Hyperinflation

What causes hyperinflation?

There are three main causes of hyperinflation and they are:

• higher supply of money
• demand-pull inflation
• cost-push inflation.

An increase in the supply of money is usually due to the government printing large amounts of money to the point that the value of the money begins to drop. When the value of money drops and yet more of it is being printed, this causes prices to increase.

The second reason for hyperinflation is demand-pull inflation. This is when the demand for goods/services is greater than the supply, which in turn causes prices to increase as shown in Figure 1. This can result from a rise in consumer spending that's linked to an expanding economy, a spike in exports, or increased government spending.

Finally, cost-push inflation is also another cause of hyperinflation. With cost-push inflation, production inputs such as natural resources and labor begin to get more expensive. As a result, business owners tend to raise their prices in order to cover increased costs and still be able to make a profit. Since the demand remains the same but production costs are higher, the business owners pass on the increase in prices to the customers and this, in turn, created cost-push inflation.

Figure 1 above shows demand-pull inflation. The aggregate price level in the economy is shown on the vertical axis, whilst real output is measured by real GDP on the horizontal axis. The long-run aggregate supply curve (LRAS) represents the full employment level of output that the economy can produce labelled by Y_F. The initial equilibrium, labelled by E₁ is at the intersection of the aggregate demand curve AD₁ and the short-run aggregate supply curve - SRAS. The initial output level is Y₁ with the price level in the economy at P₁. A positive demand shock causes the aggregate demand curve to shift to the right from AD₁ to AD₂. The equilibrium after the shift is labelled by E₂, which is located at the intersection of the aggregate demand curve AD₂ and the short-run aggregate supply curve - SRAS. The resulting output level is Y₂ with the price level in the economy at P₂. The new equilibrium is characterized by higher inflation due to an increase in aggregate demand.

Both demand-pull inflation and a higher supply of money are usually happening at the same time. When inflation begins, the government might print more money to try to better the economy. Instead due to the significant amount of money in circulation, prices begin to rise. This is known as the quantity theory of money. When people notice the prices rising they go out and buy more than they normally would to save money before the prices get even higher. All of this extra purchasing is creating shortages and higher demand which in turn pushes inflation higher, which could cause hyperinflation.

Effects of hyperinflation

When hyperinflation sets in, it causes a series of negative effects occur. These consequences include:

• Decrease in the standard of living
• Hoarding
• Money losing its value
• Banks closing

Hyperinflation: Decrease in the standard of living

In the case of ever-increasing inflation or hyperinflation where wages are being kept constant or not being increased enough to keep up with the rate of inflation, prices for goods and services are going to keep rising and people will not be able to afford to pay their living expenses.

Hyperinflation: Hoarding

Another consequence of hyperinflation setting in and an increase in prices is that people begin to hoard goods such as food. Since the prices have already risen they assume the prices are going to keep increasing. So in order to save money, they go out and purchase larger amounts of goods than they would normally. For example, instead of buying one gallon of oil, they might decide to buy five. By doing this they are causing a shortage of goods which ironically is only going to increase the price further as demand becomes greater than supply.

Hyperinflation: Money loses its value

Money ends up being worth less for two reasons during hyperinflation: an increase in supply and a decrease in purchasing power.

The more there is of something, the less it usually costs. For example, if you're purchasing a book by a famous author, the price might be around $20 or $25. But let's say the author released 100 pre-signed copies of the book. These are going to be more expensive because there are only 100 copies like this. Using the same reasoning, the increase in the amount of money that's in circulation means that it's going to be worth less because there's so much of it.

A decrease in purchasing power also devalues the currency. Due to hyperinflation, you can buy less with the money that you do have. Cash and any savings you might own decrease in value since the purchasing power of that money has gone down significantly.

