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Turkey's Inflationary Woes

May 13, 2019 in Economics

By Steve H. Hanke

Steve H. Hanke

Just what is Turkey’s inflation rate? Today, Turkey’s annual inflation rate is 49 percent. How do I measure elevated inflation? The most important price in an economy is the exchange rate between the local currency – in this case, the lira – and the world’s reserve currency, the U.S. dollar. As long as there is an active free market for currency and the data are available, changes in the 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. The application of PPP to measure elevated inflation rates is both simple and very accurate.

For example, using evidence from Germany’s 1920-23 hyperinflation, my long-time friend, distinguished economist, former Governor of the Bank of Israel, and Chairman of J.P. Morgan Chase International, Jacob Frenkel confirmed the accuracy of PPP during hyperinflations. In the July 1976 issue of the Scandinavian Journal of Economics, Frenkel plotted the Deutschmark/U.S. dollar exchange rate against both the German wholesale price index and the consumer price index. The correlations between Germany’s exchange rate and the two price indices were very close to unity throughout the episode of hyperinflation, indicating that changes in the inflation rate mirrored changes in the exchange rate.

I have expanded on the PPP insights presented by Frenkel. One article, which I co-authored with Charles Bushnell in the Fall 2017 issue of World Economics, “On Measuring Hyperinflation: Venezuela’s Episode,” lays out how the PPP approach can be used to accurately measure inflation in cases in which the annual inflation rate exceeds 30 percent, as it presently does in Turkey.

Beyond the theory of PPP, the intuition of why PPP represents the ‘gold standard’ for measuring elevated rates of inflation is clear. For example, during episodes of hyperinflation, virtually all goods and services are either priced in a stable foreign currency (the U.S. dollar) or a local currency. In Venezuela, for example, bolivar prices are determined by referring to the dollar prices of goods, and then converting them to local bolivar prices after observing the black market exchange rate. 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 I can use high-frequency data to calculate …read more

Source: OP-EDS

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