High Inflation Economies Research Articles

Inflation, Output, and Stabilization in a High Inflation Economy: Turkey, 1980-2000

This paper surveys and examines the sources of fluctuations in inflation and output in Turkey. Using a dynamic open economy aggregate supply - aggregate demand model with imperfect capital mobility and structural vector-autoregressions, the authors consider real oil price, supply, balance of payments, real demand, and monetary disturbances. Empirical results indicate that inflation is driven by monetary and real demand disturbances while output is mainly driven by aggregate supply disturbances. The historical decomposition shows that a substantial portion of inflation is aggregate demand-driven core inflation. A credible disinflation program accompanied by structural reform is likely to stabilize the economy with little output costs.

The impact of inflation on financial sector performance

A growing theoretical literature describes mechanisms whereby even predictable increases in the rate of inflation interfere with the ability of the financial sector to allocate resources effectively. This paper empirically assesses these predictions. The evidence indicates that there is a significant, and economically important, negative relationship between inflation and both banking sector development and equity market activity. Further, the relationship is nonlinear. As inflation rises, the marginal impact of inflation on banking lending activity and stock market development diminishes rapidly. Moreover, we find evidence of thresholds. For economies with inflation rates exceeding 15 percent, there is a discrete drop in financial sector performance. Finally, while the data indicate that more inflation is not matched by greater nominal equity returns in low-inflation countries, nominal stock returns move essentially one-for-one with marginal increases in inflation in high-inflation economies.

Endogenous Price Stickiness and Business Cycle Persistence

Both imperfect information and sticky prices allow nominal shocks to act as business cycle impulses, but only sticky prices propagate the real effects of nominal shocks. A simple model of imperfect information and sticky prices developed herein indicates that high rates of inflation lead to less price stickiness, and hence less persistent output fluctuations. Estimation of the model, as well as simple autocorrelations of real output, indicate that indeed output fluctuations are less persistent in high inflation economies. These results lend little support to models in which output persistence is explained through persistent real shocks, capital accumulation, or adjustment costs.

Non‐Linear Dynamics of Inflation in High Inflation Economies

Attempts by governments to finance a substantial proportion of expenditure by seigniorage can lead to multiple inflationary equilibria. Theoretical models suggest that, in these circumstances, inflation follows a non‐linear process with up to three steady states and that the stability characteristics of these depend on the process by which expectations are formed. In this paper we show that the exponential smooth transition autoregression (ESTAR) model is capable of exhibiting the required characteristics and so provides a suitable vehicle for analysing inflation in high inflation economies. We estimate ESTAR models for three well‐known inflationary episodes—the German hyperinflation of the early 1920s and post‐Second World War inflations in Argentina and Brazil. Our results imply that, during the periods in question, each of these economies possessed a stable low‐level equilibrium rate of inflation but that the variances of inflation shocks were large enough to drive each economy into a high inflation state. For Brazil, this high inflation state is stable around a particular value but in the cases of Argentina and Germany the high inflation state is characterized by inflation cycles.

Inflation and asset returns

Sustained inflation is detrimental to long-run growth and the financial system. A recent theoretical literature suggests that high inflation implies low real returns on assets. These low returns exacerbate informational frictions, interfering with the functioning of financial markets and the allocation of investment. We investigate the plausibility of an inverse relationship between inflation and real returns. Inflation and nominal equity returns are negatively correlated or uncorrelated for all low-to-moderate inflation economies examined. Safe nominal rates of return and inflation are only weakly positively correlated. However, for high inflation economies inflation and nominal returns are strongly positively correlated.

Long-Run Exchange Rate Dynamics: A Panel Data Study

Long-run movements of real exchange rates are studied using a panel data set comprising 51 economies. The purchasing power parity hypothesis (PPP) is examined first using unit root tests. It is found that PPP does not hold for the full sample of countries, but it may hold for the advanced economies, as well as open and high-inflation economies. Using the recently developed mean group and pooled mean group estimators, the paper finds support for the Balassa-Samuelson hypothesis in both advanced and developing economies; and for the influence of shifts in the terms of trade.

