(c) Sales and purchases take place at prices that compensate for the expected loss of
purchasing power during the credit period, even if the period is short;
(d) Interest rates, wages, and prices are linked to a price index; and
(e) The cumulative inflation rate over three years is approaching or exceeds 100%. (IAS
No. 29, IASC, 1989).The purpose of the IASB definition is to indicate which enterprises should present
primary financial statements that are stated in terms of the measuring unit current at
the balance sheet date. This requires use of a general price level index, whether the
financial statements are based on a historical cost approach or a current cost ap-
proach.
The FASB has defined a “highly inflationary” economy as one that has cumulative
inflation of approximately 100% or more over a three-year period.^1 The purpose was
to define those foreign operations of companies for which the current exchange rate
method of translation was not appropriate. In the case of foreign operations in
“highly inflationary” economies, the historical exchange rate is used in place of the
current rate. Since the FASB does not require the primary statements of the foreign
operation to be restated for “hyperinflation,” there must be a presumption that using
historical exchange rates based on the U.S. dollar somehow accounts for inflation.
This is debatable, since inflation rates measure the price of goods and services within
an economy, while exchange rates measure the trade conditions between two differ-
ent economies.
An economic theory proposes that exchange rates will maintain purchasing power
parity between two economies. This depends upon exchange rates adjusting for the
differences in purchasing power between two economies with different rates of in-
flation. Thus, if foreign statements were price level adjusted and converted at current
rates, the results might approach an inflation adjustment, if purchasing power parity
held. However, the use of the FASB method for highly inflationary economies does
not adjust for inflation; it ignores it.
20.4 ECONOMIC CAUSES OF INFLATION. Inflationhas been defined by Paul
Samuelson in this fashion: “Inflation occurs when the general level of prices and
costs is rising—rising prices for bread, gasoline, cars; rising wages, land prices,
rentals on capital goods.”^2 The Keynesian economists and the monetarists differ in
their view of the causes of inflation. The Keynesians cite two major causes of infla-
tion: “demand-pull,” where aggregate demand is greater than supply, and “cost-
push.” In demand-pull, there are shortages of products in periods of high demand,
and this leads to increased prices. In cost-push, labor, material, energy, or other input
factors rise and lead to higher prices.
The monetarists, primarily Milton Friedman, hold the theory that the supply of
money is the primary factor determining aggregate demand and that control of infla-
tion is through controlling the money supply. The Keynesians believe that inflation is
controllable with fiscal policies.
There is also an international aspect to inflation. The trade deficits that the United
20.4 ECONOMIC CAUSES OF INFLATION 20 • 3(^1) FAS No. 52, paragraph 11, FASB, 1981.
(^2) Samuelson, 1985, p. 226.