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This book presents a theoretical framework to explain chronic inflation and hyperinflation. The roots of these two phenomenon are a fiscal monetary regime in which money issues finance the public deficit. Chronic inflation is modeled by using both the old and the new Keynesian model, with a different policy rule. Instead of using the Taylor rule, the central bank policy rule states that money is issued to finance the public deficit. The chronic inflation models take into account the fact that indexation mechanisms adjust prices and wages, yielding the inertial component of inflation. The dynamics of these models can be very unstable under parameter changes or shocks that hit the economy. The previous hyperinflation models surveyed in this book attempt to explain hyperinflation as a bubble phenomenon because they assume a constant real deficit financed by money. The mechanics of hyperinflation models in this book explains hyperinflation by a fiscal crisis, characterized by an increasing fiscal deficit. This fiscal crisis yields an intertemporal budget constraint that is not sustainable. The analysis of the pathology of hyperinflation uses the same tools employed to understand the pathologies of public debt and external debt crises. The hyperinflation model allows a taxonomy of hyperinflations, namely bubble, weak and strong, that can be tested with the inflation tax revenue curve.



Chapter 1. Hyperinflation Theories: An Abridged Survey

According to Cagan’s definition hyperinflation starts in a month when the price level increases at least by 50 % and it ends when the price level drops below 50 % and stays there by at least one year. This was Cagan’s empirical criteria to select episodes of hyperinflation. Using this definition Hanke and Krus (2013) were able to identify 56 episodes of hyperinflation worldwide since the first one in France (1796) up to the last one that occurred in Zimbabwe (2007). However, this number should be taken as a lower bound estimate if one takes into account a proper definition of hyperinflation. I will define hyperinflation as a pathology that arises when the price of money goes to zero in finite time.
Fernando de Holanda Barbosa

Chapter 2. The Origins and Consequences of Inflation in Latin America

Inflation in Brazil and other Latin American countries such as Argentina, Mexico, Bolivia, Chile and Peru, has been of an endemic nature. The question that normally arises among the economists who try to understand this situation is how to explain the difference between inflation in Latin America and other parts of the world, such as North America, Western Europe and Asia.
Fernando de Holanda Barbosa

Chapter 3. Chronic Inflation and Hyperinflation

The typical models that try to explain hyperinflation contain three basic ingredients: (1) the portfolio allocation decision with the specification of a money demand equation in which the expected inflation rate is a key argument; (2) a mechanism that describes the expectations formation; and (3) an equation representing the government deficit financing through money issuing. Cagan (1956) took into account the first two ingredients, but considered money as exogenous, while Kalecki (1962) hyperinflation model contained the three ingredients. The current economic literature follows this theoretical framework and has several contributions that analyze the properties of the hyperinflation models. Evans and Yarrow (1981) and Buiter (1987), among others, state that rational models are unable to produce hyperinflationary processes, although they are able to generate hyperdeflationary processes. Kiguel (1989) based on the hypothesis that prices and wages are not flexible, introduced in his model the assumption that the money market does not adjust instantaneously, but according to a partial adjustment mechanism. Having this additional hypothesis, the model with rational expectations is able to generate hyperinflationary processes to some values of the structural parameters of the model.
Fernando de Holanda Barbosa

Chapter 4. Chronic Inflation in the New Keynesian Model

The New Keynesian model became the workhorse for the analysis of monetary policy. This framework contains two equations and three variables, inflation, output gap and the nominal rate of interest. To close the model it uses an interest rate rule, such as a Taylor rule, as a monetary policy rule, since most central banks follow the strategy of targeting inflation. In chronic inflation countries, money issue finances the fiscal deficit. In such an environment, the strategy of the central bank is to collect inflation tax from the public and to give the proceeds to the government. Thus, the specification of the monetary policy rule depends on the size of the fiscal deficit financed by money and the policy instrument is not the rate of interest but the rate of growth of money. My main goal in this chapter is to analyze the New Keynesian model under this monetary policy rule. This chapter is organized as follows: Sect. 2 presents the model specification. Section 3 analyzes the dynamical system, its equilibrium and stability. Section 4 provides an empirical assessment of the parameters that determine the model’s properties. Section 5 gives the concluding remarks.
Fernando de Holanda Barbosa

Chapter 5. Inflation Tax and Money Essentiality

This chapter addresses the issue of money essentiality using Brock’s (1975) model. We present an argument which casts doubt on the conclusion reached by Obstfeld and Rogoff (1983), henceforth called O–R, based on the same theoretical framework. According to O–R, speculative hyperinflation—under a pure fiat money regime—can be ruled out only when severe restrictions are placed on individual preferences, e.g., agents must have infinitely negative utility when their real balances are zero. We argue that this restriction can be tested with data from hyperinflation experiments by looking at the behavior of the inflation tax, as real balances approach zero.
Fernando de Holanda Barbosa

Chapter 6. Hyperinflation: Inflation Tax and Economic Policy Regime

Hyperinflation is a phenomenon characterized by destruction of money value at a finite time interval. Economic theory attempts to explain this phenomenon by using two alternative hypotheses: fundamentals and bubbles. In the first hypothesis, the model produces a steady state in which the real quantity of money is zero (m=0) and the price level is infinite, or hyperinflation occurs due to the nonexistence of an equilibrium solution of the model.
Fernando de Holanda Barbosa

Chapter 7. Competitive Equilibrium Hyperinflation Under Rational Expectations

Cagan’s (1956) seminal work provided the first attempt to explain the hyperinflation phenomenon. That essay was so influential that small variations of Cagan’s model can be found in several textbooks, such as Blanchard and Fischer (1989), Obstfeld and Rogoff (1996) and Romer (2001).Cagan’s model is capable of generating hyperinflation under two types of expectation mechanisms: adaptive and rational. Both are unsatisfactory because adaptive expectations yield systematic forecasting errors, while rational expectations need to be combined with a partial adjustment mechanism in the monetary market. Moreover, both mechanisms require violation of the government intertemporal budget constraint to generate a hyperinflation. That is, in Cagan’s model hyperinflation is not a competitive equilibrium outcome.
Fernando de Holanda Barbosa

Chapter 8. Hyperinflation Pitfalls: Fundamentals Versus Bubbles

In the set-up of our hyperinflation model, in a joint paper with Sallum (Barbosa et al. 2006, thereafter BCS), we were very careful to avoid some traps that have plagued the literature on hyperinflation. In our model, hyperinflation is caused by fundamentals not by bubbles. We showed that a hyperinflation path would not be a competitive equilibrium outcome if the public deficit to be financed by issuing money were constant.
Fernando de Holanda Barbosa

Chapter 9. Bubble, Weak and Strong Hyperinflation: Theory and Empirical Evidence

The monthly (continuous) inflation rate that maximizes the inflation tax revenue varies widely (from 18.3 to 143 %), according to semi-elasticity estimates for the German hyperinflation made by several authors (Cagan 1956; Barro 1970; Frenkel 1977; Sargent 1977; Goodfriend 1982; Burmeister and Wall 1987; Christiano 1987; Casella 1989; Taylor 1991; Engsted 1993; Imrohoroglu 1993; Michael et al. 1994). Those estimates lead one to conclude that during hyperinflation the German government could have obtained more tax revenue with lower inflation rates.
Fernando de Holanda Barbosa


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