. Retrieved May 21, 2011.
^ Frank Shostak, "Commodity Prices and Inflation: What's the connection", Mises Institute
^ Earl J. Hamilton, American Treasure and the Price Revolution in Spain, 1501–1650 Harvard Economic Studies, 43 (Cambridge, Massachusetts: Harvard University Press, 1934)
^ John Munro: The Monetary Origins of the 'Price Revolution':South Germany Silver Mining, Merchant Banking, and Venetian Commerce, 1470–1540, Toronto 2003^{[dead link]}
^ Walton, Timothy R. (1994). The Spanish Treasure Fleets. Pineapple Press (FL). p. 85. ISBN 1-56164-049-2.
^ The Price Revolution in Europe: Empirical Results from a Structural Vectorautoregression Model. Peter Kugler and Peter Bernholz, University of Basel, 2007^{[dead link]} (Demonstrates that it was the increased supply of precious metals that caused it and notes the obvious logical flaws in the contrary arguments that have become fashionable in recent decades)
^ Tracy, James D. (1994). Handbook of European History 1400–1600: Late Middle Ages, Renaissance, and Reformation. Boston: Brill Academic Publishers. p. 655. ISBN 90-04-09762-7.
^ Michael F. Bryan, "On the Origin and Evolution of the Word 'Inflation'"
^ Mark Blaug, "Economic Theory in Retrospect", pg. 129: "...this was the cause of inflation, or, to use the language of the day, 'the depreciation of banknotes.'"
^ Michael F. Bryan, On the Origin and Evolution of the Word "Inflation" [2]
^ ^a ^b Federal Reserve Board's semiannual Monetary Policy Report to the CongressRoundtable^{[dead link]}Introductory statement by Jean-Claude Trichet on July 1, 2004
^ Kiley, Michael J. (2008) (PDF). Estimating the common trend rate of inflation for consumer prices and consumer prices excluding food and energy prices. Federal Reserve Board.
^ See:
- Taylor & Hall 1993;
- Blanchard 2000;
- Barro 1997
^ The numbers reported here refer to the US Consumer Price Index for All Urban Consumers, All Items, series CPIAUCNS, from base level 100 in base year 1982. They were downloaded from the FRED database at the Federal Reserve Bank of St. Louis on August 8, 2008.
^ "Median Price Changes: An Alternative Approach to Measuring Current Monetary Inflation" (PDF). Retrieved May 21, 2011.
^ Bulkley, George (March 1981). "Personal Savings and Anticipated Inflation". The Economic Journal 91 (361): 124–135.doi:10.2307/2231702. JSTOR 2231702.
^ Encyclopædia Britannica, "The cost-push theory".
^ "Les Egyptiens souffrent aussi de l'accélération de l'inflation", Céline Jeancourt-Galignani – La Tribune, February 10, 2011
^ AFP (January 27, 2011). "Egypt protests a ticking time bomb: Analysts". The New Age. Retrieved January 29, 2011.
^ "Les prix alimentaires proches de «la cote d'alerte»" – Le Figaro, with AFP, February 20, 2011
^ Thorsten Polleit, "Inflation Is a Policy that Cannot Last", Mises Institute
^ Tobin, James, American Economic Review, march (1969), "Inflation and Unemployment"
^ Mundell, James, Journal of Political Economy, LXXI (1963), 280–83 "Inflation and Real Interest"
^ Tobin, J. Econometrica, V 33, (1965), 671–84 "Money and Economic Growth"
^ Tsaing, S.C., Journal of Money, Credit and Banking, I(1969), 266–80 "A Critical Note on the Optimum Supply of Money"
^ (p272)
^ Robert J. Gordon (1988), Macroeconomics: Theory and Policy, 2nd ed., Chap. 22.4, 'Modern theories of inflation'. McGraw-Hill.
^ O'Sullivan, Arthur; Sheffrin, Steven M. (2003) [January 2002]. Economics: Principles in Action. The Wall Street Journal:Classroom Edition (2nd ed.). Upper Saddle River, New Jersey 07458: Pearson Prentice Hall: Addison Wesley Longman. p. 341. ISBN 0-13-063085-3. Retrieved May 3, 2009.
^ Coe, David T. Nominal Wages. The NAIRU and Wage Flexibility. Organisation for Economic Co-operation and Development.
^ Lagassé, Paul (2000). "Monetarism". The Columbia Encyclopedia (6th ed.). New York: Columbia University Press.ISBN 0-7876-5015-3.
^ Friedman, Milton. A Monetary History of the United States 1867–1960 (1963).
^ Shostak, PhD, Frank (March 2, 2002). "Defining Inflation". Mises Institute. Retrieved September 20, 2008.
^ Ludwig von Mises Institute, "True Money Supply"
^ Joseph T. Salerno, (1987), Austrian Economic Newsletter, "The "True" Money Supply: A Measure of the Medium of Exchange in the U.S. Economy"
^ Frank Shostak, (2000), "The Mystery of the Money Supply Definition"
^ Workingpapers
^ Lawrence H. White, “The Research Program of Austrian Economics,” in Roger Koppl, ‘’Explorations in Austrian Economics,’‘ Volume 11 of Advances in Austrian economics, Emerald Group Publishing, 2008 p. 12 ISBN 1-84855-330-7, ISBN 978-1-84855-330-9
^ White, Lawrence H.. "Inflation by Lawrence H. White, accessed April 13, 2011". Econlib.org. Retrieved May 21, 2011.
^ http://en.wikipedia.org/wiki/File:US_Historical_Inflation_Ancient.svg
^ Bordo, M. (2002) "Gold Standard" Concise Encyclopedia of Economics
^ Barsky, Robert B; J Bradford DeLong (1991). "Forecasting Pre-World War I Inflation: The Fisher Effect and the Gold Standard". Quarterly Journal of Economics 106 (3): 815–36. doi:10.2307/2937928. JSTOR 2937928. Retrieved September 27, 2008.
^ DeLong, Brad. "Why Not the Gold Standard?". Retrieved September 25, 2008.
^ ^a ^b Flanagan, Tammy (September 8, 2006). "COLA Wars". Government Executive. National Journal Group. Retrieved September 23, 2008.

[edit]References

Abel, Andrew; Bernanke, Ben (2005). Macroeconomics (5th ed.). Pearson
Barro, Robert J. (1997). Macroeconomics. Cambridge, Mass: MIT Press. p. 895. ISBN 0-262-02436-5
Blanchard, Olivier (2000). Macroeconomics (2nd ed.). Englewood Cliffs, N.J: Prentice Hall. ISBN 0-13-013306-X
Mankiw, N. Gregory (2002). Macroeconomics (5th ed.). Worth
Hall, Robert E.; Taylor, John B. (1993). Macroeconomics. New York: W.W. Norton. p. 637. ISBN 0-393-96307-1
Burda, Michael C.; Wyplosz, Charles (1997). Macroeconomics: a European text. Oxford [Oxfordshire]: Oxford University Press. ISBN 0-19-877468-0

[edit]Further reading

Auernheimer, Leonardo, "The Honest Government's Guide to the Revenue From the Creation of Money," Journal of Political Economy, Vol. 82, No. 3, May/June 1974, pp. 598–606.
Baumol, William J. and Alan S. Blinder, Macroeconomics: Principles and Policy, Tenth edition. Thomson South-Western, 2006. ISBN 0-324-22114-2
Friedman, Milton, Nobel lecture: Inflation and unemployment 1977
Mishkin, Frederic S., The Economics of Money, Banking, and Financial Markets, New York, Harper Collins, 1995.
Federal Reserve Bank of Boston, "Understanding Inflation and the Implications for Monetary Policy: A Phillips Curve Retrospective", Conference Series 53, June 9–11, 2008, Chatham, Massachusetts. (Also cf. Phillips curve article)

[edit]External links

United States Bureau of Labor Statistics Consumer Price Index homepage
Inflation 1290–2006 – Based on the historical Consumer Price Index of the Swedish Riksbank
Inflation Calculator
Historical documents relating to inflation in the United States

DEFLATION

2012-08-13T18:14:00.006-07:00

Deflation

From Wikipedia, the free encyclopedia

For other uses, see Deflation (disambiguation).

Not to be confused with Disinflation.

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In economics, deflation is a decrease in the general price level of goods and services.^[1] Deflation occurs when theinflation rate falls below 0% (a negativeinflation rate). This should not be confused with disinflation, a slow-down in the inflation rate (i.e. when inflation declines to lower levels).^[2] Inflation reduces the real value of money over time; conversely, deflation increases the real value of money – the currency of a national or regional economy. This allows one to buy more goods with the same amount of money over time.

Economists generally believe that deflation is a problem in a modern economy because they believe it may lead to a deflationary spiral.^[3]Historically not all episodes of deflation correspond with periods of poor economic growth.^[4]

[edit]Causes and corresponding types

This section does not cite anyreferences or sources.(January 2010)

The neutrality of this article is disputed.Relevant discussion may be found on the talk page. Please do not remove this message until the dispute is resolved. (September 2010)

In the IS/LM model (Investment and Saving equilibrium/ Liquidity Preference and Money Supply equilibrium model), deflation is caused by a shift in the supply-and-demand curve for goods and services, particularly a fall in the aggregate level ofdemand. That is, there is a fall in how much the whole economy is willing to buy, and the going price for goods. Because the price of goods is falling, consumers have an incentive to delay purchases and consumption until prices fall further, which in turn reduces overall economic activity. Since this idles the productive capacity, investment also falls, leading to further reductions in aggregate demand. This is the deflationary spiral. An answer to falling aggregate demand is stimulus, either from the central bank, by expanding the money supply, or by the fiscal authority to increase demand, and to borrow at interest rates which are below those available to private entities.

In more recent economic thinking, deflation is related to risk: where the risk-adjusted return on assets drops to negative, investors and buyers will hoard currency rather than invest it, even in the most solid of securities.^[5] This can produce a liquidity trap. A central bank cannot, normally, charge negative interest for money, and even charging zero interest often produces less stimulative effect than slightly higher rates of interest. In a closed economy, this is because charging zero interest also means having zero return on government securities, or even negative return on short maturities. In an open economy it creates a carrytrade, and devalues the currency. A devalued currency produces higher prices for imports without necessarily stimulating exports to a like degree.

In monetarist theory, deflation must be associated with either a reduction in the money supply, a reduction in the velocity of money or an increase in the number of transactions. But any of these may occur separately without deflation. It may be attributed to a dramatic contraction of the money supply, or to adherence to a gold standard or other external monetary base requirement.

However, deflation is the natural condition of hard currency economies when the supply of money is not increased as much as positive population growth and economic growth. When this happens, the available amount of hard currency per person falls, in effect making money more scarce; and consequently, the purchasing power of each unit of currency increases. Deflation occurs when improvements in production efficiency lower the overall price of goods.Competition in the marketplace often prompts those producers to apply at least some portion of these cost savings into reducing the asking price for their goods. When this happens, consumers pay less for those goods; and consequently deflation has occurred, since purchasing power has increased.

Rising productivity and reduced transportation cost created structural deflation during the acceleration productivity era of from 1870–1900,^[6] but there was mild inflation for about a decade before the establishment of the Federal Reserve in 1913. There was inflation during World War I, but deflation returned again after that war and during the 1930s depression. Most nations abandoned the gold standard in the 1930s. There is less reason to expect deflation, aside from the collapse of speculative asset classes, under a fiat monetary system with low productivity growth.

In mainstream economics, deflation may be caused by a combination of the supply and demand for goods and the supply and demand for money, specifically the supply of money going down and the supply of goods going up. Historic episodes of deflation have often been associated with the supply of goods going up (due to increased productivity) without an increase in the supply of money, or (as with the Great Depression and possibly Japan in the early 1990s) the demand for goods going down combined with a decrease in the money supply. Studies of the Great Depression by Ben Bernanke have indicated that, in response to decreased demand, the Federal Reserve of the time decreased the money supply, hence contributing to deflation.

Demand-side causes are:

Growth deflation: an enduring decrease in the real cost of goods and services resulting in competitive price cuts.

A structural deflation existed from 1870s until the cycle upswing that started in 1895. The deflation was caused by the decrease in the production and distribution costs of goods. It resulted in competitive price cuts when markets were oversupplied. The mild inflation after 1895 was attributed to the increase in gold supply that had been occurring for decades.^[7] There was a sharp rise in prices during World War I, but deflation returned at the war's end. By contrast, under a fiat monetary system, there was high productivity growth from the end of World War II until the 1960s, but no deflation.^[8]

See: Deflation#Scarcity of official money and Long Depression#Myth of the Long Depression.

Productivity and deflation are discussed in a 1940 study by the Brookings Institution that gives productivity by major US industries from 1919 to 1939, along with real and nominal wages. Persistent deflation was clearly understood as being the result of the enormous gains in productivity of the period.^[9] By the late 1920s, most goods were over supplied, which contributed to high unemployment during the Great Depression.^[10]

Cash building (hoarding) deflation: attempts to save more cash by a reduction in consumption leading to a decrease in velocity of money.^{[citation needed]}

Supply-side causes are:

Bank credit deflation: a decrease in the bank credit supply due to bank failures or increased perceived risk of defaults by private entities or a contraction of the money supply by the central bank.^{[citation needed]}

[edit]Debt deflation

Main article: Debt deflation

Debt deflation is a complicated phenomenon associated with the end of long term credit cycles. It was proposed as a theory by Irving Fisher (1933) to explain the deflation of the Great Depression.^[11]

[edit]Money supply side deflation

From a monetarist perspective, deflation is caused primarily by a reduction in the velocity of money and/or the amount of money supply per person.

A historical analysis of money velocity and monetary base shows an inverse correlation: for a given percentage decrease in the monetary base the result is nearly equal percentage increase in money velocity.^[5] This is to be expected because monetary base (M_B), velocity of base money (V_B), price level (P) and real output (Y) are related by definition: M_B*V_B = P*Y. However, it is important to note that the monetary base is a much narrower definition of money than M₂money supply. Additionally, the velocity of the monetary base is interest rate sensitive, the highest velocity being at the highest interest rates.^[5]

In the early history of the United States there was no national currency and an insufficient supply of coinage.^[12] Banknotes were the majority of the money in circulation. During financial crises many banks failed and their notes became worthless. Also, banknotes were discounted relative to gold and silver, the discount depending on the financial strength of the bank.^[13]

In recent years changes in the money supply have historically taken a long time to show up in the price level, with a rule of thumb lag of at least 18 months. More recently Alan Greenspan cited the time lag as taking between 12 and 13 quarters.^[14] Bonds, equities and commodities have been suggested as reservoirs for buffering changes in money supply.^[15]

[edit]Credit deflation

In modern credit-based economies, deflation may be caused by the central bankinitiating higher interest rates (i.e., to 'control' inflation), thereby possibly popping an asset bubble. In a credit-based economy, a fall in money supply leads to markedly less lending, with a further sharp fall in money supply, and a consequent sharp fall-off in demand for goods. The fall in demand causes a fall in prices as a supply glut develops. This becomes a deflationary spiral when prices fall below the costs of financing production. Businesses, unable to make enough profit no matter how low they set prices, are then liquidated. Banks get assets which have fallen dramatically in value since their mortgage loan was made, and if they sell those assets, they further glut supply, which only exacerbates the situation. To slow or halt the deflationary spiral, banks will often withhold collecting on non-performing loans (as in Japan, and most recently America and Spain). This is often no more than a stop-gap measure, because they must then restrict credit, since they do not have money to lend, which further reduces demand, and so on.

