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Venezuela's Hyperinflation And The IMF's Faulty Forecasts

25 Apr 2018

Steve H. Hanke

When it comes to inflation, I agree with Lord Kelvin. From
a lecture the British physicist deliveredat the
Institute of Civil Engineers on May 3, 1883: “I often say that when
you can measure what you are speaking about, and express it in
numbers, you know something about it; but when you cannot measure
it, when you cannot express it in numbers, your knowledge is of a
meager and unsatisfactory kind; it may be the beginning of
knowledge, but you have scarcely, in your thoughts, advanced to the
stage of science, whatever the matter may be.”

At present, the world’s highest inflation rate is in Venezuela,
where the annual rate is 15,657%. Venezuela’s bout of
hyperinflation began on November 13, 2016, when the monthly
inflation rate first breached the 50% per month hyperinflation
threshold. Today, Venezuela’s monthly inflation rate stands at
167%. So, Venezuela is a member of the rogues’ gallery of
hyperinflation episodes, of which there have only been 58 in recorded history. The chart below paints
the picture of Venezuela’s hyperinflation calamity.

The inflation rates in the chart above are measured by The Johns Hopkins-Cato Institute Troubled Currencies
Project (TCP)
, which I direct. In 2013, after the Banco Central
de Venezuela (BCV) stopped reporting inflation statistics on a
regular basis, we began measuring Venezuela’s inflation. We employ
high-frequency data that allow for the daily measurements of both
monthly and annual inflation rates. We measure. We do not forecast.
Indeed, forecasting in a hyperinflationary setting is a mug’s
game.

How do we measure? The most important price in an
economy is the exchange rate between the local currency - in this
case, the bolivar - and the world’s reserve currency, the U.S.
dollar. As long as there is an active black market (read: free
market) for currency and the data are available, changes in the
black market exchange rate can be reliably transformed into
accurate measurements of countrywide inflation rates. The economic
principle of purchasing power parity (PPP) allows for this
transformation. And the application of PPP to measure elevated
inflation rates is rather simple.

During periods of elevated inflation, PPP is the proper theory
to use for measurement. Indeed, PPP holds during episodes of
hyperinflation, and it holds very tightly. So, with Nobel
Prize-winner Tjalling Koopmans’s admonishment to economists in
mind, we are measuring, and we are measuring with the correct
theory.

Beyond the theory of PPP, the intuition of why PPP represents
the ‘gold standard’ for measuring inflation during
hyperinflation episodes is clear. All items in an economy that is
hyperinflating are either priced in a stable foreign currency (the
U.S. dollar) or a local currency (the bolivar). If they are bolivar
prices, they are determined by referring to the dollar prices of
goods, and then converting them to local bolivar prices after
checking with the spot black-market exchange rate. Indeed, when the
price level is increasing rapidly and erratically on a day-by-day,
hour-by-hour, or even minute-by-minute basis, exchange rate
quotations are the only source of information on how fast inflation
is actually proceeding. That is why PPP holds and why we can use
high-frequency (daily) data to calculate Venezuela’s inflation
rate.

So much for the way things should be measured correctly. With
that in mind, let’s take a look at the International Monetary
Fund’s (IMF) treatment of Venezuela’s inflation. We conduct this
analysis not only because the IMF is the premier international body
that deals with the monetary matters of its 189 member countries,
but also because whatever the IMF utters is treated by the
financial press as gospel. In consequence, IMF data are widely
reported and drive public opinion.

In the past year and a half, the IMF has reported a variety of
numbers for the annual inflation rate in Venezuela. None of the
IMF’s numbers can be replicated. This is a problem — one that renders all of the
IMF’s inflation numbers unusable because, among other things, they
fail to pass the scientific smell test. Never mind. The following
is a catalogue of the IMF’s inflation numbers for Venezuela that
have been reported since September 2016.

  • IMF World Economic Outlook, October 2016
    • End of 2015 annual inflation rate (Data Source - BCV):
      180.9%
    • End of 2016 annual inflation rate projection: 720.0%
    • End of 2017 annual inflation rate projection: 2,200.0%
  • IMF World Economic Outlook, April 2017
    • End of 2016 annual inflation rate (Data Source - BCV):
      274.4%
    • End of 2017 annual inflation rate projection: 1,133.8%
    • End of 2018 annual inflation rate projection: 2,529.6%
  • IMF World Economic Outlook, October 2017
    • End of 2016 annual inflation rate (Data Source - BCV):
      302.6%
    • End of 2017 annual inflation rate IMF projection: 1,133.0%
    • End of 2018 annual inflation rate IMF projection: 2529.6%
  • IMF World Economic Outlook, April 2018
    • End of 2016 annual inflation rate: 2,818.4%
    • End of 2017 annual inflation rate IMF projection:
      12,874.6%
    • End of 2018 annual inflation rate IMF projection:
      12,874.6%

Until the April 2018 World Economic Outlook(WEO), the IMF
wrote the same general disclaimer about its Venezuelan numbers in
each issue of its report:

Projecting the economic outlook in Venezuela, including
assessing past and current economic developments as the basis for
the projections, is complicated by the lack of discussions with the
authorities (the last Article IV consultation took place in 2004),
long intervals in receiving data with information gaps, incomplete
provision of information, and difficulties in interpreting certain
reported economic indicators in line with economic
developments.”

In the April 2018 WEO, the disclaimer was altered. It now
includes:

The effects of hyperinflation and the noted data gaps
mean that IMF staff’s projected macroeconomic indicators need to be
interpreted with caution.”

These disclaimers are laughable. No one has ever been able to
accurately forecast the course or the duration of an episode of
hyperinflation. But, that hasn’t stopped the IMF from offering up
inflation forecasts for Venezuela that have proven to be wildly
inaccurate. And, for an example of the absurdity of the IMF’s
projections, just consider its year-end forecasts for 2018 and
2019. Both values for the annual rate are 12,824.6%. These
forecasts are absurd. After all, the current measured annual
inflation rate is already 15,657%, and climbing. And the same
forecast for both 2018 and 2019 contain a touch of spurious
accuracy to boot: note the decimal point.

What makes the IMF’s inflation numbers for Venezuela so
troubling is that they should have never been reported in the first
place. There is no practical basis for making a forecast of
inflation during episodes of hyperinflation, which the IMF has
repeatedly done. One can measure hyperinflation accurately, but one
cannot forecast its course or duration. And if the IMF’s Original
Sin is not bad enough, the financial press has regularly and
religiously published the IMF’s forecasts of Venezuela’s
hyperinflation. This is disturbing. It has left the public with the
false impression that it is possible to forecast episodes of
hyperinflation.

Steve Hanke is a professor of applied economics at The Johns Hopkins University and senior fellow at the Cato Institute.

Click here to view the full article which appeared in CATO Journal