In economics, hyperinflation is defined as extreme economic inflation with prices rising at a very high rate in a very short time.
In order to understand what hyperinflation is, it is important to have clear in mind what inflation is. Inflation is a sustained increase in the general price level of goods and services in an economy over a certain period of time.
With hyperinflation, inflation reaches high levels in short times, therefore quickly eroding the real value of the local currency. In this environment, people, in order to minimize their holdings in the local currency, will switch to more stable and safe assets, like foreign currencies (US Dollar, Euro, etc.).
In an economy, from a more technical point of view, there is hyperinflation when prices have risen by more than 50% per month, which is equivalent to a yearly rate of 12,874.63%.
To illustrate the context, now in major economies around the world, the target inflation rate is at around 2% per year.
In order to measure inflation, monetary authorities and governments use the inflation rate, which is the annualized percentage change in a general price index (usually the consumer price index) over time.
Indexes are made up of baskets of goods and services that are considered representative of household purchases, and therefore can be considered representative of the general market.
If in a specific time period, that basket of goods and services, sees an increase in the price of 2%, it means that there has been inflation.
Indexes are usually computed monthly or quarterly, depending on the necessities of the authorities that need that data, and the most used are The Consumer Price index, The Wholesale Price Index, and the Producer Price Index.
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Causes of Hyperinflation
Hyperinflation can have different causes, all of which are connected with the causes of inflation, however, hyperinflation in history has been caused for the most part by excessive money creation (excessive money supply), implemented in order to finance excessive government budget deficits, especially in moments of severe depression.
Depression consists of a prolonged period in which the economy contracts, it can last years and exhibit a high level of unemployment, an increasing number of bankruptcies, lower productive output and a decrease in the availability of credit.
In order to respond to this situation, central banks tend to increase the supply of money, because it usually tends to encourage banks to lend more, as well as consumers and businesses to spend more, both for consuming and investing purposes.
Even though this process is common and widely used in periods of slow growth or recession, if the increase in money supply is excessive compared to the corresponding growth in the output of goods and services (often identified in the Gross Domestic Product, the measure of the production of goods and services in an economy), the result can lead to hyperinflation.
The main problem is that the excessive increase in money creation with respect to the increase in total output creates a vicious circle, where, given that monetary inflation and price inflation grow at fast rates, the local population is less likely to hold large amounts of the local currency, because it loses its value fastly.
Therefore people will spend it as soon as they earn it, in order to buy assets that hold intrinsic value, or foreign currencies that are more stable.
The problem with this is that when the velocity of money flow increases, the acceleration in prices increases too, which means that the resulting increase in the general level of prices is greater than the increase of the money supply.
It is important to note that, even though the excessive money supply has been historically the main cause for hyperinflation, another common cause is that of negative supply shocks, which in these extreme cases are often associated with wars, natural disasters or political instability.
Effects of Hyperinflation
Even though the effects of hyperinflation may seem similar to those of “common” inflation, they are not. In fact, the main problems with hyperinflation are the violence and destruction that it creates, because of its speed.
When an economy gets hit by a hyperinflationary period, given that inflation gets worse and worse every day, people begin hoarding, because they are worried that the same goods will cost much more tomorrow, or that they can no longer be found.
The compulsory stockpiling of goods leads to shortages, from durable goods to perishable goods, like food and consumables. At this stage, when even the most basic goods become scarce, the economy starts falling apart.
Hyperinflation wipes out the purchasing power of savings of people and makes the afflicted area anathema to investment.
At this stage, when the domestic currency starts becoming almost useless, actors in the economy start to adopt other forms of stable money.
In some cases, where the government is not able to reform the currency, they can decide to legalize the stable foreign currencies, that will since then be used legally for transactions inside the country, allowing then to try to import goods that they are lacking.
For example, during the crisis of hyperinflation that recently hit Zimbabwe, the local money was driven out by foreign stable currencies, mainly the US dollar and the South African rand.
Another common thing that happens in countries experiencing hyperinflation is the printing of money in larger denominations by the central bank, which happens because the smaller denomination notes become worthless.
One of the most notable examples of this is what happened in late 1923 in the Weimar Republic of Germany, where during the hyperinflation that hit the country, the Weimar government’s Reichsbank issued banknotes with a face value of 100 trillion marks (100,000,000,000,000).
This was a necessary measure because, at the height of the inflation, one US dollar was worth 4 trillion German marks.
How it can be solved
One possible solution that countries can use to go out from a situation of hyperinflation, could come from the imposition of the shock therapy.
The shock therapy consists of the sudden release of price and currency controls, withdrawal of state subsidies, and immediate trade liberalization within a country, usually including also large-scale privatization of previously public-owned assets.