[edit]Historical examples of credit deflation

In the early economic history of the United States, cycles of inflation and deflation correlated with capital flows between regions, with money being loaned from the financial center in the Northeast to the commodity producing regions of the [mid]-West and South. In a procyclical manner, prices of commodities rose when capital was flowing in, that is, when banks were willing to lend, and fell in the depression years of 1818 and 1839 when banks called in loans.^[16] Also, there was no national currency at the time and there was a scarcity of coins. Most money circulated as banknotes, which typically sold at a discount according to distance from the issuing bank and the bank's perceived financial strength. When banks failed their notes were redeemed for bank reserves, which often did not result in payment at par value, and sometimes the notes became worthless. Notes of weak surviving banks traded at steep discounts.^[12]^[13] During the Great Depression, people who owed money to a bank whose deposits had been frozen would sometimes buy bank books (deposits of other people at the bank) at a discount and use them to pay off their debt at par value.^[17]

A financial crisis in England in 1818 caused banks to call in loans and curtail new lending, draining specie out of the U.S. The Bank of the United States also reduced its lending. Prices for cotton and tobacco fell. The price of agricultural commodities also were pressured by a return of normal harvests following 1816, the year without a summer, that caused large scale famine and high agricultural prices.^[18]

There were several causes of the deflation of the severe depression of 1839-43, which included an oversupply of agricultural commodities (importantly cotton) as new cropland came into production following large federal land sales a few years earlier, banks requiring payment in gold or silver, the failure of several banks, default by several states on their bonds and British banks cutting back on specie flow to the U.S.^[16]^[19]

This cycle has been traced out on the broad scale during the Great Depression. Partly because of overcapacity and market saturation and partly as a result of theSmoot-Hawley Tariff Act, international trade contracted sharply, severely reducing demand for goods, thereby idling a great deal of capacity, and setting off a string of bank failures.^[10] A similar situation in Japan, beginning with the stock and real estate market collapse in the early 1990s, was arrested by the Japanese government preventing the collapse of most banks and taking over direct control of several in the worst condition. This scenario was again repeated almost twenty years later in the United States. After the "dot com" stock market crash at the turn of the century and the 2007-2008 financial crisis, American banks were "saved from collapse" by the US Federal Reserve Bank. These occurrences are the matter of intense debate.

[edit]Scarcity of official money

The United States had no national paper money until 1862 (greenbacks used to fund the Civil War), but these notes were discounted to gold until 1877. There was also a shortage of U.S. minted coins. Foreign coins, such as Mexican silver, were commonly used.^[12] At times banknotes were as much as 80% of currency in circulation before the Civil War. In the financial crises of 1818-19 and 1837–41, many banks failed, leaving their money to be redeemed below par value from reserves. Sometimes the notes became worthless, and the notes of weak surviving banks were heavily discounted.^[13] The Jackson administration opened branch mints, which over time increased the supply of coins. Following the 1848 discovery of gold in California, enough gold came to market to devalue gold relative to silver. To equalize the value of the two metals in coinage, the U.S. mint slightly reduced the silver content of new coinage in 1853.^[12]

When structural deflation appeared in the years following 1870, a common explanation given by various government inquiry committees was a scarcity of gold and silver, although they usually mentioned the changes in industry and trade we now call productivity. However, David A. Wells (1890) notes that the U. S. money supply during the period 1879-1889 actually rose 60%, the increase being in gold and silver, which rose against the percentage of national bank and legal tender notes. Furthermore, Wells argued that the deflation only lowered the cost of goods that benefited from recent improved methods of manufacturing and transportation. Goods produced by craftsmen did not decrease in price, nor did many services, and the cost of labor actually increased. Also, deflation did not occur in countries that did not have modern manufacturing, transportation and communications.^[6]

By the end of the 19th century the deflation ended and turned to mild inflation.William Stanley Jevons predicted rising gold supply would cause inflation decades before it actually did. Irving Fisher blamed the world wide inflation of the pre WW I years on rising gold supply.^[20]

In economies with an unstable currency, barter and other alternate currency arrangements such as dollarization are common, and therefore when the 'official' money becomes scarce (or unusually unreliable), commerce can still continue (e.g., most recently in Zimbabwe).^{[citation needed]} Since in such economies the central government is often unable, even if it were willing, to adequately control the internal economy, there is no pressing need for individuals to acquire official currency except to pay for imported goods. In effect, barter acts as a protective tariff in such economies, encouraging local consumption of local production.^{[citation needed]} It also acts as a spur to mining and exploration, because one easy way to make money in such an economy is to dig it out of the ground.

[edit]Effects

The effects of deflation are:

Decreasing nominal prices for goods and services
Increasing buying power of cash money and all assets denominated in cash terms
May decrease investment and lending if cash holdings are seen as preferable (aka hoarding)
Benefits recipients of fixed incomes

Deflation was present during most economic depressions in US history^[21]Deflation is generally regarded negatively, as it causes a transfer of wealth from borrowers and holders of illiquid assets, to the benefit of savers and of holders of liquid assets and currency, and because confused pricing signals^{[citation needed]} cause malinvestment, in the form of under-investment.

In this sense it is the opposite of the more usual scenario of inflation, whose effect is to tax currency holders and lenders (savers) and use the proceeds to subsidize borrowers, including governments, and to cause malinvestment as overinvestment. Thus inflation encourages short term consumption and can similarly over-stimulate investment in projects that may not be worthwhile in real terms (for example the housing or dot.com bubbles), while deflation retards investment even when there is a real-world demand not being met. In modern economies, deflation is usually caused by a drop in aggregate demand, and is associated with economic depression, as occurred in the Great Depression and the Long Depression.

Nobel laureate Friedrich Hayek, an Austrian Economist, stated of deflation during the Great Depression:

I agree with Milton Friedman that once the Crash had occurred, the Federal Reserve System pursued a silly deflationary policy. I am not only against inflation but I am also against deflation. So, once again, a badly programmed monetary policy prolonged the depression.

Interview with Diego Pizano (1979)^[22]

While an increase in the purchasing power of one's money benefits some, it amplifies the sting of debt for others: after a period of deflation, the payments to service a debt represent a larger amount of purchasing power than they did when the debt was first incurred. Consequently, deflation can be thought of as an effective increase in a loan's interest rate. If, as during the Great Depression in the United States, deflation averages 10% per year, even an interest-free loan is unattractive as it must be repaid with money worth 10% more each year. Under normal conditions, the Fed and most other central banks implement policy by setting a target for a short-term interest rate — the overnight federal funds rate in the US — and enforcing that target by buying and selling securities in open capital markets. When the short-term interest rate hits zero, the central bank can no longer ease policy by lowering its usual interest-rate target. With interest rates near zero, debt relief becomes an increasingly important tool in managing deflation.

In recent times, as loan terms have grown in length and loan financing (or leveraging) is common among many types of investments, the costs of deflation to lenders has grown larger. Deflation can discourage private investment, because there is reduced expectations on future profits when future prices are lower. Consequently with reduced private investments, spiraling deflation can cause a collapse in aggregate demand. Without the "hidden risk of inflation", it may become more prudent for institutions to hold on to money, and not to spend or invest it (burying money). They are therefore rewarded by holding money. This "hoarding" behavior is seen as undesirable by most economists, as Hayek points out:

It is agreed that hoarding money, whether in cash or in idle balances, is deflationary in its effects. No one thinks that deflation is in itself desirable.^[23]

Some believe that, in the absence of large amounts of debt, deflation would be a welcome effect because the lowering of prices increases purchasing power.

Since deflationary periods disfavor debtors (including most farmers), they are often periods of rising populist backlash. For example, in the late 19th century, populists in the US wanted debt relief or to move off the new gold standard, and onto: a silver standard (the supply of silver was increasing relatively faster than the supply of gold making silver less deflationary than gold), bimetal standard, or paper money like the recently-ended Greenbacks.

[edit]Deflationary spiral

Main article: Debt deflation

A deflationary spiral is a situation where decreases in price lead to lower production, which in turn leads to lower wages and demand, which leads to further decreases in price.^[24] Since reductions in general price level are called deflation, a deflationary spiral is when reductions in price lead to a vicious circle, where a problem exacerbates its own cause. The Great Depression was regarded by some as a deflationary spiral.^[25] A deflationary spiral is the modernmacroeconomic version of the general glut controversy of the 19th century. Another related idea is Irving Fisher's theory that excess debt can cause a continuing deflation. Whether deflationary spirals can actually occur is controversial, with its possibility being disputed by freshwater economists(including the Chicago school of economics) and Austrian School economists.

[edit]Counteracting deflation

This section does not cite anyreferences or sources.(September 2010)

During severe deflation, targeting an interest rate (the usual method of determining how much money to create) may be ineffective, because even lowering the short-term interest rate to zero may result in a real interest rate which is too high to attract credit-worthy borrowers. Thus the central bank must directly set a target for the quantity of money (called "quantitative easing") and may use extraordinary methods to increase the supply of money, e.g. purchasing financial assets of a type not usually used by the central bank as reserves (such asmortgage backed securities). Before he was Chairman of the United StatesFederal Reserve, Ben Bernanke claimed in 2002, "...sufficient injections of money will ultimately always reverse a deflation",^[26] although Japan's deflationary spiral was not broken by this very sort of quantitative easing.

Until the 1930s, it was commonly believed by economists that deflation would cure itself. As prices decreased, demand would naturally increase and the economic system would correct itself without outside intervention.

This view was challenged in the 1930s during the Great Depression. Keynesian economists argued that the economic system was not self-correcting with respect to deflation and that governments and central banks had to take active measures to boost demand through tax cuts or increases in government spending. Reserve requirements from the central bank were high compared to recent times. So were it not for redemption of currency for gold (in accordance with the gold standard), the central bank could have effectively increased money supply by simply reducing the reserve requirements and through open market operations (e.g., buying treasury bonds for cash) to offset the reduction of money supply in the private sectors due to the collapse of credit (credit is a form of money).

With the rise of monetarist ideas, the focus in fighting deflation was put on expanding demand by lowering interest rates (i.e., reducing the "cost" of money). This view has received a setback in light of the failure of accommodative policies in both Japan and the US to spur demand after stock market shocks in the early 1990s and in 2000–2002, respectively. Austrian economists worry about the inflationary impact of monetary policies on asset prices. Sustained low real rates can cause higher asset prices and excessive debt accumulation. Therefore, lowering rates may prove to be only a temporary palliative, aggravating an eventual debt deflation crisis.

With interest rates near zero, debt relief becomes an increasingly important tool in managing deflation.

[edit]Special borrowing arrangements

When the central bank has lowered nominal interest rates to zero, it can no longer further stimulate demand by lowering interest rates. This is the famous liquidity trap. When deflation takes hold, it requires "special arrangements" to lend money at a zero nominal rate of interest (which could still be a very high real rate of interest, due to the negative inflation rate) in order to artificially increase the money supply.

[edit]Historical examples

[edit]In Hong Kong

Following the Asian financial crisis in late 1997, Hong Kong experienced a long period of deflation which did not end until the 4th quarter of 2004 [2]. Many East Asian currencies devalued following the crisis. The Hong Kong dollar however, was pegged to the US Dollar, leading to an adjustment instead by a deflation ofconsumer prices. The situation was worsened by the increasingly cheap exports from Mainland China, and weak consumer confidence in Hong Kong. This deflation was accompanied by an economic slump that was more severe and prolonged than those of the surrounding countries that devalued their currencies in the wake of the Asian financial crisis.^[27]^[28]

[edit]In Ireland

In February 2009, Ireland's Central Statistics Office announced that during January 2009, the country experienced deflation, with prices falling by 0.1% from the same time in 2008. This is the first time deflation has hit the Irish economy since 1960. Overall consumer prices decreased by 1.7% in the month.^[29]

Brian Lenihan, Ireland's Minister for Finance, mentioned deflation in an interview with RTÉ Radio. According to RTÉ's account, "Minister for Finance Brian Lenihan has said that deflation must be taken into account when Budget cuts in child benefit, public sector pay and professional fees are being considered. Mr Lenihan said month-on-month there has been a 6.6% decline in the cost of living this year."^{[citation needed]}

This interview is notable in that the deflation referred to is not discernibly regarded negatively by the Minister in the interview. The Minister mentions the deflation as an item of data helpful to the arguments for a cut in certain benefits. The alleged economic harm caused by deflation is not alluded to or mentioned by this member of government. This is a notable example of deflation in the modern era being discussed by a senior financial Minister without any mention of how it might be avoided, or whether it should be.^[30]

[edit]In Japan

This section does not cite anyreferences or sources.(September 2010)

Deflation started in the early 1990s. The Bank of Japan and the government tried to eliminate it by reducing interest rates and 'quantitative easing', but did not create a sustained increase in broad money and deflation persisted. In July 2006, the zero-rate policy was ended.

Systemic reasons for deflation in Japan can be said to include:

Tight monetary conditions. The Bank of Japan kept monetary policy loose only when inflation was below zero, tightening whenever deflation ends.^[31]

Unfavorable demographics. Japan has an aging population (22.6% over age 65) that is not growing and will soon start a long decline. The Japanese death rate recently exceeded its birth rate.

Fallen asset prices. In the case of Japan asset price deflation was a mean reversion or correction back to the price level that prevailed before the asset bubble. There was a rather large price bubble in equities and especially real estate in Japan in the 1980s (peaking in late 1989).

Insolvent companies: Banks lent to companies and individuals that invested in real estate. When real estate values dropped, these loans could not be paid. The banks could try to collect on the collateral (land), but this wouldn't pay off the loan. Banks delayed that decision, hoping asset prices would improve. These delays were allowed by national banking regulators. Some banks made even more loans to these companies that are used to service the debt they already had. This continuing process is known as maintaining an "unrealized loss", and until the assets are completely revalued and/or sold off (and the loss realized), it will continue to be a deflationary force in the economy. Improving bankruptcy law, land transfer law, and tax law have been suggested (by The Economist) as methods to speed this process and thus end the deflation.

Insolvent banks: Banks with a larger percentage of their loans which are "non-performing", that is to say, they are not receiving payments on them, but have not yet written them off, cannot lend more money; they must increase their cash reserves to cover the bad loans.

Fear of insolvent banks: Japanese people are afraid that banks will collapse so they prefer to buy (United States or Japanese) Treasury bonds instead of saving their money in a bank account. This likewise means the money is not available for lending and therefore economic growth. This means that the savings rate depresses consumption, but does not appear in the economy in an efficient form to spur new investment. People also save by owning real estate, further slowing growth, since it inflates land prices.

Imported deflation: Japan imports Chinese and other countries' inexpensive consumable goods (due to lower wages and fast growth in those countries) and inexpensive raw materials, many of which reached all time real price minimums in the early 2000s. Thus, prices of imported products are decreasing. Domestic producers must match these prices in order to remain competitive. This decreases prices for many things in the economy, and thus is deflationary.

Stimulus Spending: According to both Austrian and Monetarist economic theory, Keynesian 'stimulus' spending actually has a depressing effect. This is because the government is competing against private industry, and usurping private investment dollars.^[32] In 1998, for example, Japan produced a 'stimulus' package of more than 16 trillion Yen, over half of it public works that would have a quashing effect on an equivalent amount of private, wealth-creating economic activity.^[33] Overall, Japan's 'stimulus' packages added up to over one hundred trillion Yen, and yet they failed. According to these economic schools, that 'stimulus' money actually perpetuated the problem it was intended to cure.

In November 2009 Japan has returned to deflation, according to the Wall Street Journal. Bloomberg L.P. reports that consumer prices fell in October 2009 by a near-record 2.2%.^[34]

[edit]In the United States

Annual inflation (in blue) and deflation (in green) rates in the United Statesfrom 1666 to 2004.

There have been four significant periods of deflation in the United States.

