J. Atsu Amegashie
July 9, 2022
Steve Hanke, a professor of applied economics in the department of Environmental Health and Engineering at John Hopkins University (USA), has for, some years, embarked on a mission to compute inflation rates in several countries, especially developing countries. On social media, he was not known to Ghanaians until he recently tweeted (in July 2022) that “Today, I measure inflation in Ghana at a stunning 49.35%/yr. In a last ditch effort, the govt has begun negotiations w/ the IMF on a bailout deal. Another IMF loan won’t save Ghana’s economy.” In another tweet on July 3, 2022, he wrote “On June 30, I measured Ghana’s inflation at a stunning 49%/yr — almost 2x the official inflation rate of 28%/yr.”
Ghana is not the only country whose official inflation rate is, in the opinion of Steve Hanke, grossly under-reported or manipulated. On May 21, 2016, he tweeted “Nigeria’s implied inflation rate is 58.6% (“official” = 12.7%), meaning their Central Bank’s *lie* coefficient = 4.6.” (By the way, inflation rates are typically computed by statistical agencies, not central banks. Nigeria is not an exception).
On June 10, 2022, Steve Hanke tweeted “Today, I accurately measure inflation in Pakistan at 40.95%, nearly 3x the bogus official inflation rate of 13.76%/yr. Pakistan MUST mothball the State Bank and install a currency board.” Egypt, Sudan, Turkey, etc, according to Steve Hanke, have under-reported their inflation rates. In his opinion, they are liars (his lie coefficient is his computed inflation rate divided by the official inflation rate); their central banks are inefficient; currency boards are better. That’s Hanke’s mantra and agenda.
In this article, I shall argue that on statistical, methodological, and theoretical grounds, Steve Hanke’s computations are dubious.
Steve Hanke’s methodology is not novel. It is based on the well-known theory of purchasing power parity (PPP). It is the simple proposition that, once converted to a common currency, the prices of goods and services in various countries should be the equal. Thus, it is also called “the law of one price”. Suppose a pair of shoes costs $100 in the USA. According to PPP, if the same shoe costs 800 cedis in Ghana, then the exchange rate should be $1 = 8 cedis. Suppose the shoe costs 700 cedis in Ghana but the exchange rate is $1 = 8 cedis. Then consumers in the USA will increase their demand for the shoe in Ghana because it costs them $100 in the USA but costs the equivalent of 100*(7/8) = $87.5 in Ghana. This increase in demand for the shoe in Ghana will increase the demand for cedis till the cedi appreciates in value from $1 = 8 cedis to $1 = 7 cedis, resulting in the same price of the shoe, at this new exchange rate, in both the USA and Ghana (according to PPP). This process under which economic agents take advantage of differences in prices is known as arbitrage.
The preceding discussion assumes that arbitrage will take place. But what if USA consumers must incur shipping and transportation costs to buy the shoe from Ghana? Then the arbitrage incentive will not be strong. So, if transportation costs exist (a reality), PPP is not expected to hold. The second limitation of PPP is that not all goods are traded internationally. PPP may not hold for koobi, gari, haircuts, kenkey, housing services (rent), trotro services, etc because these goods are not significantly traded between Ghana and the USA, for example. Not all goods in a country’s consumer price index (CPI) are internationally traded. These are limitations of using PPP to estimate inflation rates.
Let E be the exchange rate between the cedi and the dollar, defined as the number of cedis required to buy a dollar. Let Pg (in cedis) be the price of an item in Ghana and let Pu be the price (in dollars) of the *same* item in the USA. Then PPP implies that:
Pg = E*Pu. …….. (1)
This is what is known as the static or absolute version of PPP. The dynamic or relative version of PPP is derived via algebraic manipulation of equation (1) and may be written as:
Percentage change in Pg = percentage change in E plus percentage change in Pu. ……. (2)
or
Inflation in Ghana = depreciation/appreciation of the cedi plus inflation in the USA. ……. (2a)
We can rewrite (2a) as
Percentage change in E = Inflation in Ghana minus inflation in USA …. (3),
where percentage in E is the same “depreciation/appreciation of the cedi”.