Hyperinflation: Banks closing

When hyperinflation begins people begin to withdraw more of their money. They usually are spending the money on hoarding goods during times of hyperinflation, paying increasingly high bills, and the rest that they have they want to keep with them and not in a bank, because trust in banks goes down in unstable times. Due to the decrease of people keeping their money in the bank, the banks themselves usually go out of business.

Impact of hyperinflation

The impact that hyperinflation has on someone depends on the type of person we're talking about. There is a difference between how inflation or hyperinflation is going to affect people of different tax brackets, and businesses vs the average consumer.

For a family that is low to middle class, hyperinflation affects them harder and sooner. A rise in prices for them could completely change the way that they budget their money. For those who are upper-middle to higher class, hyperinflation takes longer to affect them because even if prices start increasing, they have the money in order to pay it without it forcing them to change their spending habits.

Businesses lose out during hyperinflation for a couple of reasons. One of the reasons is that their customers have been affected by hyperinflation and thus are not out shopping and spending as much money as they did before. The second reason is that due to prices increasing, businesses have to pay more for materials, goods, and labor. With an increase in costs needed to run their business and a decrease in sales, the business suffers and might close its doors.

Those who profit are exporters and borrowers. Exporters are able to make money off of their countries' suffering from hyperinflation. The reason behind that is the devaluation of the local currency making exports cheaper. The exporter then sells these goods and receives foreign money as payment which holds its value. Borrowers also have some benefits as the loans that they took out practically get erased. Since the local currency keeps losing value, their debt is practically nothing in comparison.

Hyperinflation examples

Some hyperinflation examples include:

• Vietnam in the late 1980s
• former Yugoslavia in the 1990s
• Zimbabwe from 2007 to 2009
• Turkey since the end of 2017
• Venezuela since November 2016

Let's discuss the hyperinflation in Yugoslavia in a bit more detail. An example from not too long ago of hyperinflation is former Yugoslavia in the 1990s. On the brink of collapse, the country had already been suffering from high inflation rates of over 75% per year.¹ By 1991, Slobodan Milosevic (the leader of the Serbian territory) had forced the central bank to give loans worth over $1.4 billion to his associates and the bank was left practically empty. To stay in business the government bank had to print significant amounts of money and this caused the inflation already present in the country to skyrocket. The hyperinflation rate was practically doubling daily from that point on until it reached 313 million percent in the month of January 1994.¹ Lasting over 24 months this was the second-longest hyperinflation ever recorded with the number one spot belonging to Russia in the 1920s which was over 26 months long.¹

Figure 2. Hyperinflation in Yugoslavia 1990s, StudySmarter Originals. Source: The Yugoslav Hyperinflation of 1992-1994

As seen in Figure 2 (which depicts annual levels as opposed to monthly), although 1991 and 1992 were also suffering from high rates of inflation, the high rates are practically invisible on the graph compared to the hyperinflation rate in 1993. In 1991 the rate was 117.8%, in 1992 the rate was 8954.3%, and in late 1993 the rate reached $1.16\times {10}^{14}$or 116,545,906,563,330% (over 116 trillion percent!). This goes to show that once hyperinflation sets in, it becomes far too easy for it to get more and more out of control until it collapses the economy.

Prevention of hyperinflation

While it is difficult to tell when hyperinflation is going to hit, some things can be done by the government to slow it down before it gets to be difficult to come back from:

• Set up governmental controls and limits on prices and wages - if there's a limit on prices and wages, businesses will not be able to increase prices past a certain point which should help stop/slow the rate of inflation.
• Reduce the supply of money in circulation - if there's not an increase in the supply of money, devaluation of the money is less likely to occur.
• Reduce the amount of government spending - decreased government spending helps slow economic growth, and with it, the rate of inflation.
• Make banks loan less of their assets - the less money there is to lend, the less money customers will be able to borrow from the bank, which decreases spending, thereby reducing the price level.
• Increase the supply of goods/services - the more of a supply there is of goods/services, the smaller of a chance there is of cost-push inflation.