Inflation: stylised facts
Conceptually, the term “inflation” encapsulates the notion of an erosion of the
purchasing power of money.2
Inflation can be thought of as a change in the value of
the numeraire vis-à-vis all goods and services. When looked at from this perspective,
in its purest form, inflation would imply a proportional and synchronous change in all
prices.3
As such, it would leave the relative prices of all goods and services unchanged:
only their prices expressed in terms of the numeraire would vary.
In practice, however, price changes are never perfectly synchronous. Different
goods and services have different adjustment speeds. This is because the process of
changing prices uses valuable firm resources and very frequent adjustments need
not be optimal, especially in the presence of long-term relationships between
buyers and sellers (“nominal rigidities”).4
For example, the prices of commodities
are much more variable than those of, say, manufactured goods and, even more so,
of services.
Therefore, inflation, measured as the change in some general and
comprehensive price index, will always reflect changes in relative prices in addition
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to underlying inflation.
Some measures of inflation seek to partly disentangle the
two, in a very rough fashion, most commonly by excluding the most volatile items.
This, however, still misses the rich nature of granular price changes, both transitory
and long-lasting, if not permanent. Longer-lasting ones tend to be driven by
structural “real” forces, such as changes in consumer preferences and relative
productivity trends.
From a historical perspective, focusing on countries with a long history of price
data, extended phases of high inflation have been relatively rare. The Great Inflation
of the 1970s is the archetypal example. High rates of inflation have also typically
followed wars. A look at cross-country historical data since 1870 (Graph 1.A) reveals
that inflation was low, although volatile, over the years of the first globalisation
era (1870–1914) but surged during World War I and World War II. In the aftermath
of World War II, most belligerents experienced high inflation for some years
(Graph 1.B). Again, the 1970s stand out for both the length and global reach of
inflationary forces.
Extremely high-inflation episodes, or hyperinflations,5
are even less frequent.
These typically follow periods of major political upheavals and a generalised loss of
confidence in institutions. The defining characteristics of hyperinflations are large
budget deficits that are increasingly directly financed by central banks (often due
to the inability to collect sufficient revenues via taxes). One consequence is spiralling
exchange rate depreciations.6
Telling examples include post-revolutionary France
and the aftermath of World War I in the Soviet Union and Germany. More recently,
some countries in Latin America experienced hyperinflation in the wake of the debt
crisis of 1982, while Russia saw an inflation rate of around 2,500% in 1992 following
the collapse of the Soviet Union.
The dynamics of inflation vary systematically with its level along a number of
dimensions, pointing to important differences between low- and high-inflation
regimes. In particular, it is well known that when inflation becomes durably low, its
volatility tends to fall, as does its persistence.7
However, looking under the hood at
more granular price increases reveals several additional striking features.
