The Inflation Bogeyman

One could argue at length about whether Russia's current leaders came to power through a lawful election following constitutional procedure or whether they relied on undemocratic methods to establish and maintain authority.

In some respects, however, the answer doesn't really matter, because whatever method political leaders use to get their authority, they are all afraid of inflation. Eighty years ago, British economist John Maynard Keynes wrote that Lenin was correct in asserting that inflation was the most reliable weapon to bring down a capitalist regime.

From a purely economic standpoint, even 20 percent annual inflation rate for several consecutive years is no justification for taking extraordinary measures such as placing price controls on food and consumer goods. The broad economic distortions caused by price controls typically result in much higher inefficiencies than those caused by inflation. Elected leaders, however, often feel political pressure to do something radical like placing caps on prices. Last week, for example, the Finance Ministry unveiled a plan for price controls that would entail large-scale government interference in the markets for food and certain consumer goods.

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Indeed, leaders' pathological fear of inflation often dictates government policy. For example, two decades ago, when basic goods such as sugar and tobacco products were rationed in Moscow and butter had not been seen on store shelves for years in many major cities, Soviet authorities refused to remove the existing price freeze because they feared that a sharp increase would spark widespread public unrest.

The Soviet leaders' aversion to allowing prices to rise may have its roots in the events of 1962, when meat prices rose by 100 percent, which led to protests in several southern cities. In Novocherkassk, for example, the authorities used tanks to suppress protests. Between the two evils of open inflation and hidden inflation, which is manifested in the shortages of goods, the Soviet leaders were convinced that a prolonged deficit of goods, including food staples, was the lesser evil.

China offers another example. The 7 percent inflation rate projected for China's economy next year has frightened authorities into attempting to put some controls on food prices. Now we will see whether basic economic laws still work in China. The country has had three decades of phenomenal economic growth, but this does not mean that price controls will not result in a deficit. China's current political system is itself less than 30 years old and has not yet faced the true test of whether it can successfully adjust its economic policy to manage a major macroeconomic shock.

Contrary to popular belief, there is no consensus among economists about the way inflation affects economic growth. Of course, hyperinflation -- price increases of 50 percent or more over several consecutive months -- is extremely harmful to the economy, but it is also extremely rare.

The more relevant question is how moderate inflation rates affect economic growth. In his study published in 1995, Harvard economist Robert Barro concluded that several consecutive years of more than 10 percent inflation does have a detrimental impact on the economy. But Barro also offered a caveat: If the periods of unusually high inflation were excluded from the data, then the conventional conclusions about the dangers of inflation need to be qualified. Most other research also indicates that, although inflation has some negative effects on growth, they are not catastrophic.

As it turns out, Soviet leaders were mistaken in their belief that people prefer deficits to higher prices. In a referendum held in April 1993, following 15 months of 1,000 percent annual inflation, a majority of Russians nonetheless voted to approve the government's economic policy. Apparently, faced with two evils, they preferred to live with high inflation rather than without basic goods.

Konstantin Sonin, a professor at the New Economic School/CEFIR, is a columnist for Vedomosti.