Long-Run Exchange Rate Dynamics: A Panel Data Study

Long-run movements of real exchange rates are studied using a panel data set comprising 51 economies. The purchasing power parity hypothesis (PPP) is examined first using unit root tests. It is found that PPP does not hold for the full sample of countries, but it may hold for the advanced economies, as well as open and high-inflation economies. Using the recently developed mean group and pooled mean group estimators, the paper finds support for the Balassa-Samuelson hypothesis in both advanced and developing economies; and for the influence of shifts in the terms of trade.

Political stabilization cycles in high-inflation economies

High-inflation economies often exhibit stop–go cycles of inflation, rather than smooth inflationary processes. This paper relates these stop–go episodes of inflation to a political cycle: the government can try to repress inflation until after the elections in order to increase the chances of being reelected. This is modeled as a two-period game of incomplete information where voters try to pick the most competent government, and inflation (which signals lack of competency) can be lowered by the government in the short run through foreign debt accumulation. Several stabilization episodes, such as the Primavera Plan in Argentina and the Cruzado Plan in Brazil, are used to motivate the model.

GMM estimation of currency substitution in a high-inflation economy: evidence from Turkey

This paper shows that currency substitution is a first-order importance in a high inflation economy like Turkey. A money-in-the-utility function model is estimated and tested using Hansen's Generalized Method of Moments procedure. The results show that elasticity of substitution between the Turkish Lira and the US dollar is high and statistically significant. The estimate of the share of foreign balances in producing domestic money services is considerably large and statistically significant.

THE CYCLICAL BEHAVIOR OF PRICES: EVIDENCE FROM SEVEN DEVELOPING COUNTRIES

NE of the stylized facts that characterize an economy over the business cycle is the movement of prices with real output. In the literature on the demand and real theories of business cycles, the two main theories state that if movements of output result from demand shocks, prices are expected to be procyclical; by contrast, if shocks originate from the supply side then prices are expected to be countercyclical. Lucas provided evidence in support of a positive correlation between prices and real output [24][25]. Olson also argues that newclassical as well as Keynesian economics agree on the positive correlation between the variables in relevance [28]. The same holds in Mankiw [26]. Cooley and Ohanian confirm the price countercyclicality for the United States [11], and Backus and Kehoe confirm it for other countries [1]. By contrast, other studies have reached the opposite conclusions (Bernanke [2]). The pioneering works of Kydland and Prescott [20] and Long and Plosser [23] initiated an attempt to explain certain stylized facts of U.S. business cycle behavior. This attempt—the so-called real business cycle theory—considered that what is responsible for the presence of business cycle phenomena are exogenous technological shocks and the accompanying propagation mechanism generated by the behavior of economic agents to optimize their behavior within an environment characterized by rational expectations and market-clearing conditions. These business cycle models attempt to explain the fluctuations in macroeconomic aggregates via the technological or any other “real” channel supporting the presence of an inverse relationship between prices and output. Mankiw has criticized real business cycle models on the grounds that they show that prices are not procyclical [26]. Countercyclicality of prices connotes that prices and output are negatively correlated. Moreover, the countercyclical behavior of prices suggests that real output

Endogenous Price Stickiness and Business Cycle Persistence

Both imperfect information and sticky prices allow nominal shocks to act as business cycle impulses, but only sticky prices propagate the real effects of nominal shocks. A simple model of imperfect information and sticky prices developed herein indicates that high rates of inflation lead to less price stickiness, and hence less persistent output fluctuations. Estimation of the model, as well as simple autocorrelations of real output, indicate that indeed output fluctuations are less persistent in high inflation economies. These results lend little support to models in which output persistence is explained through persistent real shocks, capital accumulation, or adjustment costs.

Analysing inflation by the fractionally integrated ARFIMA-GARCH model

This paper considers the application of long-memory processes to describing inflation for 10 countries. We implement a new procedure to obtain approximate maximum likelihood estimates of an ARFIMA-GARCH process; which is fractionally integrated I(d) with a superimposed stationary ARMA component in its conditional mean. Additionally, this long-memory process is allowed to have GARCH type conditional heteroscedasticity. On analysing monthly post-World War II CPI inflation for 10 different countries, we find strong evidence of long memory with mean reverting behaviour for all countries except Japan, which appears stationary. For three high inflation economies there is evidence that the mean and volatility of inflation interact in a way that is consistent with the Friedman hypothesis. Copyright 1996 by John Wiley & Sons, Ltd.

