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Chapter 11 Inflations Big and Small

Rising Prices

Through the years, people have been willing to wear some absurd slogans on their clothing. But surely one of the worst was the “WIN” button, introduced by United States President Gerald Ford in a speech on October 8, 1974.President Ford’s speech can be read and heard here: http://www.fordlibrarymuseum.gov/library/speeches/740121.asp. The button, shown in the following figure, was the symbol of a campaign against a perceived a social evil. And what was this great evil? It was inflation. “WIN” stood for “whip inflation now.” President Ford asked citizens to wear WIN buttons as a sign that they were enlisted in the battle against inflation.

Figure 11.1 Button: Whip Inflation Now

Wearing buttons might not have been the first bit of advice economists would have given to a leader interested in battling inflation. But this episode makes it evident that President Ford and his advisors viewed inflation as a major social problem. The president even invoked wartime imagery, concluding his speech by saying the following:President Ford’s speech can be read and heard here: http://www.fordlibrarymuseum.gov/library/speeches/740121.asp.

Only two of my predecessors have come in person to call upon Congress for a declaration of war, and I shall not do that. But I say to you with all sincerity that our inflation, our public enemy number one, will, unless whipped, destroy our country, our homes, our liberties, our property, and finally our national pride, as surely as any well-armed wartime enemy.

I concede there will be no sudden Pearl Harbor to shock us into unity and to sacrifice, but I think we have had enough early warnings. The time to intercept is right now. The time to intercept is almost gone.

My friends and former colleagues, will you enlist now? My friends and fellow Americans, will you enlist now? Together with discipline and determination, we will win.

When President Ford initiated this campaign, the US inflation rate was about 12 percent. In other words, a shirt that cost $10.00 in 1973 cost about $11.20 in 1974. This was the highest inflation rate that the United States had experienced since World War II. Inflation running at this rate is, at the very least, a significant inconvenience.

Still, compared to the experience of many countries, this level of inflation is negligible. Between World War I and World War II, Germany, Hungary, Austria, and Poland experienced massive rates of inflation. In one month in 1923, the annual inflation rate in Germany was 6,829 percent. This number is very difficult to fathom; it is astronomical compared to the inflation that President Ford was facing. At this rate of inflation, prices were doubling every three to four days.

Such rapid price increases forced people to change their behavior in extraordinary ways. The instant workers received their pay, they would rush out and spend it, for even a delay of a few hours could mean that your wages would buy fewer goods and services. Even ordering in a café became a game to beat inflation: “The price increases began to be dizzying. Menus in cafes could not be revised quickly enough. A student at Freiburg University ordered a cup of coffee at a cafe. The price on the menu was 5,000 Marks. He had two cups. When the bill came, it was for 14,000 Marks. ‘If you want to save money,” he was told, “and you want two cups of coffee, you should order them both at the same time.’”This comes from a PBS page with many excerpts about the German hyperinflation: “The German Hyperinflation, 1923,” Commanding Heights: The Battle for the World Economy, PBS, accessed September 20, 2011, http://www.pbs.org/wgbh/commandingheights/shared/minitext/ess_germanhyperinflation.html. And these are not just stories from long ago. In the past 25 years, there have been large inflations in Yugoslavia, Israel, Argentina, Brazil, Mexico, Ukraine, and Zimbabwe, for example.

What is the cause of inflation?

Road Map

In this chapter, we study the causes and consequences of inflation. Times of rapid inflation are especially helpful for understanding inflation in general. When inflation is the dominant feature of an economy, it is very easy to isolate the main forces at work. We will see, moreover, that the most interesting periods to study are the beginning and end of large inflations, for such times provide a particular insight into the connection between fiscal policy and monetary policy.

We first study the relationship between the inflation rate and changes in the amount of money circulating in an economy and explain that, in the long run, there is a close connection between the inflation rate and the growth rate of the money supply. We look at some data both for the United States and for other countries and examine some examples of hyperinflation. Then we explore the underlying cause of hyperinflations, which turn out to be connected to the tax and spending choices that governments make, and we conclude by discussing government policy to control inflation.