The first and most severe was during the depression from 1818-21 when prices of agricultural commodities declined by almost 50%. A credit contraction caused by a financial crisis in England drained specie out of the U.S. The Bank of the United States also contracted its lending. The price of agricultural commodities fell by almost 50% from the high in 1815 to the low in 1821, and did not recover until the late 1930s, although to a significantly lower price level. Most damaging was the price of cotton, the U.S.'s main export. Food crop prices, which had been high because of the famine of 1816 that was caused by the year without a summer, fell after the return of normal harvests in 1818. Improved transportation, mainly from turnpikes, and to a minor extent the introduction of steamboats, significantly lowered transportation costs.^[13]

The second was the depression of the late 1830s to 1843, following the Panic of 1837, when the currency in the United States contracted by about 33%, a contraction which is only matched by the Great Depression.^[35] (See: Historical examples of credit deflation) This "deflation" satisfies both definitions, that of a decrease in prices and a decrease in the available quantity of money. Despite the deflation and depression, GDP rose 16% from 1839-43.^[35]

The third was after the Civil War, sometimes called The Great Deflation. It was possibly spurred by return to a gold standard, retiring paper money printed during the Civil War.

"The Great Sag of 1873-96 could be near the top of the list. Its scope was global. It featured cost-cutting and productivity-enhancing technologies. It flummoxed the experts with its persistence, and it resisted attempts by politicians to understand it, let alone reverse it. It delivered a generation’s worth of rising bond prices, as well as the usual losses to unwary creditors via defaults and early calls. Between 1875 and 1896, according toMilton Friedman,^{[citation needed]} prices fell in the United States by 1.7% a year, and in Britain by 0.8% a year.^[36]

(Note: David A. Wells (1890) gives an account of the period and discusses the great advances in productivity which Wells argues were the cause of the deflation. The productivity gains matched the deflation.^[37] Murray Rothbard (2002) gives a similar account.^[38])

The fourth was between 1930–1933 when the rate of deflation was approximately 10 percent/year, part of the United States' slide into the Great Depression, where banks failed and unemployment peaked at 25%.

The deflation of the Great Depression occurred partly because there was an enormous contraction of credit (money), bankruptcies creating an environment where cash was in frantic demand, and when the Federal Reserve was supposed to accommodate that demand, it instead contracted the money supply by 30% in enforcement of its new real bills doctrine, so banks toppled one-by-one (because they were unable to meet the sudden demand for cash— see Fractional-reserve banking). From the standpoint of the Fisher equation (see above), there was a concomitant drop both in money supply (credit) and the velocity of money which was so profound that price deflation took hold despite the increases in money supply spurred by the Federal Reserve.

[edit]Minor deflations in the US

Throughout the history of the United States, inflation has approached zero and dipped below for short periods of time (negative inflation is deflation). This was quite common in the 19th century, and in the 20th century until the permanent abandonment of the gold standard for the Bretton Woods System in 1948. There has only been one period of deflation since, in 2008-9.

Some economists believe the United States may be currently experiencing deflation as part of the Financial crisis of 2007–2010; compare the theory of debt-deflation. Year-on-year, consumer prices dropped for six months in a row to end-August 2009, largely due to a steep decline in energy prices.^{[citation needed]}Consumer prices dropped 1 percent in October, 2008. This was the largest one-month fall in prices in the US since at least 1947. That record was again broken in November, 2008 with a 1.7% decline. In response, the Federal Reserve decided to continue cutting interest rates, down to a near-zero range as of December 16, 2008.^[39] In late 2008 and early 2009, some economists feared the US could enter a deflationary spiral.^{[citation needed]} Economist Nouriel Roubini predicted that the United States would enter a deflationary recession, and coined the term "stag-deflation" to describe it.^[40] It is the opposite of stagflation, which was the main fear during the spring and summer of 2008. The United States then began experiencing measurable deflation, steadily decreasing from the first measured deflation of -0.38% in March, to July's deflation rate of -2.10%. On the wage front, in October 2009 the state of Colorado announced that its state minimum wage, which is indexed to inflation, is set to be cut, which would be the first time a state has cut its minimum wage since 1938.^[41]

[edit]In the United Kingdom

During World War I the British pound sterling was removed from the gold standard. The motivation for this policy change was to finance World War I; one of the results was inflation, and a rise in the gold price, along with the corresponding drop in international exchange rates for the pound. When the pound was returned to the gold standard after the war it was done on the basis of the pre-war gold price, which, since it was higher than equivalent price in gold, required prices to fall to realign with the higher target value of the pound.

The UK experienced deflation of approx 10% in 1921, 14% in 1922, and 3 to 5% in the early 1930s.^[42]

[edit]See also

[edit]Notes

^ Robert J. Barro and Vittorio Grilli (1994), European Macroeconomics, chap. 8, p. 142. ISBN 0-333-57764-7
^ Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 343. ISBN 0-13-063085-3.
^ Hummel, Jeffrey Rogers. "Death and Taxes, Including Inflation: the Public versus Economists" (Jan 2007). [1]
^ Andrew Atkeson and Patrick J. Kehoe of the Federal Reserve Bank of Minneapolis Deflation and Depression: Is There an Empirical Link?
^ ^a ^b ^c Hussman, Ph.D., John, O. (2010, Oct. 25). "Bernanke Leaps into a Liquidity Trap"
^ ^a ^b Wells, David A. (1890). Recent Economic Changes and Their Effect on Production and Distribution of Wealth and Well-Being of Society. New York: D. Appleton and Co.. ISBN 0-543-72474-3.Money supply pp 222
^ Stapleford, Thomas (2009). The Cost of Living in America: A Political History of Economic Statistics, 1880-2000. Cambridge University Peess. pp. 69–73.
^ Kendrick, John (1991). U.S. Productivity Performance in Perspective , Business Economics, October 1, 1991
^ Bell, Spurgeon (1940). Productivity, Wages and National Income , The Institute of Economics of the Brookings Institution. Waverly press
^ ^a ^b Beaudreau, Bernard C. (1996). Mass Production, the Stock Market Crash and the Great Depression. New York, Lincoln, Shanghi: Authors Choice Press.
^ The Debt-Deflation Theory of Great Depressions
^ ^a ^b ^c ^d How Gold Coins Circulated in 19 th Century America David Ginsburg, pp 25-33
^ ^a ^b ^c ^d Taylor, George Rogers (1951). The Transportation Revolution, 1815-1860. New York, Toronto: Rinehart & Co.. pp. 133, 331–4. ISBN 978-0-87332-101-3.
^ Greenspan interveiw on CNBC 3 Dec. 2010
^ [|Browne, Harry] (1981). You Can Profit from a Monetary Crisis.ISBN 4-87187-322-6.
^ ^a ^b North, Douglas C. (1966). The Economic Growth of the United States 1790-1860. New York, London: W. W. Norton & Company. ISBN 978-0-393-00346-8.
^ "A market for buying bank 'passbooks' also cropped up in places like Youngstown. If you were desperate enough in 1931 for money to buy basic necessities, you could get 60 to 70 cents on the dollar for your passbooks' value. Local newspapers even printed the weekly rates for buying and selling these passbooks as they became a commodity; Roth pasted one such rate chart into his diary." from page 36 of "The Great Depression: A Diary" by Benjamin Roth, edited by James Ledbetter and Daniel B. Roth, Public Affairs, Perseus Books Group, copyright 2009.
^ Taylor 1951, pp. 336
^ Wallis, Hohn Joseph; National Bureau of Economic Research. "The Depression of 1839 to 1843"
^ Stapleford, Thomas (2009). The Cost of Living in America: A Political History of Economic Statistics, 1880-2000. Cambridge University Press. pp. 69–73.
^ The History of Economic Downturns in the US -- But Now You Know
^ F. A. Hayek, interviewed by Diego Pizano July, 1979 published in: Diego Pizano, Conversations with Great Economists: Friedrich A. Hayek, John Hicks, Nicholas Kaldor, Leonid V. Kantorovich, Joan Robinson, Paul A.Samuelson, Jan Tinbergen (Jorge Pinto Books, 2009).
^ Friedrich Hayek’s 1932 Letter on the Great Depression
^ Prof. Krugman on Deflationary Spirals
^ The Economist on the dangers of a deflationary spiral
^ Deflation: Making Sure "It" Doesn't Happen Here Remarks by Governor Ben S. Bernanke Before the National Economists Club, Washington, D.C. November 21, 2002
^ Jao, Y C (2001). "Why Was Hong Kong a Laggard in Economic Recovery". The Asian Financial Crisis and the Ordeal of Hong Kong. Quorum Books. pp. 155–170. ISBN 978-1-56720-447-6.
^ Liu, Henry C K (2003-07-04). "Why Hong Kong is in crisis". Asia Times. Retrieved 27 April 2010.
^ RTÉ News - Deflation hits economy; 1st time in 49 years
^ RTÉ News - Deflation a factor in Budget cuts - Lenihan
^ http://www.themoneyillusion.com/?p=7337
^ Why Stimulus Spending Depresses the Economy
^ Explaining Japan's Recession, Benjamin Powell
^ Japan Releases Stimulus Package as Recovery Weakens (Update3)
^ ^a ^b Atack, Jeremy; Passell, Peter (1994). A New Economic View of American History. New York: W.W. Norton and Co.. p. 102. ISBN 0-393-96315-2
^ http://www.grantspub.com/articles/inflation/^{[dead link]}
^ Wells, David A. (1890). Recent Economic Changes and Their Effect on Production and Distribution of Wealth and Well-Being of Society. New York: D. Appleton and Co.. ISBN 0-543-72474-3.
^ Rothbard, Murray (2002). History of Money and Banking in the United States. Ludwig Von Mises Inst. pp. 164–8. ISBN 0-945466-33-1.
^http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htmFRB: Press Release
^ http://www.forbes.com/2008/10/29/stagnation-recession-deflation-oped-cx_nr_1030roubini.html Get Ready for 'Stag-Deflation'
^ Colorado minimum wage set to fall, by Aldo Svaldi, The Denver Post, 13 October 2009
^ Bank of England Quarterly inflation report Feb 2009 p33 chart A

[edit]References

Ben S. Bernanke. Deflation: Making Sure "It" Doesn't Happen Here. USA Federal Reserve Board. 2002-11-21. Accessed: 2008-10-17. (Archived by WebCite at http://www.webcitation.org/5bdTTiZhU)
Michael Bordo & Andrew Filardo, Deflation and monetary policy in a historical perspective: Remembering the past or being condemned to repeat it?, In: Economic Policy, October 2005, pp 799–844.
Georg Erber, The Risk of Deflation in Germany and the Monetary Policy of the ECB. In: Cesifo Forum 4 (2003), 3, pp 24–29
Charles Goodhart and Boris Hofmann, Deflation, credit and asset prices, In: Deflation - Current and Historical Perspectives, eds. Richard C. K. Burdekin & Pierre L. Siklos, Cambridge University Press, Cambridge, 2004.
International Monetary Fund, Deflation: Determinants, Risks, and Policy Options - Findings of an Independent Task Force, Washington D. C., April 30, 2003.
International Monetary Fund, World Economic Outlook 2006 - Globalization and Inflation, Washington D. C., April 2006.
Otmar Issing, The euro after four years: is there a risk of deflation?, 16th European Finance Convention, 2 December 2002, London, Europäische Zentralbank, Frankfurt am Main
Paul Krugman, Its Baaaaack: Japan's Slump and the Return of the Liquidity Trap, In: Brookings Papers on Economic Activity 2, (1998), pp 137–205
Steven B. Kamin, Mario Marazzi & John W. Schindler, Is China "Exporting Deflation"?, International Finance Discussion Papers No. 791, Board of Governors of the Federal Reserve System, Washington D. C. January 2004.

[edit]External links

Cato Policy Report - A Plea for (Mild) Deflation
Deflation (EH.Net economic history encyclopedia)
What is deflation and how can it be prevented? (About.com)
Deflation, Free or Compulsory from Making Economic Sense by Murray N. Rothbard
Annual Inflation Rate - Japan
Why Are Japanese Wages So Sluggish? IMF Working paper

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STAGFLATION

2012-08-13T18:14:00.004-07:00

Stagflation

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In economics, stagflation is a situation in which the inflation rate is high, the economic growth rate slows down, and unemployment remains steadily high. It raises a dilemma for economic policy since actions designed to lower inflation may exacerbate unemployment, and vice versa.
The portmanteau stagflation is generally attributed to British politician Iain Macleod, who coined the phrase in his speech to Parliament in 1965.^[1]^[2]^[3] ^[4]
The concept is notable because, in the version of Keynesian macroeconomic theory which was dominant between the end of WWII and the late-1970s, inflation and recession were regarded as mutually exclusive, the relationship between the two being described by the Phillips curve. Stagflation is also notable because it has generally proven to be difficult and, in human terms as well as budget deficits, very costly to eradicate once it starts.
In the political arena, one measure of stagflation, termed the Misery Index (derived by the simple addition of the inflation rate to the unemployment rate), was used to swing presidential elections in the United States in 1976 and 1980.

