DP6792 Israel 1983: A Bout of Unpleasant Monetarist Arithmetic

Author(s): Thomas J Sargent , Joseph Zeira

Publication Date: April 2008

Keyword(s): Inflation , Inflation Tax , Public Debt , Rational Expectations

JEL(s): E31 , E50 , H60

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6792.asp.asp

From 1970 to 1985, Israel experienced high inflation. It rose in three jumps to new plateaus and eventually exceeded 400% per annum. This paper claims that anticipated monetary and fiscal effects of a massive government bailout of owners of fallen bank shares caused the last big jump in inflation that occurred in October 1983. Bank shares had just collapsed after a scandal in which it was revealed that banks had long manipulated their share prices. The government promised to reimburse innocent owners for the diminished value of their bank shares, but only after four or five years. The public believed that promise and public debt therefore implicitly increased by a large amount. That implied future monetary expansions. Because that was foreseen, inflation immediately rose as predicted by the unpleasant monetarist arithmetic of Sargent and Wallace (1981).