Friday, April 4, 2008

Hyperinflation - Causes, Costs and Examples

I recently wrote an article about Inflation in Zimbabwe, which has recently passed the 100,000% causing widespread hardship for the population.

Definition of Hyperinflation: A rapid and unchecked increase in the price level. Typically it may involve inflation rates of greater than 100% or greater than 1000% Hyperinflation is often reported per month, or even per day. Another distinguishing feature of hyperinflation is the idea that inflation is out of control. i.e. not only are prices rising rapidly, but the rate of increase is rising rapidly as well. With each cycle inflation gets worse.

Examples of Hyperinflation

— The most severe month of hyperinflation occurred in Hungary in July 1946 when prices increased by 4.19 quintillion per cent (4,190,000,000,000,000,000 %)

— In the same year the Hungarian National Bank issued a 10 quintillion pengo note (one followed by 19 zeros 10,000,000,000,000,000,000)

— During the hyperinflation episode in Germany from 1922 to 1923, the Weimar Republic printed postage stamps with a face value of one billion marks, as prices doubled every two days. At one point in 1923, the exchange rate equalled one trillion Marks to one dollar

— In Yugoslavia prices increased by 5 quadrillion per cent between October 1, 1993, and January 24, 1995

(German Kid playing with Bank Notes
(Other photos show people using bank notes to heat a stove)

What Causes Hyper Inflation

Usually, countries with hyper inflation have the following features

  • Large government debt, usually over 100% of GDP
  • Printing Money. To cope with meeting the debt, the government starts printing money. This decreases the value of existing money creating a multiplier effect where people lose confidence in money and keep demanding wage increases.
  • Reluctance / inability to deal with it. When Germany experienced hyperinflation in the 1920s it was not a phenomena they fully appreciated or understood. Their primary fear at the time was unemployment. They feared that unemployment could precipitate a Communist Revolution so they didn't want to do anything to reduce demand and possibly cause a recession.

Economic Costs of Hyper Inflation

1. Value of Savings falls. In a modern economy, interest rates are usually higher than the inflation rate. For example, if inflation is 5%. Interest rates may be 7%. Therefore, if you keep money in the bank or insurance fund, you maintain the real value of your money. However, when inflation becomes excessive, the rate of inflation is usually much higher than any potential interest rate. Therefore, people with savings see the real value of their wealth wiped out.

  • There is the story of people in Germany who began a saving scheme in 1903. For 20 years they put 10% of their wages into a pension scheme. When they cashed they pension scheme in 1923, it gave them enough money to buy a cup of coffee.

2. Menu Costs. These are the costs of dealing with rapidly rising inflation.

  • A consumer noted that the price of coffee was 5,000 Marks. He ordered one cup of coffee and when he finished drinking that coffee, he ordered another one. When the final bill came to 14,000 Marks he was told that the price of coffee and increased during the time he was drinking the first one.
  • When people got paid at 10am in the morning, they would have to spend it straight away, otherwise the wage would become worthless. There is the story that to pay teachers, the money had to be carried in a lorry. When the lorry came and distributed the wheelbarrows of money, the teachers gave it to relatives who would go off and buy goods straight away.
3. Lack of Confidence in the Finance Sector

The experience of inflation can become engraved on people's mind making them suspicious of financers, bankers and the general economic system. It is no coincidence the Nazi party were able to feed off these suspicions to introduce extremist policies.

4. Lack of Investment and Economic Growth

Ultimately hyperinflation causes people to have lower spending and firms lose confidence in investing. This can cause the economy to slow down and reduce living standards.


Anonymous said...

Thankyou so much!I value your time and effort involved to produce the article on Hyperinflation- an excellent summary of the reality faced currently by Zimbabwians

Anonymous said...

Nice article!
but you should relate it to zimbabwe and write about unemployment as well!=)

Anonymous said...

ebautuslet me givve you the rates for zimbabwe.
1992\40%, 1993-20%, 1994-25%.1995-28%, 1996-16%, 1998-48%, 1999-57%, 2000-55%, 2001-112%, 2002-198.9%, 2004-132.75%, 2005-585.84%, 2006-1281.1%, 2007-66202%, 2008-231 150 888%.
it must have been haer for them, they some even went back to batter exchange

Vincent Cate said...

I have a collection of explanations for the mechanics of hyperinflation. There are a number of different ways to look at it and I think it gives a deeper understanding if you get them all.

Unknown said...

helping me out so much right now... thank you