HYPERINFLATION IN LATIN AMERICAN COUNTRIES
ECONIMICS ASSIGNMENT- I
(09/01/2012)
ASHOK RAWAT/ ROLL NO. 13/ PGDM-A
HYPERINFLATION IN LATIN AMERICAN COUNTRIES
Ques. How did hyperinflation affect the Latin American economies? Hyperinflation eroded the usefulness of domestic money as a store of value, medium of exchange. 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. From 19671994, 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. 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 (calledris in Portuguese). Bolivia experienced its worst inflation between 1984 and 1986. Before 1984, the highest denomination was 1,000 pesos bolivianos. By 1985, the highest denomination was 10 Million pesos Bolivians. 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. In the 1987 currency reform, the Peso Boliviano was replaced by the Boliviano at a rate of 1,000,000: 1. Peru experienced its worst inflation from 19881990. 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 132%. 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. Ukraine experienced its worst inflation between 1993 and 1995. 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. This translates to a hyperinflation rate of approximately 1,400% per month. 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.
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HYPERINFLATION IN LATIN AMERICAN COUNTRIES
While robust growth has eluded most countries in the years immediately following a bout of hyperinflation, there is modestly encouraging evidence that, although it may take some time for countries to regain formal access to international capital markets, an acute financing shortage may be somewhat mitigated by the repatriation of flight capital. Yet once confidence is restored through stabilization, at least some of the wealth previously kept outside the country returns to the domestic financial system, although not enough to jump-start growth. Although the return of flight capital facilitates financial reinter mediation, it rarely increases demand for domestic money or domestic financial assets. Dollarization and other forms of financial indexation are a lasting legacy of hyperinflationa legacy that has been extremely difficult to reverse Argentina, Bolivia, and Peru, for example, were far more dollarized three years after hyperinflation than they were before. The Latin American countries with high inflation also experienced a phenomenon called dollarization, the use of U.S. dollars in place of the domestic currency. As inflation rises, people come to believe that their own currency is not a good way to store value and they attempt to exchange their domestic money for dollars. In 1973, 90 percent of time deposits in Bolivia were denominated in Bolivian pesos. By 1985, the year of the Bolivian hyperinflation, more than 60 percent of time deposit balances were denominated in dollars
Ques. How different are the modern hyperinflation episodes from the ones experienced after WWI?
.The hyperinflations after WWI were quick to arise and subsided quickly without much cost to employment and output, after governments implemented drastic fiscal and monetary reforms that restored currency convertibility and gave central banks independence to conduct monetary policy. In contrast, modern hyperinflations have not been short and swift. In most cases, they have been preceded by years of chronic high inflation. In Argentina, Brazil, and Peru, for example, year-over-year inflation remained consistently above 40 percent for 1215 years before the peak of the hyperinflation. Chronic high inflation does not necessarily degenerate into hyperinflation. But, in the five countries reviewed here, hyperinflation did ensue, triggered by an uncontrolled expansion in the money supply that was fuelled by endemic fiscal imbalances. Nor has price stability been restored overnight in modern hyperinflations. It took 14 months in Bolivia and more than 3 years in Peru for inflation rates to fall below 40 percent. It took even longer to reach single-digit inflation ratesthree and a half years in Argentina and about seven and a half years in Bolivia. In Brazil, failure to put in place the needed fiscal and monetary reforms in 198990 caused the country to experience a second, borderline hyperinflation in 1994. Another difference is that full currency convertibility and strict institutional constraints on monetary policy have not characterized the end of all modern hyperinflations. Except for Argentina, which adopted a currency board in early 1991, countries have relied on hybrid monetary and exchange regimes to bring high inflation under control. Bolivia and Peru relied
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on money targets and heavy foreign exchange intervention Brazil and Ukraine retained de jure dual exchange rates for most of the 1990s.
QUES 3: Was the monetary policy effective enough to control hyperinflation? Substantiate your answer with valid reasons. No, the monetary policy was not effective enough to control the hyperinflation completely. The rebound was not up to the mark as depicted in the graph above. However at least some of the wealth previously kept outside the country returns to the domestic financial system, although not enough to jump-start growth. Although the return of flight capital facilitates financial re intermediation, it rarely increases demand for domestic money or domestic financial assets. Dollarization and other forms of financial indexation are a lasting legacy of hyperinflationa legacy that has been extremely difficult to reverse. Argentina, Bolivia, and Peru, for example, were far more dollarized three years after hyperinflation than they were before. The results in terms of reduction in inflation was significant, the costs in terms of output were not very satisfactory. This result could be due to the credibility of the new policies on inflation expectations, allowing inflation to be reduced at a much lower cost than anticipated from standard models with high inflation inertia.
QUES 4: What role did the government play in controlling hyperinflation?
In Brazil , Appears Cruzado plan, which were categorized as heterodox plans, the plan started in 1985 was based on economic growth as a priority, renegotiation of external debt (without sacrificing economic growth and not accept the IMF conditions ), improve income distribution through the reorientation of publicspending on social programs and solve the financial imbalance of the public sector bygiving priority to increasing income and not to reduce public spending. In 1991, Collor II plan appeared unorthodox content, which sought to address the new problem of inflation, and by a fiscal and financial dealing with the problem of indebtedness of the state and local governments In 1989, seeking the eradication of hyperinflation, ARGENTINA applied the B & B plan based on orthodox measures using the exchange rate as nominal anchor, and i also make a major fiscal adjustment and structural reforms such as privatization. This plan sought to solve the perennial problem of domestic debt by enacting the forced conversion of time deposits and short-term debt indexed in dollars. Germany undertook a monetary reform, creating a new unit of currency called the
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rentenmark. The German government promised that the new currency could be converted on demand into a bond having a certain value in gold. Proponents of the standard answer argue that the guarantee of convertibility is properly viewed as a promise to cease the rapid issue of money. Implementation of drastic fiscal and monetary reforms which resulted in restoring of currency convertibility and which gave the central bank the power to formulate monetary policies. Bolivia and Peru relied on heavy foreign exchange intervention. The Governments reduced their fiscal deficits by more than 10 percent of GDP, over a three year period. Hybrid monetary and exchange regimes.