Contents

1 Causes
2 Postwar Keynesian and monetarist views
2.1 Early Keynesianism and monetarism

2.2 Neo-Keynesianism

2.3 Supply theory
2.3.1 Fundamentals

2.3.2 Explaining the 1970s stagflation

2.3.3 Theoretical responses

3 Recent views

4 Neoclassical views
4.1 Keynesian in the short run, classical in the long run

5 Alternative views
5.1 As differential accumulation

5.2 Demand-pull stagflation theory

5.3 Supply-side theory

5.4 Austrian School of economics

6 Responses

7 See also

8 Notes

9 References

[edit]Causes
Economists offer two principal explanations for why stagflation occurs. First, stagflation can result when the productive capacity of an economy is reduced by an unfavorable supply shock, such as an increase in the price of oil for an oil importing country. Such an unfavorable supply shock tends to raise prices at the same time that it slows the economy by making production more costly and less profitable.^[5]^[6]^[7]
Second, both stagnation and inflation can result from inappropriate macroeconomic policies. For example, central banks can cause inflation by permitting excessive growth of the money supply,^[8] and the government can cause stagnation by excessive regulation of goods markets and labor markets.^[9]Either of these factors can cause stagflation. Excessive growth of the money supply taken to such an extreme that it must be reversed abruptly can clearly be a cause. Both types of explanations are offered in analyses of the global stagflation of the 1970s: it began with a huge rise in oil prices, but then continued as central banks used excessively stimulative monetary policy to counteract the resulting recession, causing a runaway wage-price spiral.^[10]
[edit]Postwar Keynesian and monetarist views
[edit]Early Keynesianism and monetarism
Up to the 1960s many Keynesian economists ignored the possibility of stagflation, because historical experience suggested that high unemployment was typically associated with low inflation, and vice versa (this relationship is called the Phillips curve). The idea was that high demand for goods drives up prices, and also encourages firms to hire more; and likewise high employment raises demand. However, in the 1970s and 1980s, when stagflation occurred, it became obvious that the relationship between inflation and employment levels was not necessarily stable: that is, the Phillips relationship could shift. Macroeconomists became more skeptical of Keynesian theories, and the Keynesians themselves reconsidered their ideas in search of an explanation of stagflation.^[11]
The explanation for the shift of the Phillips curve was initially provided by themonetarist economist Milton Friedman, and also by Edmund Phelps. Both argued that when workers and firms begin to expect more inflation, the Phillips curve shifts up (meaning that more inflation occurs at any given level of unemployment). In particular, they suggested that if inflation lasted for several years, workers and firms would start to take it into account during wage negotiations, causing workers' wages and firms' costs to rise more quickly, thus further increasing inflation. While this idea was a severe criticism of early Keynesian theories, it was gradually accepted by most Keynesians, and has been incorporated into New Keynesianeconomic models.
[edit]Neo-Keynesianism
Contemporary Keynesian analyses argue that stagflation can be understood by distinguishing factors that affect aggregate demand from those that affectaggregate supply. While monetary and fiscal policy can be used to stabilize the economy in the face of aggregate demand fluctuations, they are not very useful in confronting aggregate supply fluctuations. In particular, an adverse shock to aggregate supply, such as an increase in oil prices, can give rise to stagflation.^[12]
Neo-Keynesian theory distinguished two distinct kinds of inflation: demand-pull (caused by shifts of the aggregate demand curve) and cost-push (caused by shifts of the aggregate supply curve). Stagflation, in this view, is caused by cost-push inflation. Cost-push inflation occurs when some force or condition increases the costs of production. This could be caused by government policies (such as taxes), or from purely external factors such as a shortage of natural resources or an act of war.
[edit]Supply theory
[edit]Fundamentals
Supply theories^[13] are based on the neo-Keynesian cost-push model and attribute stagflation to significant disruptions to the supply side of the supply-demand market equation, for example, when there is a sudden real or relative scarcity of key commodities, natural resources, or natural capital needed to produce goods and services. Other factors may also cause supply problems, for example, social and political conditions such as policy changes, acts of war, extremely restrictive government control of production (For example monopolizing Dictatorships).^{[citation needed]} In this view, stagflation is thought to occur when there is an adverse supply shock (for example, a sudden increase in the price ofoil or a new tax) that causes a subsequent jump in the "cost" of goods and services (often at the wholesale level). In technical terms, this results in contraction or negative shift in an economy's aggregate supply curve.^{[citation needed]}
In the resource scarcity scenario (Zinam 1982), stagflation results when economic growth is inhibited by a restricted supply of raw materials.^[14]^[15] That is, when the actual or relative supply of basic materials (fossil fuels (energy), minerals, agricultural land in production, timber, etc.) decreases and/or cannot be increased fast enough in response to rising or continuing demand. The resource shortage may be a real physical shortage or a relative scarcity due to factors such as taxes or bad monetary policy which have affected the "cost" or availability of raw materials. This is consistent with the cost-push inflation factors in neo-Keynesian theory (above). The way this plays out is that after supply shock occurs, the economy will first try to maintain momentum — that is, consumers and businesses will begin paying higher prices in order to maintain their level of demand. The central bank may exacerbate this by increasing the money supply, by lowering interest rates for example, in an effort to combat a recession. The increased money supply props up the demand for goods and services, though demand would normally drop during a recession.^{[citation needed]}
In the Keynesian model, higher prices will prompt increases in the supply of goods and services. However, during a supply shock (i.e. scarcity, "bottleneck" in resources, etc.), supplies don't respond as they normally would to these price pressures. So, inflation jumps and output drops, producing stagflation.^{[citation needed]}
[edit]Explaining the 1970s stagflation
Further information: Nixon Shock
Following Richard Nixon's imposition of wage and price controls on August 15, 1971, an initial wave of cost-push shocks in commodities was blamed for causing spiraling prices. Perhaps the most notorious factor cited at that time was the failure of the Peruvian anchovy fishery in 1972, a major source of livestock feed.^[16] The second major shock was the 1973 oil crisis, when the Organization of Petroleum Exporting Countries (OPEC) constrained the worldwide supply of oil.^[17] Both events, combined with the overall energy shortage that characterized the 1970s, resulted in actual or relative scarcity of raw materials. The price controls resulted in shortages at the point of purchase, causing, for example, queues of consumers at fueling stations and increased production costs for industry.^[18]
[edit]Theoretical responses
Under this set of theories, the solution to stagflation is to restore the supply of materials. In the case of a physical scarcity, stagflation is mitigated either by finding a replacement for the missing resources or by developing ways to increase economic productivity and energy efficiency so that more output is produced with less input. For example, in the late 1970s and early 1980s, the scarcity of oil was relieved by increases in both energy efficiency and global oil production. This factor, along with adjustments in monetary policies, helped end stagflation.^{[citation needed]}
[edit]Recent views
Until recently no macroeconomic policy had been able to predict the occurrence of stagflation.
After the fact, and several years of research, a convincing explanation was provided based on the effects of adverse supply shocks on both prices and output.^[19] According to Blanchard (2009), these adverse events were one of two components of stagflation; the other was "ideas", which Robert Lucas (famous for the Lucas Supply Curve), Thomas Sargent, and Robert Barro were cited as expressing as "wildly incorrect" and "fundamentally flawed" predictions [ofKeynesian economics] which, they said, left stagflation to be explained by "contemporary students of the business cycle".^[19] In this discussion, Blanchard hypothesizes that the recent oil price increases could trigger another period of stagflation, although this has not yet happened (pg. 152).
[edit]Neoclassical views
A purely neoclassical view^[20] of the macroeconomy rejects the idea that monetary policy can have real effects. Neoclassical macroeconomists argue thatreal economic quantities, like real output, employment, and unemployment, are determined by real factors only. Nominal factors like changes in the money supply only affect nominal variables like inflation. The neoclassical idea that nominal factors cannot have real effects is often called "monetary neutrality"^[21] or also the "classical dichotomy".
Since the neoclassical viewpoint says that real phenomena like unemployment are essentially unrelated to nominal phenomena like inflation, a neoclassical economist would offer two separate explanations for 'stagnation' and 'inflation'. Neoclassical explanations of stagnation (low growth and high unemployment) include inefficient government regulations or high benefits for the unemployed that give people less incentive to look for jobs. Another neoclassical explanation of stagnation is given by real business cycle theory, in which any decrease inlabor productivity makes it efficient to work less. The main neoclassical explanation of inflation is very simple: it happens when the monetary authoritiesincrease the money supply too much.^[22]
In the neoclassical viewpoint, the real factors that determine output and unemployment affect the aggregate supply curve only. The nominal factors that determine inflation affect the aggregate demand curve only.^[23] When some adverse changes in real factors are shifting the aggregate supply curve left at the same time that unwise monetary policies are shifting the aggregate demand curve right, the result is stagflation.
Thus the main explanation for stagflation under a classical view of the economy is simply policy errors that affect both inflation and the labor market. Ironically, a very clear argument in favor of the classical explanation of stagflation was provided by Keynes himself. In 1919, John Maynard Keynes described the inflation and economic stagnation gripping Europe in his book The Economic Consequences of the Peace. Keynes wrote:
"Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some." [...]
"Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."
Keynes explicitly pointed out the relationship between governments printing money and inflation.
"The inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance."
Keynes also pointed out how government price controls discourage production.
"The presumption of a spurious value for the currency, by the force of law expressed in the regulation of prices, contains in itself, however, the seeds of final economic decay, and soon dries up the sources of ultimate supply. If a man is compelled to exchange the fruits of his labors for paper which, as experience soon teaches him, he cannot use to purchase what he requires at a price comparable to that which he has received for his own products, he will keep his produce for himself, dispose of it to his friends and neighbors as a favor, or relax his efforts in producing it. A system of compelling the exchange of commodities at what is not their real relative value not only relaxes production, but leads finally to the waste and inefficiency of barter."
Keynes detailed the relationship between German government deficits and inflation.
"In Germany the total expenditure of the Empire, the Federal States, and the Communes in 1919-20 is estimated at 25 milliards of marks, of which not above 10 milliards are covered by previously existing taxation. This is without allowing anything for the payment of the indemnity. In Russia, Poland, Hungary, or Austria such a thing as a budget cannot be seriously considered to exist at all."
"Thus the menace of inflationism described above is not merely a product of the war, of which peace begins the cure. It is a continuing phenomenon of which the end is not yet in sight."
[edit]Keynesian in the short run, classical in the long run
While most economists believe that changes in money supply can have some real effects in the short run, neoclassical and neo-Keynesian economists tend to agree that there are no long-run effects from changing the money supply. Therefore, even economists who consider themselves neo-Keynesians usually believe that in the long run, money is neutral. In other words, while neoclassical and neo-Keynesian models are often seen as competing points of view, they can also be seen as two descriptions appropriate for different time horizons. Many mainstream textbooks today treat the neo-Keynesian model as a more appropriate description of the economy in the short run, when prices are 'sticky', and treat the neoclassical model as a more appropriate description of the economy in the long run, when prices have sufficient time to adjust fully.^{[citation needed]}
Therefore, while mainstream economists today might often attribute short periods of stagflation (not more than a few years) to adverse changes in supply, they would not accept this as an explanation of very prolonged stagflation. More prolonged stagflation would be explained as the effect of inappropriate government policies: excessive regulation of product markets and labor markets leading to long-run stagnation, and excessive growth of the money supply leading to long-run inflation.^{[citation needed]}
[edit]Alternative views
[edit]As differential accumulation
Main article: Differential accumulation
Political economists Jonathan Nitzan and Shimshon Bichler have proposed an explanation of stagflation as part of a theory they call differential accumulation, which says firms seek to beat the average profit and capitalization rather than maximize. According to this theory, periods of mergers and acquisitions oscillate with periods of stagflation. When mergers and acquisitions are no longer politically feasible (governments clamp down with anti-monopoly rules), stagflation is used as an alternative to have higher relative profit than the competition. With increasing mergers and acquisitions, the power to implement stagflation increases.
Stagflation appears as a societal crisis, such as during the period of the oil crisis in the 70s and in 2006 to 2008. Inflation in stagflation, however, doesn't affect all firms equally. Dominant firms are able to increase their own prices at a faster rate than competitors. While in the aggregate no one appears to be profiting, differentially dominant firms improve their positions with higher relative profits and higher relative capitalization. Stagflation is not due to any actual supply shock, but because of the societal crisis that hints at a supply crisis. It is mostly a 20th and 21st century phenomenon that has been mainly used by the "weapondollar-petrodollar coalition" creating or using Middle East crises for the benefit of pecuniary interests.^[24]
[edit]Demand-pull stagflation theory
Demand-pull stagflation theory explores the idea that stagflation can result exclusively from monetary shocks without any concurrent supply shocks or negative shifts in economic output potential. Demand-pull theory describes a scenario where stagflation can occur following a period of monetary policy implementations that cause inflation. This theory was first proposed in 1999 by Eduardo Loyo of Harvard University's John F. Kennedy School of Government.^[25]
[edit]Supply-side theory
Supply-side economics emerged as a response to US stagflation in the 1970s. It largely attributed inflation to the ending of the Bretton Woods system in 1971 and the lack of a specific price reference in the subsequent monetary policies (Keynesian and Monetarism). Supply-side economists asserted that the contraction component of stagflation resulted from an inflation-induced rise in real tax rates (see bracket creep)^{[citation needed]}
[edit]Austrian School of economics
Adherents to the Austrian School maintain that creation of new money ex nihilobenefits the creators and early recipients of the new money relative to late recipients. Money creation is not wealth creation; it merely allows early money recipients to outbid late recipients for resources, goods, and services. Since the actual producers of wealth are typically late recipients, increases in the money supply weakens wealth formation and undermines the rate of economic growth. Says Austrian economist Frank Shostak:
"The increase in the money supply rate of growth coupled with the slowdown in the rate of growth of goods produced is what the increase in the rate of price inflation is all about. (Note that a price is the amount of money paid for a unit of a good.) What we have here is a faster increase in price inflation and a decline in the rate of growth in the production of goods. But this is exactly what stagflation is all about, i.e., an increase in price inflation and a fall in real economic growth. Popular opinion is that stagflation is totally made up. It seems therefore that the phenomenon of stagflation is the normal outcome of loose monetary policy. This is in agreement with [Phelps and Friedman (PF)]. Contrary to PF, however, we maintain that stagflation is not caused by the fact that in the short run people are fooled by the central bank. Stagflation is the natural result of monetary pumping which weakens the pace of economic growth and at the same time raises the rate of increase of the prices of goods and services."^[26]
[edit]Responses
Stagflation undermined support for Keynesian consensus. The rise of conservative theories of economics, including monetarism, can be traced to the failure of Keynesian policies to combat stagflation or explain it to the satisfaction of economists and policy-makers.^{[citation needed]}
Federal Reserve chairman Paul Volcker very sharply increased interest rates from 1979-1983 in what was called a "disinflationary scenario." After U.S. prime interest rates had soared into the double-digits, inflation did come down; these interest rates were the highest long-term prime interest rates that had ever existed in modern capital markets.^[27] Volcker is often credited with having stopped at least the inflationary side of stagflation, although the American economy also dipped into recession. Starting in approximately 1983, growth began a recovery. Both fiscal stimulus and money supply growth were policy at this time. A five- to six-year jump in unemployment during the Volcker disinflation suggests Volcker may have trusted unemployment to self-correct and return to its natural rate within a reasonable period.^{[citation needed]}
[edit]See also
Agflation

Biflation

Deflation

Economic stagnation

Inflation

Hyperinflation

Inflationism

Stagflation in the United States

ZIRP

[edit]Notes
^ Online Etymology Dictionary. Douglas Harper, Historian.http://dictionary.reference.com/browse/stagflation (accessed: May 05, 2007).

^ British House of Commons' Official Report (also known as Hansard), 17 November 1965, page 1,165.

^ Edward Nelson and Kalin Nikolov (2002), Bank of England Working Paper #155 (Introduction, page 9). (Note: Nelson and Nikolov also point out that the term 'stagflation' has sometimes been erroneously attributed to Paul Samuelson.)

^ N. Gregory Mankiw (2008). Principles of Macroeconomics, page 464

^ J. Bradford DeLong (3-10-1998). "Supply Shocks: The Dilemma of Stagflation". University of California at Berkeley. Retrieved 2008-01-24.

^ Burda, Michael; Wyplosz, Charles (1997). Macroeconomics: A European Text, 2nd ed. Oxford University Press. pp. 338–339

^ Hall, Robert; John Taylor (1986). Macroeconomics: Theory, Performance, and Policy. Norton. ISBN 0-393-95398-X.

^ Blanchard (2000), op. cit., Ch. 9, pp. 172-173, and Ch. 23, pp. 447-450.

^ Blanchard (2000), op. cit., Ch. 22-2, pp. 434-436.

^ Barsky, Robert; Kilian, Lutz (2000). A Monetary Explanation of the Great Stagflation of the 1970s. University of Michigan[1]

^ Blanchard (2000), op. cit., Chap. 28, p. 541.

^ Abel, Andrew; Ben Bernanke and Andrew Abel (1995). "Chap. 11".Macroeconomics (2nd ed.). Addison-Wesley. ISBN 0-201-54392-3.

^ Bronfenbrenner, Martin (1976). "Elements of Stagflation Theory".Zeitschrift für Nationalökonomie 36: 1–8. doi:10.1007/BF01283912.

^ Smith, V.Kerry (1979). Scarcity and Growth Reconsidered. Johns Hopkins Press for Resources for the Future

^ Krautkraemer, Jeffrey (March, 2002). ECONOMICS OF SCARCITY: STATE OF THE DEBATE. Washington State University

^ Humphrey, Thomas M. (1973). "Historical Origins of the Cost-Push Fallacy" (PDF). Economic Quarterly, Federal Reserve Bank of Richmond, Summer 1998, v.98 No.3.

^ "Over a Barrel". Time Magazine. 1983-10-03. Retrieved 2010-05-24.

^ ("Panic at the Pump". Time Magazine. 1974-01-14. Retrieved 2010-05-24.

^ ^a ^b Blanchard, Olivier (2009). Macroeconomics (Instructor's Review Copy) (5th ed.). Prentice Hall. pp. 152, 583, 584, G–9. ISBN 0-13-013306-X.

^ Abel & Bernanke (1995), op. cit., Ch. 11.

^ Abel & Bernanke (1995), op. cit., Ch. 11, pp. 378-9.

^ Barro, Robert; Vittorio Grilli (1994). European Macroeconomics. Macmillan. p. 139. ISBN 0-333-57764-7.

^ Abel & Bernanke (1995), Ch. 11, pp. 376-7.

^ Nitzan, Jonathan (June 2001). "Regimes of differential accumulation: mergers, stagflation and the logic of globalization". Review of International Political Economy 8 (2): 226–274.doi:10.1080/09692290010033385.

