Unit 7 Macroeconomic policy in the global economy

7.1 Chainsaws, government spending, and inflation

In 2022 and 2023, Javier Milei, a candidate in Argentina’s presidential election, campaigned with a revving chainsaw in hand. As he travelled the country, he was sometimes welcomed by supporters waving their own chainsaws in the air.

Javier Milei was elected president in November 2023 and embarked on what he called his Chainsaw Plan—his blueprint for slashing public spending.

hyperinflation

Economists usually define hyperinflation as a monthly inflation rate of more than 50%. In such situations, a unit of currency loses more than 99% of its real spending power within a year.

Milei was not the first president of Argentina to try to reform the country’s economy. In the 1920s, it was one of the richest countries in the world. But since then Argentines have lived through decades of economic instability and high inflation, including periods of hyperinflation, as shown in Figure 7.1. 

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Figure 7.1 Argentina’s CPI inflation rate (1960–2023).

Timothy J. Kehoe, Juan Pablo Nicolini, Thomas J. Sargent, ‘A Framework for Studying the Monetary and Fiscal History of Latin America’, 1960–2017. Federal Reserve Bank of Minneapolis.

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Argentina’s inflation rate exceeded 100% per annum

From the mid-1970s to the late 1980s, in most years inflation in Argentina exceeded 100% (the rate at which prices double every year).

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Argentina’s inflation rate (zoomed out)

A wider vertical axis scale shows that there were a few episodes of extreme inflation.
At its peak in 1989, annual inflation reached nearly 5,000%, meaning prices increased by a factor of almost 50 in a single year.
With such high rates of inflation in some years, the standard measure of inflation becomes very hard to interpret.

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An alternative view of price changes in Argentina and the US: comparing CPI levels.

To compare high rates of inflation we plot the level of the CPI on a ratio scale. The steeper the slope, the higher the inflation rate. Every time the series goes through a gridline, the CPI increases by a factor of ten.
The chart shows that over the entire sample the cost of a typical basket of goods and services in Argentina increased by a factor of nearly a quadrillion (1 followed by 15 zeroes, or \(10^{15}\)).
In the US, the cost of a typical basket of goods and services increased by a factor of roughly 10.

Turning the economy around proved no easy task. Figures published in early 2024 showed annual inflation in Argentina close to 300%, making it the highest rate in the world. 

Argentines have developed strategies for dealing with high inflation. Teresa, a cleaner from the city of Mar del Plata, says: ‘I joined a club where people swap items. Last week, I swapped a pair of shoes that one of my clients gave me in exchange for milk, toothpaste, bread, and other food items.’

Noira, a nurse from the city of Mendoza, says she tries to buy large quantities of goods that will not go off. ‘I buy popular non-perishable things like coffee and toilet paper in bulk to prevent the devaluation of my salary,’ the 59-year-old explains. What she does not use herself, she tries to sell to friends and colleagues. 

Others, like 23-year-old business student, Jorge, try to convert their pesos to US dollars. He takes every chance to buy US dollars on the black market, because he believes that they will hold their value better than the peso. Jorge also stores these dollars at home, because he does not trust the banking system. In an earlier economic crisis, in 2001, Argentines had faced limitations in withdrawing cash from banks and many banks collapsed. Jorge’s father lost his life savings.

Argentina has not been alone in having high inflation. In 2022, for example, most countries in the world were hit to some extent by the inflationary supply shocks arising from the Russia–Ukraine war. But Figure 7.2 shows that the outcomes for inflation in that year differed greatly among countries, and that the countries with high inflation were typically—like Argentina—in some kind of crisis.

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Figure 7.2 Inflation around the world in 2022.

International Monetary Fund. 2024.

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Inflation rates in 2022, ranked from highest to lowest

Inflation in 2022 was unusually high in most parts of the world, with many countries hit by the rise in fuel and food prices resulting from the war in Ukraine.
But inflation that is considered ‘high’ in some countries was still lower than inflation in other countries. Some countries have had consistently higher inflation, even before the events of 2022.
You’d need to use the maximum zoom facility, or a magnifying glass, to identify the countries with the highest inflation. But before moving on to the next slide, guess which countries have the highest inflation rates, and what these countries have in common.