Steve Hanke, unlike statistical agencies, does *not* collect data on the prices of a basket of goods and services. He uses market exchange rates (in some cases, black-market rates) and official inflation rates reported by the USA’s Bureau of Statistics and a variant of equation (3) to solve for the inflation rates of Ghana, Pakistan, Nigeria, Turkey, etc. Note that he assumes that the inflation rates reported by the USA’s Bureau of Statistics are accurate but believes that the inflation rates reported by several other statistical agencies are wrong or deliberately manipulated. He does not provide any justification for his skepticism.
Jeff Frenkel (1976), in a seminal contribution, tested the validity of relative PPP using the 1920s hyperinflation in Germany. Steve Hanke admits that equation (3) or relative PPP is likely to be an accurate method for computing inflation *only if* inflation is very high. He adopts Cagan’s (1956) threshold of 50% monthly inflation. Before he computes his inflation rates, where does he get the inflation rates to determine the 50% threshold for the countries to include in his analysis? These must be official inflation figures. Why then does Steve Hanke claim that he is applying relative PPP to high-inflation economies and yet cast doubt on the official inflation rates reported by the statistical agencies of some countries? It is also known that relative PPP is likely to hold only if the cause of the high inflation is excessive growth of money. The recent increases in inflation in Ghana, for example, was not caused by excessive growth of money.
To test the validity of relative PPP, researchers do not use Hanke’s approach. It is not surprising that none of Hanke’s work on this subject appears in journals with high technical standards. Researchers test the validity of relative PPP by estimating the equation in (3). They use market exchange rates and official inflation rates to estimate equation (3) and then test whether their estimated parameters are statistically significant. Because they use official inflation rates in their statistical analysis, they do not — unlike Steve Hanke — turn around to cast doubt on those official rates, regardless of whether their tests support or reject relative PPP. These researchers assume that the inflation rates reported by the statistical service of the USA and the statistical services of other countries are accurate. Steve Hanke assumes that only the USA’s reported inflation rates are accurate. Hanke does not follow standard statistical methods in testing the validity of relative PPP. He *assumes* that relative PPP is valid and applies it indiscriminately, including to periods when countries are not experiencing hyperinflation.
Steve Hanke computes inflation rates for various countries, although they are routinely computed by statistical agencies of those countries, because he wants to paint a bad picture of central banks. That was why he referred to a so-called *lie* coefficient for the Central Bank of Nigeria, although he ought to have known that it is the Bureau of National Statistics, not the Central Bank of Nigeria, that computes Nigeria’s inflation rates. By claiming that official inflation rates are grossly under-reported, he wants to give the impression that central banks are incompetent in controlling inflation. In his opinion, “… the Achilles’ heels of these countries (developing countries) are their crummy little central banks. They basically make everyone poor.” OK. Just don’t use dubious methods to make your case.
Even if Steve Hanke is right that the inflation rates of some countries are under-reported, it is for the wrong reasons (so many wrong reasons, as explained above). When we don’t find official inflation rates credible, we question the weights assigned to various commodity groups, look at out own experience, albeit narrow, with inflation, etc. I note that, in addition to the overall inflation rate, the Ghana Statistical Service also computes inflation rates for several subgroups of goods and services. Therefore, anyone worried about inappropriate weights may look at the inflation rates of various subgroups. Steve Hanke should pay research assistants to collect data on the prices of goods and services in the countries whose statistical agencies he disparages. Try that, Steve.
*References*
Cagan, C. (1956). The monetary dynamics of hyperinflation. In Milton Friedman (ed). Studies in the Quantity Theory of Money. Chicago: University of Chicago Press.
Frankel, J. (1976). A monetary approach to the exchange rate: doctrinal aspects and empirical evidence. Scandinavian Journal of Economics.
Hanke, S.H., and Kwok, A.K. (2009). On the measurement of Zimbabwe’s hyperinflation. Cato Journal.
Hanke, S.H., and Bushnell, C. (2017). On measuring hyperinflation: the Venezuela Episode. World Economics.
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