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Method: Calculating Inflation in Venezuela

By: Fergus Hodgson - @FergHodgson - Dec 2, 2014, 4:35 pm

Español The calculation of inflation, the “ongoing fall in the overall purchasing power of the monetary unit,” is no easy task. Authoritarian regimes also tend to resist reporting it, or they misreport it when they do.

(Cato Facebook)
(Cato Facebook)

So readers are clear on how one arrives at the conclusion that November represented a period of hyperinflation for the Venezuelan bolívar — in excess of 50 percent inflation in one month — let me lay the method on the table.

Essentially, it is taken straight from the Troubled Currencies Project of the Cato Institute, led by Steve Hanke (under methodology). Hanke “collects black-market exchange-rate data for these troubled currencies and estimates the implied inflation rates for each country.”

I have simply replaced the formula’s annual numbers with monthly numbers. The underlying data is the black-market exchange rate between the Venezuelan bolívar and the US dollar, from DolarToday, and the inflation rate in the United States, from the US Bureau of Labor Statistics (PDF).

The logic behind the formula is that if the US dollar experienced a measured level of inflation over a particular period, we can assess the purchasing power of another currency by comparing its value on the exchange market over that same period. If, for example, the US dollar had 20 percent inflation over a year, and its exchange rate with another currency remained unchanged in that time, we can infer that the other currency also experienced 20 percent inflation. If the US dollar gained ground on the exchange market, we can infer that the other currency had a higher rate of inflation, and vice versa.

The one key assumption here is purchasing power parity, that “the exchange rate adjusts so that an identical good in two different countries has the same price when expressed in the same currency.” Although there may be departures from this, it is a reliable assumption given goods traded across two jurisdictions, smuggled onto the black market if necessary.

Troubled Currencies Project formula. (Cato Institute)
Troubled Currencies Project formula. (Cato Institute)

A distilled version of the formula used goes like this: (1 + the monthly inflation rate in troubled-currency country) = (1 + the monthly inflation rate in the United States) × (1 + the monthly percentage change in the exchange rate).

The monthly rate for the United States is 0.14 percent, from the November BLS release, and the average over the past year. (The monthly rates ranged from -0.2 to 0.4.)

The change to the exchange rate, between November 1 and December 1, is 55.05 percent. It started at 102.56 per US dollar and finished at 159.02.

That equates to 55.27 percent inflation for November, or an astounding 19,633 percent per year. On this basis, the Venezuelan bolívar has exceeded the 50 percent rule-of-thumb threshold for hyperinflation in a month.

One should note that the data is not seasonally adjusted, and that should temper the implication that the rate will remain this high. In saying that, Venezuela has been verging on hyperinflation for the past couple of years, and it exceeded an annual rate of 300 percent over a year ago. The pressure towards ever-higher levels of inflation has been building for a considerable period of time.

One element of the formula that might come into question is the US measure of inflation, that perhaps the actual rate in the United States is higher than reported by the Bureau of Labor Statistics. Unfortunately for holders of the Venezuelan bolívar, any higher level of inflation in the United States would only amplify the estimated rate for Venezuela. In fact, to get the November rate below 50 percent, the United States would have to have had deflation of 3.3 percent.

Fergus Hodgson Fergus Hodgson

Fergus Hodgson was the founding editor in chief of the PanAm Post, up until January 2016, and he now studies finance at Tulane University in Louisiana and Francisco Marroquín University in Guatemala. Originally from New Zealand, he has also lived in Argentina, Canada, Colombia, Ecuador, Ireland, and the United States. Follow @FergHodgson and his Facebook page.