^ Loyo, Eduardo (June 1999). Demand-Pull Stagflation (Draft Working Paper). National Bureau of Economic Research New Working Papers[2]

^ Frank Shostak (10-10-2006). "Did Phelps Really Explain Stagflation?".Mises Daily. Ludwig von Mises Institute. Retrieved 2011-02-22.

^ (Homer, Sylla & Sylla 1996, p. 1)

[edit]References
Homer, Sidney; Sylla, Richard Eugene; Sylla, Richard (1996). A History of Interest Rates.

Rutgers University Press. ISBN 978-0-8135-2288-3. Retrieved 2008-10-27

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A central bank, reserve bank, or monetary authority is a public institution that manages a state's currency, money supply, and interest rates. Central banks also usually oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the nation's monetary base, and usually also prints the national currency, which usually serves as the nation's legal tender.^[1]^[2] Examples include the European Central Bank (ECB), the Federal Reserve of the United States, and the People's Bank of China.^[3]

The primary function of a central bank is to manage the nation's money supply (monetary policy), through active duties such as managing interest rates, setting the reserve requirement, and acting as a lender of last resort to the banking sector during times of bank insolvency or financial crisis. Central banks usually also have supervisory powers, intended to prevent commercial banks and other financial institutions from reckless or fraudulent behavior. Central banks in most developed nations are institutionally designed to be independent from political interference.

[edit]History

The Bank of England, established in 1694.

Prior to the 17th century most money was commodity money, typically gold or silver. However, promises to pay were widely circulated and accepted as value at least five hundred years earlier in both Europe and Asia. The Song Dynasty was the first to issue generally circulating paper currency, while the Yuan Dynasty was the first to use notes as the predominant circulating medium. In 1455, in an effort to control inflation, the succeeding Ming Dynasty ended the use of paper money and closed much of Chinese trade. The medieval European Knights Templar ran an early prototype of a central banking system, as their promises to pay were widely respected, and many regard their activities as having laid the basis for the modern banking system.

As the first public bank to "offer accounts not directly convertible to coin", the Bank of Amsterdam established in 1609 is considered to be the precursor to modern central banks.^[4] The central bank of Sweden ("Sveriges Riksbank" or simply "Riksbanken") was founded in Stockholm from the remains of the failed bank Stockholms Banco in 1664 and answered to the parliament ("Riksdag of the Estates") thus making it the oldest central bank still operating today.^[5] One role of the Swedish central bank was lending to the government,^[6] which was likewise true of the Bank of England, created in 1694 by Scottish businessman William Paterson in the City of London at the request of the English government to help pay for a war. The War of the Second Coalition led to the creation of the Banque de France in 1800.

Although central banks today are generally associated with fiat money, the 19th and early 20th centuries central banks in most of Europe and Japan developed under the international gold standard, elsewhere free banking or currency boards were more usual at this time. Problems with collapses of banks during downturns, however, was leading to wider support for central banks in those nations which did not as yet possess them, most notably in Australia.

The US Federal Reserve was created by the U.S. Congress through the passing of The Federal Reserve Act in the Senate and its signing by President Woodrow Wilson on the same day, December 23, 1913. Australia established its first central bank in 1920, Colombia in 1923, Mexico and Chile in 1925 and Canada and New Zealand in the aftermath of the Great Depression in 1934. By 1935, the only significant independent nation that did not possess a central bank was Brazil, which subsequently developed a precursor thereto in 1945 and the present central bank twenty years later. Having gained independence, African and Asian countries also established central banks or monetary unions.

The People's Bank of China evolved its role as a central bank starting in about 1979 with the introduction of market reforms, which accelerated in 1989 when the country adopted a generally capitalist approach to its export economy. Evolving further partly in response to the European Central Bank, the People's Bank of China has by 2000 become a modern central bank. The most recent bank model, was introduced together with the euro, involves coordination of the European national banks, which continue to manage their respective economies separately in all respects other than currency exchange and base interest rates.

[edit]Naming of central banks

There is no standard terminology for the name of a central bank, but many countries use the "Bank of Country" form (for example: Bank of England, Bank of Canada, Bank of Mexico). Some are styled "national" banks, such as the National Bank of Ukraine; but the term "national bank" is more often used by privately owned commercial banks, especially in the United States. In other cases, central banks may incorporate the word "Central" (for example, European Central Bank, Central Bank of Ireland); but the Central Bank of India is a (government-owned) commercial bank and not a central bank. The word "Reserve" is also often included, such as the Reserve Bank of India, Reserve Bank of Australia, Reserve Bank of New Zealand, the South African Reserve Bank, and U.S. Federal Reserve System. Many countries have state-owned banks or other quasi-government entities that have entirely separate functions, such as financing imports and exports.

In some countries, particularly in some Communist countries, the term national bank may be used to indicate both the monetary authority and the leading banking entity, such as the Soviet Union's Gosbank (state bank). In other countries, the term national bank may be used to indicate that the central bank's goals are broader than monetary stability, such as full employment, industrial development, or other goals.

[edit]Activities and responsibilities

United States Federal Reserve

Functions of a central bank may include:

implementing monetary policies.
determining Interest rates
controlling the nation's entire money supply
the Government's banker and the bankers' bank ("lender of last resort")
managing the country's foreign exchange and gold reserves and the Government's stock register
regulating and supervising the banking industry
setting the official interest rate – used to manage both inflation and the country's exchange rate – and ensuring that this rate takes effect via a variety of policy mechanisms

[edit]Monetary policy

Central banks implement a country's chosen monetary policy. At the most basic level, this involves establishing what form of currency the country may have, whether a fiat currency, gold-backed currency (disallowed for countries with membership of the International Monetary Fund), currency board or a currency union. When a country has its own national currency, this involves the issue of some form of standardized currency, which is essentially a form of promissory note: a promise to exchange the note for "money" under certain circumstances. Historically, this was often a promise to exchange the money for precious metals in some fixed amount. Now, when many currencies are fiat money, the "promise to pay" consists of the promise to accept that currency to pay for taxes.

A central bank may use another country's currency either directly (in a currency union), or indirectly (a currency board). In the latter case, exemplified by Bulgaria, Hong Kong and Latvia, the local currency is backed at a fixed rate by the central bank's holdings of a foreign currency.

In countries with fiat money, the expression "monetary policy" may refer more narrowly to the interest-rate targets and other active measures undertaken by the monetary authority.

[edit]Goals of monetary policy

The European Central Bank building inFrankfurt

High employment

Frictional unemployment is the time period between jobs when a worker is searching for, or transitioning from one job to another. Unemployment beyond frictional unemployment is classified as unintended unemployment.

For example, structural unemployment is a form of unemployment resulting from a mismatch between demand in the labour market and the skills and locations of the workers seeking employment. Macroeconomic policy generally aims to reduce unintended unemployment.

Keynes labeled any jobs that would be created by a rise in wage-goods (i.e., a decrease in real-wages) as involuntary unemployment:

Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment.

—John Maynard Keynes, The General Theory of Employment, Interest and Money p11

Price stability;

Inflation is defined either as the devaluation of a currency or equivalently the rise of prices relative to a currency.

Since inflation lowers real wages, Keynesians view inflation as the solution to involuntary unemployment. However, "unanticipated" inflation leads to lender losses as the real interest rate will be lower than expected. Thus, Keynesian monetary policy aims for a steady rate of inflation.

Economic growth

Economic growth can be enhanced by investment in capital, such as more or better machinery. A low interest rate implies that firms can loan money to invest in their capital stock and pay less interest for it. Lowering the interest is therefore considered to encourage economic growth and is often used to alleviate times of low economic growth. On the other hand, raising the interest rate is often used in times of high economic growth as a contra-cyclical device to keep the economy from overheating and avoid market bubbles.

Interest rate stability

Financial market stability

Foreign exchange market stability

Conflicts among goals

Goals frequently cannot be separated from each other and often conflict. Costs must therefore be carefully weighed before policy implementation.

[edit]Currency issuance

Similar to commercial banks, central banks hold assets (government bonds, foreign exchange, gold, and other financial assets) and incur liabilities (currency outstanding). Central banks create money by issuing interest-free currency notes and selling them to the public in exchange for interest-bearing assets such as government bonds. When a central bank wishes to purchase more bonds than their respective national governments make available, they may purchase private bonds or assets denominated in foreign currencies.

The European Central Bank remits its interest income to the central banks of the member countries of the European Union. The US Federal Reserve remits all its profits to the U.S. Treasury. This income, derived from the power to issue currency, is referred to as seigniorage, and usually belongs to the national government. The state-sanctioned power to create currency is called the Right of Issuance. Throughout history there have been disagreements over this power, since whoever controls the creation of currency controls the seigniorage income.

[edit]Interest rate interventions

Typically a central bank controls certain types of short-term interest rates. These influence the stock- and bond markets as well as mortgage and other interest rates. The European Central Bank for example announces its interest rate at the meeting of its Governing Council; in the case of the U.S. Federal Reserve, the Board of Governors.

Both the Federal Reserve and the ECB are composed of one or more central bodies that are responsible for the main decisions about interest rates and the size and type of open market operations, and several branches to execute its policies. In the case of the Federal Reserve, they are the local Federal Reserve Banks; for the ECB they are the national central banks.

[edit]Limits on policy effects

Although the perception by the public may be that the "central bank" controls some or all interest rates and currency rates, economic theory (and substantial empirical evidence) shows that it is impossible to do both at once in an open economy.Robert Mundell's "impossible trinity" is the most famous formulation of these limited powers, and postulates that it is impossible to target monetary policy (broadly, interest rates), the exchange rate (through a fixed rate) and maintain free capital movement. Since most Western economies are now considered "open" with free capital movement, this essentially means that central banks may target interest rates or exchange rates with credibility, but not both at once.

In the most famous case of policy failure, Black Wednesday, George Soros arbitraged the pound sterling's relationship to theECU and (after making $2 billion himself and forcing the UK to spend over $8bn defending the pound) forced it to abandon its policy. Since then he has been a harsh critic of clumsy bank policies and argued that no one should be able to do what he did.

The most complex relationships are those between the yuan and the US dollar, and between the euro and its neighbours. The situation in Cuba is so exceptional as to require the Cuban peso to be dealt with simply as an exception, since the United States forbids direct trade with Cuba. US dollars were ubiquitous in Cuba's economy after its legalization in 1991, but were officially removed from circulation in 2004 and replaced by the convertible peso.

[edit]Policy instruments

Bank of Japan

The main monetary policy instruments available to central banks are open market operation, bank reserve requirement, interest rate policy, re-lending and re-discount (including using the term repurchase market), andcredit policy (often coordinated with trade policy). While capital adequacyis important, it is defined and regulated by the Bank for International Settlements, and central banks in practice generally do not apply stricter rules.

To enable open market operations, a central bank must hold foreign exchange reserves (usually in the form of government bonds) and official gold reserves. It will often have some influence over any official or mandated exchange rates: Some exchange rates are managed, some are market based (free float) and many are somewhere in between ("managed float" or "dirty float").

[edit]Interest rates

By far the most visible and obvious power of many modern central banks is to influence market interest rates; contrary to popular belief, they rarely "set" rates to a fixed number. Although the mechanism differs from country to country, most use a similar mechanism based on a central bank's ability to create as much fiat money as required.

The mechanism to move the market towards a 'target rate' (whichever specific rate is used) is generally to lend money or borrow money in theoretically unlimited quantities, until the targeted market rate is sufficiently close to the target. Central banks may do so by lending money to and borrowing money from (taking deposits from) a limited number of qualified banks, or by purchasing and selling bonds. As an example of how this functions, the Bank of Canada sets a target overnight rate, and a band of plus or minus 0.25%. Qualified banks borrow from each other within this band, but never above or below, because the central bank will always lend to them at the top of the band, and take deposits at the bottom of the band; in principle, the capacity to borrow and lend at the extremes of the band are unlimited.^[7] Other central banks use similar mechanisms.

It is also notable that the target rates are generally short-term rates. The actual rate that borrowers and lenders receive on the market will depend on (perceived) credit risk, maturity and other factors. For example, a central bank might set a target rate for overnight lending of 4.5%, but rates for (equivalent risk) five-year bonds might be 5%, 4.75%, or, in cases of inverted yield curves, even below the short-term rate. Many central banks have one primary "headline" rate that is quoted as the "central bank rate". In practice, they will have other tools and rates that are used, but only one that is rigorously targeted and enforced.

"The rate at which the central bank lends money can indeed be chosen at will by the central bank; this is the rate that makes the financial headlines." – Henry C.K. Liu.^[8] Liu explains further that "the U.S. central-bank lending rate is known as the Fed funds rate. The Fed sets a target for the Fed funds rate, which its Open Market Committee tries to match by lending or borrowing in the money market ... a fiat money system set by command of the central bank. The Fed is the head of the central-bank because the U.S. dollar is the key reserve currency for international trade. The global money market is a USA dollar market. All other currencies markets revolve around the U.S. dollar market." Accordingly the U.S. situation is not typical of central banks in general.

A typical central bank has several interest rates or monetary policy tools it can set to influence markets.

Marginal lending rate (currently 1.5% in the Eurozone) – a fixed rate for institutions to borrow money from the central bank. (In the USA this is called the discount rate).
Main refinancing rate (0.75% in the Eurozone) – the publicly visible interest rate the central bank announces. It is also known as minimum bid rate and serves as a bidding floor for refinancing loans. (In the USA this is called the federal funds rate).
Deposit rate (0.00% in the Eurozone) – the rate parties receive for deposits at the central bank.

These rates directly affect the rates in the money market, the market for short term loans.

[edit]Open market operations

Through open market operations, a central bank influences the money supply in an economy directly. Each time it buyssecurities, exchanging money for the security, it raises the money supply. Conversely, selling of securities lowers the money supply. Buying of securities thus amounts to printing new money while lowering supply of the specific security.

The main open market operations are:

Temporary lending of money for collateral securities ("Reverse Operations" or "repurchase operations", otherwise known as the "repo" market). These operations are carried out on a regular basis, where fixed maturity loans (of one week and one month for the ECB) are auctioned off.
Buying or selling securities ("direct operations") on ad-hoc basis.
Foreign exchange operations such as forex swaps.

All of these interventions can also influence the foreign exchange market and thus the exchange rate. For example thePeople's Bank of China and the Bank of Japan have on occasion bought several hundred billions of U.S. Treasuries, presumably in order to stop the decline of the U.S. dollar versus the renminbi and the yen.

[edit]Capital requirements

All banks are required to hold a certain percentage of their assets as capital, a rate which may be established by the central bank or the banking supervisor. For international banks, including the 55 member central banks of the Bank for International Settlements, the threshold is 8% (see the Basel Capital Accords) of risk-adjusted assets, whereby certain assets (such as government bonds) are considered to have lower risk and are either partially or fully excluded from total assets for the purposes of calculating capital adequacy. Partly due to concerns about asset inflation and repurchase agreements, capital requirements may be considered more effective than reserve requirements in preventing indefinite lending: when at the threshold, a bank cannot extend another loan without acquiring further capital on its balance sheet.

[edit]Reserve requirements

Historically, bank reserves have formed only a small fraction of deposits, a system called fractional reserve banking. Banks would hold only a small percentage of their assets in the form of cash reserves as insurance against bank runs. Over time this process has been regulated and insured by central banks. Such legal reserve requirements were introduced in the 19th century as an attempt to reduce the risk of banks overextending themselves and suffering from bank runs, as this could lead to knock-on effects on other overextended banks. See also money multiplier.

As the early 20th century gold standard was undermined by inflation and the late 20th century fiat dollar hegemony evolved, and as banks proliferated and engaged in more complex transactions and were able to profit from dealings globally on a moment's notice, these practices became mandatory, if only to ensure that there was some limit on the ballooning of money supply. Such limits have become harder to enforce. The People's Bank of China retains (and uses) more powers over reserves because the yuan that it manages is a non-convertible currency.