The short-run inflamation tax in a high-inflation economy

The short-run inflamation tax in a high-inflation economy

Output, inflation, and stabilization in a small open economy: Evidence from Mexico

We study the sources of fluctuation in output and inflation for Mexico, considering fiscal, real, money growth, exchange rate, and asset market disturbances, which are identified using an estimable equilibrium model incorporating important features of high-inflation economies. Changes in inflation are influenced by all shocks, while output growth is explained by real, fiscal, and asset shocks. The results lend strong support to the fiscal view of inflation, and to a lesser degree support the balance of payments view. We also find that higher inflation and higher budget deficits cause each other to spiral upward.

Real Exchange Rate Movements in High Inflation Countries

We empirically assess the sources of fluctuations in the real exchange rates of four high inflation countries, for which monetary shocks are generally believed to be predominant. In a benchmark model we identify fiscal, monetary, and output shocks based on a general-equilibrium optimizing model. We then estimate two alternative extensions. In the first, we decompose the output shock into supply and demand disturbances; in the second, the monetary shock is further decomposed into money supply and nominal exchange rate disturbances. Monetary shocks are found to be generally significant. Real shocks, especially those associated with government policy restrictions on the flow of currency, income from foreign investments, capital, and/or goods, are uniformly more influential however. The paper suggests that analyses of real exchange rates in high inflation economies using models emphasizing monetary shocks and sticky prices could be improved by not negtecting real shocks.

Exchange rate volatility in high inflation economies: An econometric study of Poland and Brazil

This paper analyses exchange rate series for Poland and Brazil. The Polish series, related to the period soon after the first liberalizing measures, presents a high volatility which is not accounted for by some selected ‘fundamentals’. The Brazilian series, though also keeping evidence of excessive volatility, is cointegrated with fundamentals similar to those of the Polish case. This raises the issue of a learning process taking place during persistent inflations. Unsuccessful one-shot stabilization plans can reinforce this process, leaving a lasting imprint in the excessive volatility pattern. The message seems clear, though maybe not easy to implement: agents take some time to learn to live in non-stable environments; to avoid this by one-shot measures — if unsuccessful — can have a very high cost and pre-empt future corrections.

Cointegration Tests of the Monetary Exchange Rate Model for Three High-Inflation Economies

Tests of cointegration are applied to the monetary model of the exchange rate to determine if the model represents a long-run equilibrium relation for three high-inflation countries. The countries tested are Argentina, Chile, and Israel, each paired with the United States as the base country. Evidence favorable to cointegration among the variables of the monetary model is found using Johansen's maximum likelihood procedure. Copyright 1994 by Ohio State University Press.

Currency substitution in Turkey

Although currency substitution is a widely observed phenomenon in both developed and developing counries, most of the studies on currency substitutioin in small open economies have focused on high inflatin South American countries. This paper extends the previous analysis to a newly industrializing, high-inflation economy, namely Turkey. A vector autoregression model has beeb estimated employing the certain policy variables to investigate the dynamics of currency substitution in the economy. Dynamic impulse responses show that the residents have a preference for substitutiong foregn currencies for domestic currency because of reawl-exchange-rate depreciations. The results suggest that to stop or to reverse the on-going currency substition process a plicy aiming to increase the expected real return on domestic assets should be adopted.

Indexation, staggering and disinflation

Since high inflation makes very frequent price adjustments desirable, costs of taking optimal price decisions may become high, and indexation may emerge as an economical rule of thumb to update prices between optimal adjustments. We introduce indexation in a model of staggered price setting, where individual prices, when not adjusted by inflation, are set optimally. We show that it is more difficult to disinflate in a model with indexation than in a standard fixed price staggering model: the costs associated with a given path of money disinflation are higher and the time necessary to stabilize an inflationary economy while keeping output at its natural level is about three times longer. As a consequence, the paper explains why disinflation may be more difficult in high inflation economies.

Fiscal inconsistencies and high inflation

This paper presents a simple model of steady-state inflationary financing. The discrepancy between the target level of spending and a (fixed) taxing capacity indicates the degree of fiscal pressures; this variable need not be monotonically related to the measured deficit, since actual expenditures are endogenous. Large fiscal inconsistencies generate unique steady states located on the ‘bad’ side of the inflation-tax Laffer curve. There, high inflation may coexist with low observed deficits, and the revenue constraint results in ‘repressed spending’. Such situations correspond qualitatively with the loss of control over fiscal policies typical of high inflation economies.