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The 10 highest inflation rates in 2022

The ten countries with the unfortunate distinction of having the highest inflation rates in 2022, ranging from 43% to 187%.
Among them were a number of countries that were quite regularly in the international headlines at the time, but generally not for positive reasons.
Many were in a crisis of some kind.

monetary policy

Central bank or government actions aimed at influencing economic activity through changes in interest rates or the prices of financial assets. See also: quantitative easing.

The analysis in Unit 5 explains how an independent central bank can use monetary policy to keep inflation close to a stable, low target. Although supply shocks like those in 2022 may raise inflation temporarily, inflation-targeting central banks have mostly controlled inflation reasonably successfully around the target rate of around 2%; and by early 2024, inflation rates were typically back close to target.

Hyperinflation in Argentina and elsewhere suggests that very different monetary policy choices have been made there. In this unit, we broaden the scope of analysis to consider countries in which we observe a wide range of inflation rates. In some large countries, for example, inflation rates were recorded as follows: Türkiye—in the top ten in Figure 7.2—at 72%, Pakistan (20%), Poland (14%), and Brazil (9%). We examine the processes by which high and volatile inflation emerges in some countries and at some times.

Setting the scene: Inflation in Germany, Spain, and the UK

Figure 7.1 shows that in the recent past, inflation rates across the world have differed by very large amounts. In any given country, there have also been large changes over time. Figure 7.3 compares the inflationary experiences of three European countries—Germany, Spain, and the UK—over the period 1960 to 2024.

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Figure 7.3 CPI inflation in Germany, the UK, and Spain.

FRED. 2024. Consumer Price Index: Total for United Kingdom, Consumer Price Index: All Items: Total for Germany, Consumer Price Index: All Items: Total for Spain, ONS. 2024. Consumer price inflation time series.
Note: Before 1990 the data relates to West Germany.

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CPI inflation in Germany

We start with Germany. The German inflation rate has been remarkably stable. Inflation has sometimes been driven up by major shocks: the oil price shocks of the 1970s, the impact of reunification in the early 1990s, and most recently, the war in Ukraine. But these increases have always been reversed within a few years, and, strikingly, over the entire period inflation on this basis has always remained in single figures.

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CPI inflation in Germany and the UK

Data on German and UK inflation shows some striking contrasts and some striking similarities.
During the early 1960s, the UK and Germany both started out with similar, and low, inflation rates. But from the end of the 1960s onwards, inflation rates diverged significantly. Both countries were hit, to a similar extent, by the impact of the oil shocks of the 1970s, but in the UK the result was a rapid rise in inflation, peaking at around 25% in the mid-1970s. Thereafter, UK inflation fell but remained well above German inflation until the mid-1990s.
From the mid-1990s onwards, the gap between the two inflation rates largely disappeared, with both countries having similarly low rates. They had a similar spike in inflation in 2022 due to the war in Ukraine, but in both countries, as of mid-2024, this spike had more or less unwound.

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CPI inflation in Germany, the UK, and Spain

Finally, we add data for Spanish inflation. In many respects, the pattern for Spain is like that of the UK. Spanish inflation also rose steeply during the 1970s, before falling to similar rates to Germany’s. But Spanish inflation started out higher and was more volatile during the 1960s. And even after it fell from the late 1990s onwards, for several years during the early 2000s Spanish inflation remained distinctly higher than both German and UK inflation.

This comparison, alongside the Argentine experience discussed earlier in this section, raises a number of questions:

• Why did German inflation remain so stable?
• Why did inflation take off in both Spain and the UK?
• What brought Spanish and UK inflation down towards the German rate in the second half of the period?
• Why did Spanish inflation converge less closely to German inflation during the early 2000s?
• Why has inflation in some countries—Argentina being a prime example—been much higher even than the historic peak rates in Spain and the UK, and sometimes even verged on hyperinflation?
• While Spain and the UK appear to have found a ‘cure’ for inflation, why have other countries, like Argentina, failed to get inflation under control?

In this unit, we show how we can address these questions. We shall argue that the differences between countries, and their changing experiences over time, are strongly related to their monetary policy regimes, and the role of the exchange rate. We start by examining the different policy regimes that countries put in place.