Loan activity by banks plays a fundamental role in determining the money supply. The central-bank money after aggregate settlement – "final money" – can take only one of two forms:

physical cash, which is rarely used in wholesale financial markets,
central-bank money which is rarely used by the people

The currency component of the money supply is far smaller than the deposit component. Currency, bank reserves and institutional loan agreements together make up the monetary base, called M1, M2 and M3. The Federal Reserve Bank stopped publishing M3 and counting it as part of the money supply in 2006.^[9]

[edit]Exchange requirements

To influence the money supply, some central banks may require that some or all foreign exchange receipts (generally from exports) be exchanged for the local currency. The rate that is used to purchase local currency may be market-based or arbitrarily set by the bank. This tool is generally used in countries with non-convertible currencies or partially convertible currencies. The recipient of the local currency may be allowed to freely dispose of the funds, required to hold the funds with the central bank for some period of time, or allowed to use the funds subject to certain restrictions. In other cases, the ability to hold or use the foreign exchange may be otherwise limited.

In this method, money supply is increased by the central bank when it purchases the foreign currency by issuing (selling) the local currency. The central bank may subsequently reduce the money supply by various means, including selling bonds or foreign exchange interventions.

[edit]Margin requirements and other tools

In some countries, central banks may have other tools that work indirectly to limit lending practices and otherwise restrict or regulate capital markets. For example, a central bank may regulate margin lending, whereby individuals or companies may borrow against pledged securities. The margin requirement establishes a minimum ratio of the value of the securities to the amount borrowed.

Central banks often have requirements for the quality of assets that may be held by financial institutions; these requirements may act as a limit on the amount of risk and leverage created by the financial system. These requirements may be direct, such as requiring certain assets to bear certain minimum credit ratings, or indirect, by the central bank lending to counterparties only when security of a certain quality is pledged as collateral.

[edit]Banking supervision and other activities

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In some countries a central bank through its subsidiaries controls and monitors the banking sector. In other countries banking supervision is carried out by a government department such as the UK Treasury, or an independent government agency (for example, UK's Financial Services Authority). It examines the banks'balance sheets and behaviour and policies toward consumers. Apart from refinancing, it also provides banks with services such as transfer of funds, bank notes and coins or foreign currency. Thus it is often described as the "bank of banks".

Many countries such as the United States will monitor and control the banking sector through different agencies and for different purposes, although there is usually significant cooperation between the agencies. For example, money center banks, deposit-taking institutions, and other types of financial institutions may be subject to different (and occasionally overlapping) regulation. Some types of banking regulation may be delegated to other levels of government, such as state or provincial governments.

Any cartel of banks is particularly closely watched and controlled. Most countries control bank mergers and are wary of concentration in this industry due to the danger of groupthink and runaway lending bubbles based on a single point of failure, the credit culture of the few large banks.

[edit]Independence

Over the past decade, there has been a trend towards increasing the independence of central banks as a way of improving long-term economic performance. However, while a large volume of economic research has been done to define the relationship between central bank independence and economic performance, the results are ambiguous.

Advocates of central bank independence argue that a central bank which is too susceptible to political direction or pressure may encourage economic cycles ("boom and bust"), as politicians may be tempted to boost economic activity in advance of an election, to the detriment of the long-term health of the economy and the country. In this context, independence is usually defined as the central bank's operational and management independence from the government.

The literature on central bank independence has defined a number of types of independence.

Legal independence: The independence of the central bank is enshrined in law. This type of independence is limited in a democratic state; in almost all cases the central bank is accountable at some level to government officials, either through a government minister or directly to a legislature. Even defining degrees of legal independence has proven to be a challenge since legislation typically provides only a framework within which the government and the central bank work out their relationship.

Goal independence: The central bank has the right to set its own policy goals, whether inflation targeting, control of the money supply, or maintaining a fixed exchange rate. While this type of independence is more common, many central banks prefer to announce their policy goals in partnership with the appropriate government departments. This increases the transparency of the policy setting process and thereby increases the credibility of the goals chosen by providing assurance that they will not be changed without notice. In addition, the setting of common goals by the central bank and the government helps to avoid situations where monetary and fiscal policy are in conflict; a policy combination that is clearly sub-optimal.

Operational independence: The central bank has the independence to determine the best way of achieving its policy goals, including the types of instruments used and the timing of their use. This is the most common form of central bank independence. The granting of independence to the Bank of England in 1997 was, in fact, the granting of operational independence; the inflation target continued to be announced in the Chancellor's annual budget speech to Parliament.

Management independence: The central bank has the authority to run its own operations (appointing staff, setting budgets, and so on.) without excessive involvement of the government. The other forms of independence are not possible unless the central bank has a significant degree of management independence. One of the most common statistical indicators used in the literature as a proxy for central bank independence is the "turn-over-rate" of central bank governors. If a government is in the habit of appointing and replacing the governor frequently, it clearly has the capacity to micro-manage the central bank through its choice of governors.

It is argued that an independent central bank can run a more credible monetary policy, making market expectations more responsive to signals from the central bank. Recently, both the Bank of England (1997) and the European Central Bank have been made independent and follow a set of published inflation targets so that markets know what to expect. Even thePeople's Bank of China has been accorded great latitude due to the difficulty of problems it faces, though in the People's Republic of China the official role of the bank remains that of a national bank rather than a central bank, underlined by the official refusal to "unpeg" the yuan or to revalue it "under pressure". The People's Bank of China's independence can thus be read more as independence from the USA which rules the financial markets, than from the Communist Party of China which rules the country. The fact that the Communist Party is not elected also relieves the pressure to please people, increasing its independence.

Governments generally have some degree of influence over even "independent" central banks; the aim of independence is primarily to prevent short-term interference. For example, the chairman of the U.S. Federal Reserve Bank is appointed by thePresident of the U.S. (all nominees for this post are recommended by the owners of the Federal Reserve, as are all the board members), his choice must be confirmed by the Congress, and he must appear and testify before congress twice a year.

International organizations such as the World Bank, the Bank for International Settlements (BIS) and the International Monetary Fund (IMF) are strong supporters of central bank independence. This results, in part, from a belief in the intrinsic merits of increased independence. The support for independence from the international organizations also derives partly from the connection between increased independence for the central bank and increased transparency in the policy-making process. The IMF's Financial Services Action Plan (FSAP) review self-assessment, for example, includes a number of questions about central bank independence in the transparency section. An independent central bank will score higher in the review than one that is not independent.

[edit]See also

[edit]References

^ Sullivan, arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 254. ISBN 0-13-063085-3.
^ "central bank – Britannica Online Encyclopedia". britannica.com. Retrieved 2 November 2010.
^ "The Structure of the Federal Reserve System". federalreserveeducation.org. Retrieved 1 October 2010.
^ Quinn, Stephen; Roberds, William (2006), "An Economic Explanation of the Early Bank of Amsterdam, Debasement, Bills of Exchange, and the Emergence of the First Central Bank", Federal Reserve Bank of Atlanta, Working Paper 2006–13
^ History of Sveriges Riksbank
^ Bordo, M. (2007), "A Brief History of Central Banks", Federal Reserve Bank of Cleveland.
^ Bank of Canada backgrounder: Target for the Overnight Rate
^ Asia Times article explaining modern central bank function in detail
^ Reserve, Federal. "Fed stops publishing M3". press release. Federal Reserve Board. Retrieved 9 March 2006.

[edit]External links

List of central bank websites at the Bank for International Settlements
Central Bank Rates: worldwide rates, monetary meetings, central banks
Interactive map of all the central banks
International Journal of Central Banking
The Federal Reserve System: Purposes and Functions – A publication of the U.S. Federal Reserve, describing its role in the macroeconomy
The Eurosystem – Website of the European Central Bank describing the structure of the central banking system in theEurozone
A hundred ways to skin a cat: comparing monetary policy operating procedures in the United States, Japan and the euro areaPDF (176 KB) – C E V Borio, Bank for International Settlements, Basel
"Chairman Ben Bernanke Lecture Series Part 1" Recorded live on March 20, 2012 10:35am MST at a class at George Washington University

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The Federal Reserve System was created on December 23, 1913, when President Woodrow Wilson signed the Federal Reserve Act into law. The system is composed of a central, independent governmental agency--the Board of Governors--in Washington, D.C., and 12 regional Federal Reserve Banks, located in major cities throughout the nation. Today, the Federal Reserve sets the nation's monetary policy, supervises and regulates banking institutions, maintains the stability of the financial system, and provides financial services to depository institutions, the U.S. government, and foreign official institutions. Press Release Collections Inventory (PDF)

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The United States dollar (sign: $; code: USD; also abbreviated US$), also referred to as the U.S. dollar or American dollar, is the official currency of the United States of America and its overseas territories. It is divided into 100 smaller units called cents.

The U.S. dollar is the currency most used in international transactions and is one of the world's dominant reserve currencies.^[15] Several countries use it as their official currency, and in many others it is the de facto currency.^[16] It is also used as the sole currency in some British Overseas Territories, the British Virgin Islands and the Turks and Caicos islands.

[edit]Overview

The Constitution of the United States of America provides that the United States Congress shall have the power "To coin Money".^[17] Laws implementing this power are currently codified in Section 5112 of Title 31 of the United States Code. Section 5112 prescribes the forms in which the United States dollars shall be issued.^[18] Those coins are both designated in Section 5112 as "legal tender" in payment of debts.^[18] The Sacagawea dollar is one example of the copper alloy dollar. The pure silver dollar is known as the American Silver Eagle. Section 5112 also provides for the minting and issuance of other coins, which have values ranging from one cent to fifty dollars.^[18] These other coins are more fully described in Coins of the United States dollar.

The Constitution provides that "a regular Statement and Account of the Receipts and Expenditures of all public Money shall be published from time to time".^[19] That provision of the Constitution is made specific by Section 331 of Title 31 of the United States Code.^[20] The sums of money reported in the "Statements" are currently being expressed in U.S. dollars (for example, see the 2009 Financial Report of the United States Government).^[21] The U.S. dollar may therefore be described as the unit of account of the United States.

The word "dollar" is one of the words in the first paragraph of Section 9 of Article 1 of the U.S. Constitution. In that context, "dollars" is a reference to the Spanish milled dollar, a coin that had a monetary value of 8 Spanish units of currency, orreales. In 1792 the U.S. Congress adopted legislation titled An act establishing a mint, and regulating the Coins of the United States. Section 9 of that act authorized the production of various coins, including "DOLLARS OR UNITS—each to be of the value of a Spanish milled dollar as the same is now current, and to contain three hundred and seventy-one grains and four sixteenth parts of a grain of pure, or four hundred and sixteen grains of standard silver". Section 20 of the act provided, "That the money of account of the United States shall be expressed in dollars, or units... and that all accounts in the public offices and all proceedings in the courts of the United States shall be kept and had in conformity to this regulation". In other words, this act designated the United States dollar as the unit of currency of the United States.

The U.S. dollar bill uses the decimal system, consisting of 100 equal cents (symbol ¢). It is also officially divided into 1,000mills or ten dimes, while ten dollars is equal to an eagle. However, only cents are in everyday use as divisions of the dollar; "dime" is used solely as the name of the coin with the value of 10¢, while "eagle" and "mill" are largely unknown to the general public, though mills are sometimes used in matters of tax levies, and gasoline prices are usually in the form of $X.XX9 per gallon, e.g., $3.599, sometimes written as $3.59⁹⁄₁₀. When currently issued in circulating form, denominations equal to or less than a dollar are emitted as U.S. coinswhile denominations equal to or greater than a dollar are emitted as Federal Reserve notes (with the exception of gold, silver and platinum coins valued up to $100 as legal tender, but worth far more as bullion). Both one-dollar coins and notes are produced today, although the note form is significantly more common. In the past, "paper money" was occasionally issued in denominations less than a dollar (fractional currency) and gold coins were issued for circulation up to the value of $20 (known as the "double eagle," discontinued in the 1930s). The term eagle was used in the Coinage Act of 1792 for the denomination of ten dollars, and subsequently was used in naming gold coins. Paper currency less than one dollar in denomination, known as "fractional currency," was also sometimes pejoratively referred to as "shinplasters." In 1854, James Guthrie, then Secretary of the Treasury, proposed creating $100, $50 and $25 gold coins, which were referred to as a "Union," "Half Union," and "Quarter Union,"^[22] thus implying a denomination of 1 Union = $100.

Series of 1917 $1 United States bill

Today, USD notes are made from cotton fiber paper, unlike most common paper, which is made of wood fiber. U.S. coins are produced by the United States Mint. U.S. dollar banknotes are printed by the Bureau of Engraving and Printing and, since 1914, have been issued by the Federal Reserve. The "large-sized notes" issued before 1928 measured 7.42 inches (188 mm) by 3.125 inches (79.4 mm); small-sized notes, introduced that year, measure 6.14 inches (156 mm) by 2.61 inches (66 mm) by 0.0043 inches (0.11 mm). When the current, smaller sized U.S. currency was introduced it was referred to as Philippine-sized currency because the Philippines had previously adopted the same size for its legal currency.

[edit]Etymology

Further information: Dollar

In the 16th century, Count Hieronymus Schlick of Bohemia began minting coins known as Joachimstalers (from German thal, or nowadays usually Tal, "valley", cognate with "dale" in English), named for Joachimstal, the valley where the silver was mined (St. Joachim's Valley, now Jáchymov; then part of the Holy Roman Empire, now part of the Czech Republic).^[23] Joachimstaler was later shortened to the German Taler, a word that eventually found its way into Danish and Swedish as daler, Dutch as daalder, Ethiopian as ታላሪ (talari), Hungarian as tallér, Italian as tallero, and English as dollar.^[23] Alternatively, thaler is said to come from the German coin Guldengroschen ("great guilder", being of silver but equal in value to a gold guilder), minted from the silver from Joachimsthal.

[edit]Nicknames

The colloquialism "buck" (much like the British word "quid" for the pound sterling) is often used to refer to dollars of various nations, including the U.S. dollar. This term, dating to the 18th century, may have originated with the colonial fur trade.^[24] "Greenback" is another nickname originally applied specifically to the 19th century Demand Note dollars created by Abraham Lincoln to finance the costs of the Civil War for the North.^[25] The original note was printed in black and green on the back side. It is still used to refer to the U.S. dollar (but not to the dollars of other countries). Other well-known names of the dollar as a whole in denominations include "greenmail", "green" and "dead presidents" (the last because late presidents are pictured on some of the bills).

"Grand", sometimes shortened to simply "G", is a common term for the amount of $1,000. The suffix "K" or "k" (from "kilo-") is also commonly used to denote this amount (such as "$10k" to mean $10,000). In colloquial English, when someone refers to a "large" or "stack", it is usually a reference to an amount that is a multiple of $1,000 (such as "fifty large" meaning $50,000). Banknotes' nicknames are the same as their values (such as "five", "twenty" etc.) The $100 bill is nicknamed "Benjamin", "Benji" or "Franklin" (after Benjamin Franklin, who is pictured on the note), "C-note" (C being the Roman numeral for 100), "Century note" or "bill" (e.g. "two bills" being $200). The $20 bill has been referred to as "double sawbuck", "dub" or "Jackson" (after Andrew Jackson); the $10 bill—as "sawbuck", "ten-spot" or "Hamilton" (after Alexander Hamilton); the $5 bill—as "fin", "fiver" or "five-spot". The $2 bill is sometimes called "deuce", "Tom", "Jefferson" or "T.J." (after Thomas Jefferson); and the $1 bill—"single" or "buck". The dollar has also been referred to as a "bone" and "bones" in plural (e.g. "twenty bones" is equal to $20) or a "bean". The newer designs are sometimes referred to as "Bigface" bills or "Monopoly money". Some people refer to U.S. money as "cha-chingers", "bucks", "green-backs" and "smackers".

