When it comes to inflation, I agree with Lord Kelvin. Froma lecture the British physicist deliveredat theInstitute of Civil Engineers on May 3, 1883: “I often say that whenyou can measure what you are speaking about, and express it innumbers, you know something about it; but when you cannot measureit, when you cannot express it in numbers, your knowledge is of ameager and unsatisfactory kind; it may be the beginning ofknowledge, but you have scarcely, in your thoughts, advanced to thestage 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 ofhyperinflation began on November 13, 2016, when the monthlyinflation rate first breached the 50% per month hyperinflationthreshold. Today, Venezuela’s monthly inflation rate stands at167%. So, Venezuela is a member of the rogues’ gallery ofhyperinflation episodes, of which there have only been 58 in recorded history. The chart below paintsthe picture of Venezuela’s hyperinflation calamity.
The inflation rates in the chart above are measured by The Johns Hopkins-Cato Institute Troubled CurrenciesProject (TCP), which I direct. In 2013, after the Banco Centralde Venezuela (BCV) stopped reporting inflation statistics on aregular basis, we began measuring Venezuela’s inflation. We employhigh-frequency data that allow for the daily measurements of bothmonthly and annual inflation rates. We measure. We do not forecast.Indeed, forecasting in a hyperinflationary setting is a mug’sgame.
How do we measure? The most important price in aneconomy is the exchange rate between the local currency - in thiscase, the bolivar - and the world’s reserve currency, the U.S.dollar. As long as there is an active black market (read: freemarket) for currency and the data are available, changes in theblack market exchange rate can be reliably transformed intoaccurate measurements of countrywide inflation rates. The economicprinciple of purchasing power parity (PPP) allows for thistransformation. And the application of PPP to measure elevatedinflation rates is rather simple.
During periods of elevated inflation, PPP is the proper theoryto use for measurement. Indeed, PPP holds during episodes ofhyperinflation, and it holds very tightly. So, with NobelPrize-winner Tjalling Koopmans’s admonishment to economists inmind, we are measuring, and we are measuring with the correcttheory.
Beyond the theory of PPP, the intuition of why PPP representsthe ‘gold standard’ for measuring inflation duringhyperinflation episodes is clear. All items in an economy that ishyperinflating are either priced in a stable foreign currency (theU.S. dollar) or a local currency (the bolivar). If they are bolivarprices, they are determined by referring to the dollar prices ofgoods, and then converting them to local bolivar prices afterchecking with the spot black-market exchange rate. Indeed, when theprice level is increasing rapidly and erratically on a day-by-day,hour-by-hour, or even minute-by-minute basis, exchange ratequotations are the only source of information on how fast inflationis actually proceeding. That is why PPP holds and why we can usehigh-frequency (daily) data to calculate Venezuela’s inflationrate.
So much for the way things should be measured correctly. Withthat in mind, let’s take a look at the International MonetaryFund’s (IMF) treatment of Venezuela’s inflation. We conduct thisanalysis not only because the IMF is the premier international bodythat deals with the monetary matters of its 189 member countries,but also because whatever the IMF utters is treated by thefinancial press as gospel. In consequence, IMF data are widelyreported and drive public opinion.
In the past year and a half, the IMF has reported a variety ofnumbers for the annual inflation rate in Venezuela. None of theIMF’s numbers can be replicated. This is a problem — one that renders all of theIMF’s inflation numbers unusable because, among other things, theyfail to pass the scientific smell test. Never mind. The followingis a catalogue of the IMF’s inflation numbers for Venezuela thathave 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 IMFwrote the same general disclaimer about its Venezuelan numbers ineach issue of its report:
Projecting the economic outlook in Venezuela, includingassessing past and current economic developments as the basis forthe projections, is complicated by the lack of discussions with theauthorities (the last Article IV consultation took place in 2004),long intervals in receiving data with information gaps, incompleteprovision of information, and difficulties in interpreting certainreported economic indicators in line with economicdevelopments.”
In the April 2018 WEO, the disclaimer was altered. It nowincludes:
The effects of hyperinflation and the noted data gapsmean that IMF staff’s projected macroeconomic indicators need to beinterpreted with caution.”
These disclaimers are laughable. No one has ever been able toaccurately forecast the course or the duration of an episode ofhyperinflation. But, that hasn’t stopped the IMF from offering upinflation forecasts for Venezuela that have proven to be wildlyinaccurate. And, for an example of the absurdity of the IMF’sprojections, just consider its year-end forecasts for 2018 and2019. Both values for the annual rate are 12,824.6%. Theseforecasts are absurd. After all, the current measured annualinflation rate is already 15,657%, and climbing. And the sameforecast for both 2018 and 2019 contain a touch of spuriousaccuracy to boot: note the decimal point.
What makes the IMF’s inflation numbers for Venezuela sotroubling is that they should have never been reported in the firstplace. There is no practical basis for making a forecast ofinflation during episodes of hyperinflation, which the IMF hasrepeatedly done. One can measure hyperinflation accurately, but onecannot forecast its course or duration. And if the IMF’s OriginalSin is not bad enough, the financial press has regularly andreligiously published the IMF’s forecasts of Venezuela’shyperinflation. This is disturbing. It has left the public with thefalse impression that it is possible to forecast episodes ofhyperinflation.