Macroeconomics – Case Study Example

Due 2-2 Points: 50 Case 2 Case Studies Hyperinflation in Brazil Six years of wild inflation in Brazil meant that the price level in 1994 was 3.6 million times higher than in 1988! To put that in perspective, with such inflation in the United States, a gallon of gasoline that sold for $1.50 in 1988 would have soared to $5.4 million in 1994. A pair of jeans that sold for $25 in 1988 would cost $90 million in 1994. Those were crazy times in Brazil. With the value of their currency, the cruzeiro, cheapening by the hour, people understandably did not want to hold any currency. Workers insisted on getting paid at least daily, immediately buying things before prices increased more or exchanging their cruzeiros for a more stable currency, such as the U.S. dollar. With such wild inflation, everyone, including merchants, had difficulty keeping up with prices. Different price increases among sellers of the same product encouraged buyers to shop around more.
The exploding price level meant even the simplest transactions required mountains of cash. Think again in terms of dollars. As a consequence of such inflation, lunch for two at McDonald’s would cost more than $27 million. Such a stack of $100 bills would weigh about 500 pounds. Because carrying enough money for even small purchases became physically impossible, currency was issued in ever larger denominations. Between the mid-1980s and 1994, new denominations were issued five times, each a huge multiple of the previous one. For example, the new cruzeiro real issued in 1994 exchanged for 2,750 of the cruzeiro it replaced. Larger denominations facilitated purchases. Still, lugging money around, searching for the lowest price, and generally obsessing about money sucked up time and energy and, in the process, reduced productivity. This focus on money was rational for each individual but wasteful for the economy as a whole.
Since 1994 inflation in Brazil has dropped to single digits (in 2007 it was only 3.5 percent). Fernando Henrique Cardoso, the finance minister in 1994, became a national hero for taming inflation. He was elected Brazil’s president in1994 and reelected in 1998. Although Brazil ended its inflation nightmare, hyperinflation is usually flaring up somewhere in the world. The latest victim is Zimbabwe, where inflation topped 3,700 percent in 2007, according to official estimates (the unofficial estimate is more like 10,000 percent). Based on a consumer price index of 100 in 2001, by April 2007 Zimbabwe’s official CPI reached 4,032,634. For the price of a car battery in 2007, one could have, in 2001, purchased about 300 new cars.
SOURCES: Michael Wines, “Caps on Prices Only Deepen Zimbabweans’ Misery,” New York Times, 2 August 2007; “Battle Begins for Cardoso’s Successor,” Economist, 6 January 2001; “Economic and Financial Indicators,” Economist, 23 June 2007;. For more on the Brazilian economy, go to the Central Bank of Brazil at hjttp://www.bcb.gov.br/?english. The Zimbabwe Federal Reserve Bank at http://www.rbz.co.zw/ reports official inflation and CPI estimates.
The Life-Cycle Hypothesis
Do people with high incomes save a larger fraction of their incomes than those with low income? Both theory and evidence suggest they do. The easier it is to make ends meet, the more income is left over for saving. Does it follow from this that richer economies save more than poorer ones—that economies save a larger fraction of total disposable income as they grow? In his famous book, The General Theory of Employment, Interest, and Money, published in 1936, John Maynard Keynes drew that conclusion. But as later economists studied the data—such as that presented in Exhibit 2—it became clear that Keynes was wrong. The fraction of disposable income saved in an economy seems to stay constant as the economy grows.
So how can it be that richer people save more than poorer people, yet richer countries do not necessarily save more than poorer ones? Several answers have been proposed. One of the most important is the life-cycle model of consumption and saving. According to this model, young people tend to borrow to finance education and home purchases. In middle age, people pay off debts and save more. In old age, they draw down their savings, or dissave. Some still have substantial wealth at death, because they are not sure when death will occur and because some parents want to bequeath wealth to their children. And some people die in debt. But on average net savings over a person’s lifetime tend to be small. The life-cycle hypothesis suggests that the saving rate for an economy as a whole depends on, among other things, the relative number of savers and dissavers in the population.
Other factors that influence the saving rate across countries include the tax treatment of interest, the convenience and reliability of saving institutions, national customs, and the relative cost of a household’s major purchase—housing. In Japan, for example, about 25,000 post offices nationwide have offered convenient savings accounts. Japan Post held more than $2 trillion in savings deposits in 2007, making it the world’s largest bank. The postal system accounts for about one-third of Japan’s total savings. (This saving system was on track to be privatized in late 2007.) Also, a home buyer in Japan must come up with a substantial down payment, one that represents a large fraction of the home’s purchase price, and housing there is more expensive than in the United States. Finally, borrowing is considered by some Japanese to be shameful, so households save to avoid having to borrow. Because saving in Japan is necessary, convenient, and consistent with an aversion to borrowing, the country has one of the highest saving rates in the world. In 2006, for example, Japanese households saved 20 percent of their disposable income compared with a saving rate of only about 4 percent in the United States. The saving rate is high in Japan even though interest rates there hover near zero percent (the interest rate on savings deposits in 2007 was only about 0.2 percent).
Sources: Michael Steineberger, “The Global Savings Glut,” New York Times, 11 December 2005; Martin Browning and Thomas Crossley, “The Life-Cycle Model of Consumption and Saving,” Journal of Economic Perspective 15 (Summer 2001): 3–22; OECD Economic Outlook 81 (May 2007); and Japan’s Postal Savings Home Page at http://www.yu-cho.japanpost.jp/e_index.htm.
1. (CaseStudy: Hyperinflation in Brazil) In countries such as Brazil and Russia, which had problems with high inflation, the increased use of another country’s currency (such as the U.S. dollar) became common. Why do you suppose this occurred?
Hyperinflation occurs when inflation is out-of-hand making a currency lose its value while prices soar at an alarming rate ( Sheffrin, 341). Inflation is actually a normal part of an economic cycle which occurs at certain times in a year, but when inflation is not headed towards equilibrium, hyperinflation happens There are many reasons why hyperinflation occurs in an economy. Among the prevalent factors are economic depression, aftermath of a war, as well as political turmoil and social upheavals. Nevertheless, hyperinflation’s symptom is apparent when money supply is excessive and remains unchecked thereby causing an imbalance. The situation is compounded when people immediately get into a state of panic-buying due to speculations that prices would change and the value of money would go down.
Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 341.
2. (CaseStudy: The Life-Cycle Hypothesis) According to the life-cycle hypothesis, what is the typical pattern of saving for an individual over his or her lifetime? What impact does this behavior have on an individual’s lifetime consumption pattern? What impact does the behavior have on the saving rate in the overall economy?
The typical pattern is that young people incur debts to finance education and buy things. In middle age, people try to save and pay off debts while old age is time for dissave or draw down savings. If this is a common behavior for most people, then old people have few money left for them at that time they badly need it : for hospitalization and burial. As for young people, their tendency is to go overboard in their purchases which make them work harder to pay off credit card debts. By the time this young people reach middle age, debts have already piled up since they are burdened with their child’s education and house mortgage. Behavior as illustrated in the case study of Japan has great impact in the saving rate. Since culture in Japan dictates that borrowing is shameful, people save money even if it means almost zero interest in banks. On the other hand, Americans love to borrow as exemplified by heavy usage of credit card. This also affects the economy. In fact, the recent crisis was caused by bad loans in the housing mortgage.