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The risk of nations - inflation

03/14/2015

The third, and final, risk is inflation. We view inflation as less important to companies because it does not have a direct impact on demand (except when extreme). But it makes pricing difficult and changes consumer behavior. Germany has the best performance, Turkey the worst.

Measuring inflationary risk (as opposed to measuring inflation) is difficult. Three problems arise:

Our measure is the probability of having more than 5% inflation in any given year (1970-2013), weighted towards recent years.* 5% is a common cut-off in the economic literature, and it downplays hyperinflation which is not a recurring phenomenon in any country.

Below are the low inflation-risk countries based on this index. Not surprisingly, Germany, Switzerland, Japan, and the United States are among the best performers. Other EU countries are not far behind. Small countries with currencies pegged to large stable currencies also do well.

Bar Chart

The high inflation-risk countries have some surprises. Brazil is an abysmal sixth to last, South Africa fourth, and Turkey last. Brazil exceeded 5% inflation in 42 of the past 43 years.

One reason that some countries systematically pursue inflationary policies is that it serves as a tax. Governments with poor tax collection capabilities print money to pay for public services. This in turn leads to inflation–a deliberate choice.

The full list of countries is shown below. The global median is 58%.

Go to the first installment in this series: Economic Risk

Go to the second installment in this series: Currency Risk

Go to the fourth installment in this series: Total Risk

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* We use absolute inflation rather than the variability (standard deviation) of inflation. That is, the risk is inflation itself rather than changes in inflation. This differs from our GDP and currency measures of risk.

I.e., if 12 of 43 years have inflation >5%, then the probability is 12/43=28% (but with a weight to later years). The 5% cut-off corresponds to much of the literature.