Israel 1983: A bout of unpleasant monetarist arithmetic

This paper claims that anticipations of a massive future government bailout of owners of fallen bank shares suddenly caused a big jump in inflation in Israel in October 1983. That month, the government promised that four or five years later it would compensate people for the fall in the value of their bank shares. We reason that the public believed that promise, that it understood that the public debt must jump, and further that the public anticipated that the government would finance that debt via an eventual monetary expansion. That sparked an immediate jump in inflation via the unpleasant monetarist arithmetic of Sargent and Wallace (1981).

► In 1983, inflation in Israel jumped from 120% annually to more than 400%. ► Israeli banks had manipulated share prices in a Ponzi game. ► In 1983, the banks share prices collapsed. ► The government promised to buy the shares at pre-collapse value after 5 years. ► Via unpleasant monetarist arithmetic, inflation jumped immediately in 1983.