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Monetary Policy

Long run correlations; money and prices during hyperinflations
Morten Gleditsch Maria Inês Peixoto Francois Ramiro

Main objective

• To investigate whether the quantity theory of money is observable in time-series and crosscountry analysis • Recapitulation: MV = ∑ pq

What is hyperinflation?

• A rapid escalation of prices rendering currency virtually worthless as a medium of exchange

Occurences
• Dozens of examples, most oftenly associated with wars, economic depression or political and social instabilities of other kinds • Data from Argentina, Bolivia, Israel and Nicaragua were used in the analysis conducted in this work

Methodology
• Variables analysed: Annual % change of M3 and prices • Collect relevant data series • Detect significant observations • Test whether the relationship between growth rate of money and prices excluding/including hyperinflation data is one-to-one • Test whether for a broader sample of countries, hyperinflationary countries affect this relation

Money and price correlations

Bolivia

.8

1

1985

1989

.6

.8

.2

Leverage .4

Argentina

1990 1984 1985 1976 2001 1999 2008 2000 1995 1961 1971 2007 2005 2004 1997 1996 1994 1969 19831988 2009 2006 1998 1970 1965 2002 1962 2003 1968 1964 1963 1993 1966 1974 1973 1967 1992 1981 1980 1986 1972 1977 1991 1982 1975 1978 1987 1979

.2

Leverage .4 .6

Bolivia

0

0

2008 2007 2006 2005 1997 1996 1994 1993 1992 1991 1990 1989 1988 1987 1986 1977 1975 1973 1972 1971 1970 1966 1965 1964 1963 1961 1959 982 2009 2003 1998 1983 1981 1980 1978 1976 1974 1969 1968 1962 2001 1999 1995 1979 1967 1960 1958 2002 2000 2004 1957 1956 1

1984

0

.2 .4 Normalized residual squared

.6

0

.2

.4 .6 Normalized residual squared

.8

.8

.8

1988

1984

.6

Leverage .4

1990

.2

.2

Leverage .4

Israel

.6

Nicaragua

1983 2008 2006 2005 2000 1992 1982 1980 1978 1977 1975 2007 2004 2003 2002 1999 1998 1993 1981 1974 1995 1976 1985 1979 1973 1996 1983 2001 1997 1984 1994 1986 1987 1991 1989 1980 1981 1982 2003 2004 2008 2006 2005 2002 1964 1958 2007 1995 1966 1965 1957 1978 2009 1998 1963 1969 2001 2000 1996 1988 1973 1997 1989 1970 1961 1999 1968 1959 1986 1991 1990 1993 1972 1977 1967 1960 1979 1987 1976 1974 1994 1975 1971 1962 1992 1956 1985

0

0 0

0

.2 .4 Normalized residual squared

.6

.2

.4 Normalized residual squared

.6

.8

Basic linear regression

Regression model

• Used all the collected data series and the following simple regression model: Pricet = beta1 + beta2*Moneyt + Ut

3000

2000

1000

Argentina
0 0 500 1000 prices money 1500 Fitted values 2000 2500 0 0 2000 prices

5000

10000

15000

Regression results in graphics

Bolivia
4000 money 6000 Fitted values 8000

400

200

300

100

Israel
0 0 100 200 prices money 300 Fitted values 400 500 0 0 5000 prices

5000

10000

Nicaragua
money 10000 Fitted values 15000

Regression results in figures
• For Argentina, Bolivia, Israel and Nicaragua numerical results were respectively:
- Money parameters: 1.47; 1.65; 0.83; 0.89 (beta2) - P-values: 0.00; 0.00; 0.00; 0.00 - R-square values: 0.94; 0.99; 0.84; 0.95

• Assessments:

- Growth of money is statistically significant when explaining inflations

Testing significance of hyperinflationary period

Test aim and procedure
• To check whether there is a structural change in the model during the hyperinflation periods: • Model:
Pricest=beta1+beta2moneyt+beta3dummyt+beta4dummyt*moneyt+ut

Dummyt =

1

if t belongs to hyperinflationary period

0 if not • Null hypothesis: Hyperinflationary period causes no effect in the relation between money growth and inflation

Test results
• Closer one-to-one relation without the hyperinflationary period • For all countries there was a statistically significant structural change in the model due to hyperinflationary period • In the extended model, coefficient of determination increased, meaning that introduction of dummies improves the explaination of the variation of inflation

Testing influence of hyperinflationary countries within a broader sample

Methodology
• Use of panel data analysis: Comparison of variables over years and over countries • Model:
• Pricesit= beta1+ beta2*moneyit+ beya3*dummyit+ beta4dummoneyit+ uit

1
• Dummyit =
i = country t = year

if country i was subject to hyperinflation if not

0

• Null hypothesis: No structural change in the model

Test results
• Rejection of null hyphoteses: Hyperinflationary countries do affect the overall relation of growth in money and inflation • One-to-one relation within hyperinflationary countries (beta2+beta4 = 1,03)

Nonnumerical assessments

Hyperinflation causes
• Argentina - Public sector costs exceeded what the government could raise in taxes or finance through domestic and foreign borrowing. Interest payments became crushing • Bolivia - Pursued the fiscal policy of covering government budget deficits by printing money for decades

Hyperinflation causes
• Israel - Government - fearing the loss of public support, focused on raising the standard of living, increasing spendings and accelerating inflation • Nicaragua - High debth level and reckless governmental spendings

Hyperinflation remedies
• Argentina - Pegging their national currency peso to the US dollar • Bolivia - Formulated a simple financial program to curb the hyperinflation: Maintain a balanced governmental budget by not spending more than what was raised through taxes

Hyperinflation remedies
• Israel - The government adopted the Economic Stabilization Policy: A total freeze of prices of all goods and services • Nicaragua - Monetary and fiscal policies as the ones used in Bolivia - Moreover, banking system's financial deficit cuts backed by foreign aid, reestablishing confidence in the national currency and making credit available to the private sector

Conclusion
• During hyperinflationary periods less of the price variations was attributed to the money level as exogenous shocks were also affecting • Prices in all four countries were found to be highly affected by money, and in our broad sample of countries money do affect prices according to the quantity theory of money for the hyperinflationary countries

Questions?