In French-speaking areas of Louisiana, the dollar is referred to as "piastre" (pronounced "pee-as") and the French holdover "sous" (pronounced "soo") is used to refer to the cent.

In El Salvador, the dollar can be referred to as "colón". Mainly because the country's previous currency was the Salvadoran colón.

In Panama, the equivalent of buck is "palo" (literally "stick").

In Ecuador, the dollar is referred to as "plata". (literally "silver").

In Peru, a nickname for the U.S. dollar is "coco", which is a pet name for Jorge ("George" in Spanish), a reference to the portrait of George Washington on the $1 note.

Puerto Ricans, both living in Puerto Rico and in the United States, may refer to the dollar as "peso".

In some places in Mexico, prices in U.S. dollars are referred to as "en americano" ("in American"), with the word "peso" used in Mexico primarily to refer to the Mexican peso.

Cubans call the U.S. dollar "fula". Loosely translated from Cuban jargon, it means bad or not good. American money was not bad to have or use by Cubans in the island, but its possession was penalized before the mid-1990s, hence the nickname. Cuban Americans colloquially may call them "pesos'.

[edit]Dollar sign

Main article: Dollar sign

Silver real of 1768

The symbol $, usually written before the numerical amount, is used for the U.S. dollar (as well as for many other currencies). The sign was the result of a late 18th-century evolution of the scribal abbreviation "p^s" for the peso. The p and the s eventually came to be written over each other giving rise to $.^[26]^[27]^[28]^[29]

Another popular explanation is that it comes from the Pillars of Hercules on the Spanish Coat of arms on the Spanish dollars that were minted in the New World mints in Mexico City, Potosí, Bolivia, and in Lima, Peru. These Pillars of Hercules on the silver Spanish dollar coins take the form of two vertical bars (||) and a swinging cloth band in the shape of an "S".

Yet another fictional explanation suggests that the dollar sign was formed from the capital letters U and S written or printed one on top of the other. This theory, popularized by novelist Ayn Rand in Atlas Shrugged,^[30] does not consider the fact that the symbol was already in use before the formation of the United States.^[31]

[edit]History

Obverse of rare 1934 $500 Federal Reserve Bill, featuring a portrait of President William McKinley.

Reverse of $500 Bill

The first dollar coins issued by the United States Mint (founded 1792) were similar in size and composition to the Spanish dollar. The Spanish, U.S. silver dollars, and Mexican silver pesos circulated side by side in the United States, and the Spanish dollar and Mexican peso remained legal tender until 1857. The coinage of various English colonies also circulated. The lion dollar was popular in the Dutch New Netherland Colony (New York), but the lion dollar also circulated throughout the English colonies during the 17th century and early 18th century. Examples circulating in the colonies were usually worn so that the design was not fully distinguishable, thus they were sometimes referred to as "dog dollars".^[32]

The U.S. dollar was created by the Constitution and defined by the Coinage Act of 1792. It specified a "dollar" to be based in the Spanish milled dollar and of 371 grains and 4 sixteenths part of a grain of pure or 416 grains (27.0 g) of standard silver and an "eagle" to be 247 and 4 eighths of a grain or 270 grains (17 g) of gold (again depending on purity)^[33] . The choice of the value 371 grains arose from Alexander Hamilton's decision to base the new American unit on the average weight of a selection of worn Spanish dollars. Hamilton got the treasury to weigh a sample of Spanish dollars and the average weight came out to be 371 grains. A new Spanish dollar was usually about 377 grains in weight, and so the new U.S. dollar was at a slight discount in relation to the Spanish dollar.

The Coinage Act of 1792 set the value of an eagle at 10 dollars, and the dollar at 1/10 eagle. It called for 90% silver alloy coins in denominations of 1, 1/2, 1/4, 1/10, and 1/20 dollars; it called for 90% gold alloy coins in denominations of 1, 1/2, 1/4, and 1/10 eagles.

The value of gold or silver contained in the dollar was then converted into relative value in the economy for the buying and selling of goods. This allowed the value of things to remain fairly constant over time, except for the influx and outflux of gold and silver in the nation's economy.

The early currency of the USA did not exhibit faces of presidents, as is the custom now. In fact, George Washington was against having his face on the currency, a practice he compared to the policies of European monarchs. The currency as we know it today did not get the faces they currently have until after the early 20th century; before that "heads" side of coinage used profile faces and striding, seated, and standing figures from Greek and Roman mythology and composite native Americans. The last coins to be converted to profiles of historic Americans were the dime (1946) and the Dollar (1971).

For articles on the currencies of the colonies and states, see Connecticut pound, Delaware pound, Georgia pound, Maryland pound, Massachusetts pound, New Hampshire pound,New Jersey pound, New York pound, North Carolina pound, Pennsylvania pound, Rhode Island pound, South Carolina pound and Virginia pound.

[edit]Continental currency

[edit]Silver and gold standards

From 1792, when the Mint Act was passed, the dollar was defined as 371.25 grains (24.056 g) of silver. Many historians erroneously assume gold was standardized at a fixed rate in parity with silver; however, there is no evidence of Congress making this law. This has to do with Alexander Hamilton's suggestion to Congress of a fixed 15:1 ratio of silver to gold, respectively. The gold coins that were minted however, were not given any denomination whatsoever and traded for a market value relative to the Congressional standard of the silver dollar. 1834 saw a shift in the gold standard to 23.2 grains (1.50 g), followed by a slight adjustment to 23.22 grains (1.505 g) in 1837 (16:1 ratio).

In 1862, paper money was issued without the backing of precious metals, due to the Civil War. Silver and gold coins continued to be issued and in 1878 the link between paper money and coins was reinstated. This disconnection from gold and silver backing also occurred during the War of 1812. The use of paper money not backed by precious metals had also occurred under the Articles of Confederation from 1777 to 1788. With no solid backing and being easily counterfeited, the continentals quickly lost their value, giving rise to the phrase "not worth a continental". This was a primary reason for the "No state shall... make any thing but gold and silver coin a tender in payment of debts" clause in article 1, section 10 of the United States Constitution.

The Gold Standard Act of 1900 abandoned the bimetallic standard and defined the dollar as 23.22 grains (1.505 g) of gold, equivalent to setting the price of 1 troy ounce of gold at $20.67. Silver coins continued to be issued for circulation until 1964, when all silver was removed from dimes and quarters, and the half dollar was reduced to 40% silver. Silver half dollars were last issued for circulation in 1970.

Gold coins were confiscated by Executive Order 6102 issued in 1933 by Franklin Roosevelt. The gold standard was changed to 13.71 grains (0.888 g), equivalent to setting the price of 1 troy ounce of gold at $35. This standard persisted until 1968. Between 1968 and 1975, a variety of pegs to gold were put in place. The price was at $42.22 per ounce before August 15, 1971 saw the U.S. dollar freely float on currency markets.

According to the Bureau of Engraving and Printing, the largest note it ever printed was the $100,000 Gold Certificate, Series 1934. These notes were printed from December 18, 1934 through January 9, 1935, and were issued by the Treasurer of the United States to Federal Reserve Banks only against an equal amount of gold bullion held by the Treasury. These notes were used for transactions between Federal Reserve Banks and were not circulated among the general public.

[edit]Coins

Main article: Coins of the United States dollar

Official United States coins have been produced every year from 1792 to the present.

Half-cent 1792–1857
Cent (Penny) 1793–present
2-cent 1864–1873
3-cent 1851–1889
Half Dime, or half disme 1792–1873 (Not to be confused with the Five-cent Nickel below)
Five-cent Nickel 1866–present
Dime 1792–present
20-cent 1875–1878
Quarter 1796–present
Half dollar 1794–present
Dollar coin 1794–present
Quarter Eagle ($2.50 gold coin) 1792–1929
Three-dollar piece 1854–1889 (gold coin)
Four-dollar piece 1879–1880 (gold coin)
Half Eagle ($5 gold coin) 1795–1929
Eagle ($10 gold coin) 1795–1933
Double Eagle ($20 gold coin) 1850–1933

Collector coins for which everyday transactions are non-existent.^[34]

American Eagles originally were not available from the Mint for individuals but had to be purchased from authorized dealers. In 2006 The Mint began direct sales to individuals of uncirculated bullion coins with a special finish, and bearing a "W" mintmark.
- American Silver Eagle $1 (1 troy ounce) silver bullion coin 1986–present
- American Gold Eagle $5 (1/10 troy oz), $10 (1/4 troy oz), $25 (1/2 troy oz), and $50 (1 troy oz) Gold bullion coin 1986–present
- American Platinum Eagle ($10, $25, $50, and $100 platinum coin) 1997–present

United States commemorative coins—special issue coins
- $50.00 (Half Union) 1915
- Presidential Proofs (see below) 2007–present

Technically, all these coins are still legal tender at face value, though some are far more valuable today for their numismatic value, and for gold and silver coins, their precious metal value. From 1965 to 1970 the Kennedy half dollar was the only circulating coin with any silver content though the Mint still makes what it calls Silver Proof sets for collectors.

In addition, an experimental $4.00 (Stella) coin was also minted, but never placed into circulation and is properly considered to be a pattern rather than an actual coin denomination.

The $50 coin mentioned was only produced in 1915 for the Panama-Pacific International Exposition (1915) celebrating the opening of the Panama Canal. Only 1,128 were made, 645 of which were octagonal; this remains the only U.S. coin that was not round as well as the largest and heaviest U.S. coin ever.

From 1934 to present the only denominations produced for circulation have been the familiar penny, nickel, dime, quarter, half dollar and dollar. The nickel is the only coin still in use today that is essentially unchanged (except in its design) from its original version. Every year since 1866, the nickel has been 75% copper and 25% nickel, except for 4 years during World War II when nickel was needed for the war.

[edit]Collector coins

The United States Mint produces Proof Sets specifically for collectors and speculators. Silver Proofs tend to be the standard designs but with the dime, quarter, half dollar, and in some cases the dollar having silver content. Another type of proof set is the Presidential Dollar Proof Set where four special $1 coins are minted each featuring a president.

2007 had George Washington, John Adams, Thomas Jefferson, and James Madison
2008 had James Monroe, John Quincy Adams, Andrew Jackson, and Martin Van Buren
2009 had William Henry Harrison, John Tyler, James K. Polk, and Zachary Taylor
2010 had Millard Fillmore, Franklin Pierce, James Buchanan, and Abraham Lincoln
2011 had Andrew Johnson, Ulysses S. Grant, Rutherford B. Hayes, and James A. Garfield

[edit]Dollar coins

The first United States dollar was minted in 1794. Known as the Flowing Hair Dollar, it contained 416 grains of "standard silver" (89.25% silver and 10.75% copper), as specified by Section 13^[35] of the Coinage Act of 1792. It was designated by Section 9 of that Act as having "the value of a Spanish milled dollar".

Flowing Hair Dollar

Dollar coins have not been very popular in the United States.^[36] Silver dollars were minted intermittently from 1794 through 1935; a copper-nickel dollar of the same large size, featuring President Dwight D. Eisenhower, was minted from 1971 through 1978. Gold dollars were also minted in the 19th century. The Susan B. Anthony dollar coin was introduced in 1979; these proved to be unpopular because they were often mistaken for quarters, due to their nearly equal size, their milled edge, and their similar color. Minting of these dollars for circulation was suspended in 1980 (collectors' pieces were struck in 1981), but, as with all past U.S. coins, they remain legal tender. As the number of Anthony dollars held by the Federal Reserve and dispensed primarily to make change in postal and transit vending machines had been virtually exhausted, additional Anthony dollars were struck in 1999. In 2000, a new $1 coin, featuring Sacagawea, (the Sacagawea dollar) was introduced, which corrected some of the mistakes of the Anthony dollar by having a smooth edge and a gold color, without requiring changes to vending machines that accept the Anthony dollar. However, this new coin has failed to achieve the popularity of the still-existing $1 bill and is rarely used in daily transactions. The failure to simultaneously withdraw the dollar bill and weak publicity efforts have been cited by coin proponents as primary reasons for the failure of the dollar coin to gain popular support.^[37]

In February 2007, the U.S. Mint, under the Presidential $1 Coin Act of 2005,^[38] introduced a new $1 U.S. Presidential dollar coin. Based on the success of the "50 State Quarters" series, the new coin features a sequence of presidents in order of their inaugurations, starting with George Washington, on the obverse side. The reverse side features the Statue of Liberty. To allow for larger, more detailed portraits, the traditional inscriptions of "E Pluribus Unum", "In God We Trust", the year of minting or issuance, and the mint mark will be inscribed on the edge of the coin instead of the face. This feature, similar to the edge inscriptions seen on the British £1 coin, is not usually associated with U.S. coin designs. The inscription "Liberty" has been eliminated, with the Statue of Liberty serving as a sufficient replacement. In addition, due to the nature of U.S. coins, this will be the first time there will be circulating U.S. coins of different denominations with the same president featured on the obverse (heads) side (Lincoln/penny, Jefferson/nickel, Franklin D. Roosevelt/dime,Washington/quarter and Kennedy/half dollar/dollar). Another unusual fact about the new $1 coin is Grover Cleveland will have two coins with his portrait issued due to the fact he was the only U.S. President to be elected to two non-consecutive terms.^[39]

Early releases of the Washington coin included error coins shipped primarily from the Philadelphia mint to Florida and Tennessee banks. Highly sought after by collectors, and trading for as much as $850 each within a week of discovery, the error coins were identified by the absence of the edge impressions "E PLURIBUS UNUM IN GOD WE TRUST 2007 P". The mint of origin is generally accepted to be mostly Philadelphia, although identifying the source mint is impossible without opening a mint pack also containing marked units. Edge lettering is minted in both orientations with respect to "heads", some amateur collectors were initially duped into buying "upside down lettering error" coins.^[40] Some cynics also erroneously point out that the Federal Reserve makes more profit from dollar bills than dollar coins because they wear out in a few years, whereas coins are more permanent. The fallacy of this argument arises because new notes printed to replace worn out notes which have been withdrawn from circulation bring in no net revenue to the government to offset the costs of printing new notes and destroying the old ones. As most vending machines are incapable of making change in banknotes, they commonly accept only $1 bills, though a few will give change in dollar coins.

[edit]Mint marks

Most U.S. coins bear a mint mark as part of the design, usually found on the front of the coin near the date although in the past it was more commonly found on the reverse. ThePhiladelphia Mint issues coins bearing a letter P (or no mark at all), while the Denver Mint uses a letter D. The San Francisco Mint uses an S, though no coins have been released from that mint for general circulation since 1980. It does, however, continue to strike proof coins for collectors. The West Point Mint uses a W, though this is rarely seen as the West Point mint generally only makes high denomination coins (with face values over $1.00) which are not meant for everyday use. A CC mark, for the Carson City Mint, was used from 1870 to 1893, but the mint at that location was only a temporary establishment. The New Orleans Mint used a mint mark O. It operated from 1838 until Louisiana seceded from the Union in 1861, and again from 1879 to 1909. The letter D was also used for coinage of the Dahlonega Mint from 1837 to 1861, and C was used for the Charlotte Mint during the same timespan. The latter two mints struck gold coins only.

[edit]Banknotes

Main article: Federal Reserve Note

The U.S. Constitution provides that Congress shall have the power to "borrow money on the credit of the United States".^[41] Congress has exercised that power by authorizing Federal Reserve Banks to issue Federal Reserve Notes. Those notes are "obligations of the United States" and "shall be redeemed in lawful money on demand at the Treasury Department of the United States, in the city of Washington, District of Columbia, or at any Federal Reserve bank."^[42] Federal Reserve Notes are designated by law as "legal tender" for the payment of debts.^[43] Congress has also authorized the issuance of more than 10 other types of banknotes, including the United States Note^[44] and the Federal Reserve Bank Note. The Federal Reserve Note is the only type that remains in circulation since the 1970s.

