Chapter 16 - 859-884_Krugman2e_Econ_Ch32.qxp 1/26/09 3:06...

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W O R L D V I E Inflation, Disinflation, and Deflation 859 >> 32 BRINGING A SUITCASE TO THE BANK chapter: Y THE SUMMER OF 2008, THE AFRICAN NATION of Zimbabwe had achieved an unenviable dis- tinction: in June 2008 it had the world’s highest inflation rate, 11 million percent a year. Although the gov- ernment kept introducing ever-larger denominations of its currency, the Zimbabwe dollar—for example, in May 2008 it introduced a half-billion dollar bill—it still took a lot of currency to pay for the necessities of life: a stack of Zimbabwean cash worth $100 U.S. dollars weighed about 40 pounds. Zimbabwean currency was worth so little that some people withdrawing funds from banks brought suit- cases along, in order to be able to walk away with enough cash to pay for or- dinary living expenses. Zimbabwe’s experience was shocking, but not unprecedented. In 1994 the infla- tion rate in Armenia hit 27,000%. In 1991 Nicaraguan inflation exceeded 60,000%. And even Zimbabwe’s infla- tion was mild compared with history’s most famous ex- ample of extreme inflation, which took place in Germany in 1922–1923. Toward the end of the German hyperinflation, prices were rising 16% a day, which— through compounding—meant an increase of approxi- mately 500 billion percent over the course of five months. People became so reluctant to hold paper money, which lost value by the hour, that eggs and lumps of coal began to circulate as currency. German firms would pay their workers several times a day so that they could spend their earnings before they lost value (lending new meaning to the term hourly wage ). Legend has it that men sitting down at a bar would order two beers at a time, out of fear that the price of a beer would rise before they could order a second round! The United States has never experienced that kind of inflation. The worst in- flation the U.S. has seen in modern times took place at the end of the 1970s, when consumer prices were rising at an annual rate of 13%. Yet inflation at even that rate was profoundly trou- bling to the American pub- lic, and the policies the Federal Reserve pursued in order to get U.S. inflation back down to an acceptable rate led to the deepest reces- sion since the Great Depression. What causes inflation to rise and fall? In this chap- ter, we’ll look at the underlying reasons for inflation. We’ll see that the underlying causes of very high infla- tion, the type of inflation suffered by Zimbabwe, are quite different from the causes of more moderate infla- tion. We’ll also learn why disinflation, a reduction in the inflation rate, is often very difficult. Finally, we’ll discuss the special problems associated with a falling price level, or deflation. B In 2008, the Zimbabwe dollar was so devalued by extreme inflation that this much currency was needed to pay for a single loaf of bread.
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Chapter 16 - 859-884_Krugman2e_Econ_Ch32.qxp 1/26/09 3:06...

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