Currently printed denominations are $1, $2, $5, $10, $20, $50, and $100. Notes above the $100 denomination stopped being printed in 1946 and were officially withdrawn from circulation in 1969. These notes were used primarily in inter-bank transactions or by organized crime; it was the latter usage that prompted President Richard Nixon to issue an executive order in 1969 halting their use. With the advent of electronic banking, they became less necessary. Notes in denominations of $500, $1,000, $5,000, $10,000, and $100,000 were all produced at one time; see large denomination bills in U.S. currency for details. These notes are now collector's items and are worth more than their face value to collectors.

Though still predominantly green, post-2004 series incorporate other colors to better distinguish different denominations. As a result of a 2008 decision in an accessibility lawsuit filed by the American Council of the Blind, the Bureau of Engraving and Printing is planning to implement a raised tactile feature in the next redesign of each note, except the $1 and the version of the $100 bill already in process. It also plans larger, higher-contrast numerals, more color differences, and distribution of currency readers to assist the visually impaired during the transition period.^[45]

[edit]Means of issue

Currently, the US government maintains over 800 billion US dollars in cash money (primarily Federal Reserve Notes) in circulation.^[46]^[47] The amount of cash in circulation is increased (or decreased) by the actions of the Federal Reserve System. Eight times a year, the 12-person Federal Open Market Committee meet to determine US monetary policy.^[48] Every business day, the Federal Reserve System engages in Open market operations to carry out that monetary policy.^[49] If the Federal Reserve desires to increase the money supply, it will buy securities (such as US Treasury Bonds) anonymously from banks in exchange for dollars. Conversely, it will sell securities to the banks in exchange for dollars, to take dollars out of circulation.^[50]

When the Federal Reserve makes a purchase, it credits the seller's reserve account (with the Federal Reserve). This money is not transferred from any existing funds—it is at this point that the Federal Reserve has created new high-powered money. Commercial banks can freely withdraw in cash any excess reserves from their reserve account at the Federal Reserve. To fulfill those requests, the Federal Reserve places an order for printed money from the US Treasury Department.^[51] The Treasury Department in turn sends these requests to the Bureau of Engraving and Printing (to print new dollar bills) and the Bureau of the Mint (to stamp the coins).

Usually, the short term goal of open market operations is to achieve a specific short term interest rate target. In other instances, monetary policy might instead entail the targeting of a specific exchange rate relative to some foreign currency or else relative to gold. For example, in the case of the USA the Federal Reserve targets the federal funds rate, the rate at which member banks lend to one another overnight. The other primary means of conducting monetary policy include: (i) Discount window lending (as lender of last resort); (ii) Fractional deposit lending (changes in the reserve requirement); (iii) Moral suasion (cajoling certain market players to achieve specified outcomes); (iv) "Open mouth operations" (talking monetary policy with the market).

[edit]Value

Buying power of one U.S. dollar compared to 1774 USD

Year	Equivalent buying power
1774	$1.00
1780	$0.59
1790	$0.89
1800	$0.64
1810	$0.66
1820	$0.69
1830	$0.88
1840	$0.94
1850	$1.03
1860	$0.97

Year	Equivalent buying power
1870	$0.62
1880	$0.79
1890	$0.89
1900	$0.96
1910	$0.85
1920	$0.39
1930	$0.47
1940	$0.56
1950	$0.33
1960	$0.26

Year	Equivalent buying power
1970	$0.20
1980	$0.10
1990	$0.06
2000	$0.05
2007	$0.04
2008	$0.04
2009	$0.04
2010	$0.03

U.S. Consumer Price Index 1913–2006

The 5th paragraph of Section 8 of Article 1 of the U.S. Constitution provides that the U.S. Congress shall have the power to "coin money" and to "regulate the value" of domestic and foreign coins. Congress exercised those powers when it enacted the Coinage Act of 1792. That Act provided for the minting of the first U.S. dollar and it declared that the U.S. dollar shall have "the value of a Spanish milled dollar as the same is now current".^[52]

The table to the right shows the equivalent amount of goods that, in a particular year, could be purchased with $1. The table shows that from 1774 through 2009 the U.S. dollar has lost about 96.4% of its buying power.^[53]

The decline in the value of the U.S. dollar corresponds to price inflation, which is a rise in the general level of prices of goods and services in an economy over a period of time.^[54] A consumer price index (CPI) is a measure estimating the average price of consumer goods and services purchased by households. The United States Consumer Price Index, published by the Bureau of Labor Statistics, is a measure estimating the average price of consumer goods and services in the United States.^[55] It reflects inflation as experienced by consumers in their day-to-day living expenses.^[56] A graph showing the U.S. CPI relative to 1982–1984 and the annual year-over-year change in CPI is shown at right.

The value of the U.S. dollar declined significantly during wartime, especially during the American Civil War, World War I, and World War II.^[57] The Federal Reserve, which was established in 1913, was designed to furnish an "elastic" currency subject to "substantial changes of quantity over short periods," which differed significantly from previous forms of high-powered money such as gold, national bank notes, and silver coins.^[58] Over the very long run, the prior gold standard kept prices stable—for instance, the price level and the value of the U.S. dollar in 1914 was not very different from the price level in the 1880s. The Federal Reserve initially succeeded in maintaining the value of the U.S. dollar and price stability, reversing the inflation caused by the First World War and stabilizing the value of the dollar during the 1920s, before presiding over a 30% deflation in U.S. prices in the 1930s.^[59]

Under the Bretton Woods system established after World War II, the value of the U.S. dollar was fixed to $35 per ounce, and the value of the U.S. dollar was thus anchored to the value of gold. Rising government spending in the 1960s, however, led to doubts about the ability of the United States to maintain this convertibility, gold stocks dwindled as banks and international investors began to convert dollars to gold, and as a result the value of the dollar began to decline. Facing an emerging currency crisis and the imminent danger that the United States would no longer be able to redeem dollars for gold, gold convertibility was finally terminated in 1971 by President Nixon, resulting in the "Nixon shock."^[60]

The value of the U.S. dollar was therefore no longer anchored to gold, and it fell upon the Federal Reserve to maintain the value of the U.S. currency. The Federal Reserve, however, continued to increase the money supply, resulting in stagflation and a rapidly declining value of the U.S. dollar in the 1970s. This was largely due to the prevailing economic view at the time that inflation and real economic growth were linked (the Phillips curve), and so inflation was regarded as relatively benign.^[60] Between 1965 and 1981, the U.S. dollar lost two thirds of its value.^[53]

In 1979, President Carter appointed Paul Volcker Chairman of the Federal Reserve. The Federal Reserve tightened the money supply and inflation was substantially lower in the 1980s, and hence the value of the U.S. dollar stabilized.^[60]

Over the thirty-year period from 1981 to 2009, the U.S. dollar lost over half its value.^[53] This is because the Federal Reserve has targeted not zero inflation, but a low, stable rate of inflation—between 1987 and 1997, the rate of inflation was approximately 3.5%, and between 1997 and 2007 it was approximately 2%. The so-called "Great Moderation" of economic conditions since the 1970s is credited to monetary policy targeting price stability.^[60]

There is ongoing debate about whether central banks should target zero inflation (which would mean a constant value for the U.S. dollar over time) or low, stable inflation (which would mean a continuously but slowly declining value of the dollar over time, as is the case now). Although some economists are in favor of a zero inflation policy and therefore a constant value for the U.S. dollar,^[59] others contend that such a policy limits the ability of the central bank to control interest rates and stimulate the economy when needed.^[61]

[edit]Exchange rates

Current exchange rates

Current USD exchange rates
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From fxtop.com:	AUD CAD CHF EUR GBP HKD JPY RUB INR CNY

[edit]See also

	Government of the United States portal
	Numismatics portal

[edit]References

^ U.S. Dollar and Pakistani rupee are widely accepted.
^ Bahamian dollar tied 1:1 to USD, both accepted interchangeably.
^ Barbados dollar tied at about 2:1, both accepted. Visiting Barbados FAQ: What is the local currency?, Invest Barbados
^ Alongside Cambodian Riel
^ Alongside East Timor centavo coins
^ U.S. dollar is widely used alongside the Lebanese Pound at a fixed exchange rate of 1:1,500
^ Alongside Zimbabwean dollar (suspended indefinitely from April 12, 2009), Euro, Pound Sterling, South African rand and Botswana pula. The U.S. Dollar has been adopted as the official currency for all government transactions.
^ Alongside Bermudian dollar
^ FCO country profile
^ http://wwp.greenwichmeantime.com/time-zone/asia/british-indian-ocean-territory/currency-british-indian-ocean-territory/index.htm
^ "El Salvador". CIA World Factbook. October 21, 2010. Retrieved October 27, 2010. "The US dollar became El Salvador's currency in 2001"
^ Alongside Panamanian balboa coins
^ "Ecuador". CIA World Factbook. October 18, 2010. Retrieved October 27, 2010. "The dollar is legal tender"
^ "Frequently asked questions". Retrieved January 1, 2011.
^ "The Implementation of Monetary Policy – The Federal Reserve in the International Sphere" (PDF). Retrieved August 24, 2010.
^ Benjamin J. Cohen, The Future of Money, Princeton University Press, 2006,ISBN 0-691-11666-0; cf. "the dollar is the de facto currency in Cambodia", Charles Agar, Frommer's Vietnam, 2006, ISBN 0-471-79816-9, p. 17
^ "Paragraph 5 of Section 8 of Article 1 of the Constitution of the United States of America". Topics.law.cornell.edu. Retrieved August 24, 2010.
^ ^a ^b ^c "Section 5112 of Title 31 of the United States Code". Retrieved March 16, 2010.
^ "Paragraph 7 of Section 9 of Article 1 of the Constitution of the United States of America". Topics.law.cornell.edu. Retrieved August 24, 2010.
^ "Section 331 of Title 31 of the United States Code". Law.cornell.edu. August 6, 2010. Retrieved August 24, 2010.
^ "2009 Financial Report of the United States Government" (PDF). Retrieved August 24, 2010.
^ Mehl, B. Max. "United States $50.00 Gold Pieces, 1877", in Star Rare Coins Encyclopedia and Premium Catalogue (20th edition, 1921)
^ ^a ^b National Geographic. June 2002. p. 1. Ask Us.
^ "Buck". Online Etymology Dictionary. Retrieved November 10, 2011.
^ "Paper Money Glossary". Littleton Coin Company. Retrieved November 7, 2011.
^ Cajori, Florian ([1929]1993). A History of Mathematical Notations (Vol. 2). New York: Dover, 15–29. ISBN 0-486-67766-4
^ Aiton, Arthur S. and Benjamin W. Wheeler (May 1931). "The First American Mint", The Hispanic American Historical Review 11 (2), 198 and note 2 on 198.
^ Nussbaum, Arthur (1957). A History of the Dollar. New York: Columbia University Press. p. 56. "The dollar sign, $, is connected with the peso, contrary to popular belief, which considers it to be an abbreviation of 'U.S.' The two parallel lines represented one of the many abbreviations of 'P,' and the 'S' indicated the plural. The abbreviation '$.' was also used for the peso, and is still used in Argentina."
^ "What is the origin of the $ Sign?", US Bureau of Engraving and Printing website
^ Rand, Ayn. Atlas Shrugged. 1957. Signet. 1992. p628
^ James, James Alton (1970) [1937]. Oliver Pollock: The Life and Times of an Unknown Patriot. Freeport: Books for Libraries Press. p. 356. ISBN 978-0-8369-5527-9.
^ "The Lion Dollar: Introduction". Coins.nd.edu. Retrieved August 24, 2010.
^ Mint, U.S.. "Coinage Act of 1792". U.S. treasury.
^ "IRS Court Case Shakes the Foundations of the Debt Money System". Beyondmoney.net. November 8, 2007. Retrieved August 24, 2010.
^ "Section 13 of the Coinage Act of 1792". Memory.loc.gov. Retrieved August 24, 2010.
^ CNN Money Congress tries again for a dollar coin. Written by Gordon T. Anderson. Published April 25, 2005.
^ http://www.gao.gov/new.items/d02896.pdf
^ Pub. L. No. 109-145, 119 Stat. 2664 (December 22, 2005).
^ The United States Mint. "The United States Mint Pressroom". Usmint.com. Retrieved August 24, 2010.
^ Godless Dollars
^ "Paragraph 2 of Section 8 of Article 1 of the United States Constitution". Topics.law.cornell.edu. Retrieved August 24, 2010.
^ "Section 411 of Title 12 of the United States Code". Law.cornell.edu. June 22, 2010. Retrieved August 24, 2010.
^ "Section 5103 of Title 31 of the United States Code". Law.cornell.edu. August 6, 2010. Retrieved August 24, 2010.
^ "Section 5115 of Title 31 of the United States Code". Law.cornell.edu. August 6, 2010. Retrieved August 24, 2010.
^ See Federal Reserve Note for details and references
^ "How Currency Gets into Circulation". Federal Reserve Bank of New York. Retrieved January 6, 2008.
^ "Money Stock Measures". Federal Reserve, Board of Governors. Retrieved January 6, 2008.
^ "The Federal Reserve's Beige Book". The Federal Reserve Bank of Minneapolis. Retrieved January 6, 2008.
^ Davies, Phil. "Right on Target". Retrieved January 7, 2008. "Federal Reserve Bank of Minneapolis"
^ "Open Market Operations". Federal Reserve Bank of Mew York. Retrieved January 11, 2008. "Open market operations enable the Federal Reserve to affect the supply of reserve balances in the banking system."
^ "Fact Sheets: Currency & Coins". United States Department of the Treasury. Retrieved January 22, 2008.
^ "Section 9 of the Coinage Act of 1792". Memory.loc.gov. Retrieved August 24, 2010.
^ ^a ^b ^c "Measuring Worth – Purchasing Power of Money in the United States from 1774 to 2010". Retrieved April 22, 2010.
^ Oliver Blanchard (2000). Macroeconomics (2nd ed.), Englewood Cliffs, N.J: Prentice Hall, ISBN 0-13-013306-X
^ "Consumer Price Index Frequently Asked Questions". Retrieved July 17, 2010.
^ "Consumer Price Index Frequently Asked Questions". Retrieved July 17, 2010.
^ Milton Friedman, Anna Jacobson Schwartz. A monetary history of the United States, 1867–1960. p. 546. ISBN B000OL2K26.
^ Friedman 189–190
^ ^a ^b "Central Banking—Then and Now". Retrieved July 17, 2010.
^ ^a ^b ^c ^d "Controlling Inflation: A Historical Perspective". Retrieved July 17, 2010.
^ "U.S. Monetary Policy: The Fed's Goals". Retrieved July 17, 2010.
^ "FRB: G.5A Release- Foreign Exchange Rates, Release Dates". Federalreserve.gov. Retrieved August 24, 2010.
^ ^a ^b 1970–1992. 1980 derived from AUD-USD=1.1055 and AUD-GBP=0.4957 at end of Dec 1979: 0.4957/1.1055=0.448394392; 1985 derived from AUD-USD=0.8278 and AUD-GBP=0.7130 at end of Dec 1984: 0.7130/0.8278=0.861319159
^ "Exchange Rates Between the United States Dollar and the South African Rand". Measuring Worth. Retrieved December 5, 2011.

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Links to related articles

State	Value of Dollar in State Currency
Georgia	5 Shillings
Connecticut, Massachusetts, New Hampshire, Rhode Island, Virginia	6 Shillings
Delaware, Maryland, New Jersey, Pennsylvania	7½ Shillings
New York, North Carolina	8 Shillings
South Carolina	32½ Shillings