3/11/2023 - Economy and Finance

Hyperinflation: what is and how to solve it

By julian ramos

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The debate on the origin of inflation and its possible solutions still raises opinions. Instead, when talking about hyperinflation, the points to be discussed are less. This is due, on the one hand, to the fact that this phenomenon is not as common as that of inflation, which makes it more unknown and a less popular topic about which to speak. On the other hand, among the professionals of economic science there is agreement on which situations originate hyperinflation and on the measures that can effectively combat this phenomenon. This note marks the main problems and some of the solutions that countries have implemented in the face of hyperinflation episodes.

What is and what problems brings a hyperinflation?

A hyperinflation is an out-of-control inflation. There are different criteria from which inflation rate is considered hyperinflation. To simplify this issue, we will use the widely accepted definition that uses the economist Philip Cagan (1956) in his article The Monetary Dynamics of Hyperinflation. It points out that an episode of hyperinflation occurs when the price level exceeds 50% monthly and remains above that threshold for several months.

As we mention, hyperinflation is uncontrolled inflation. Therefore, the problems that occur when there is inflation also present, and more acutely, in an episode of hyperinflation. First of all, the purchasing power fell and the wealth falls drastically. Secondly, the currency suffers an extreme devaluation. Thirdly, in view of the rapid loss of purchasing power, people can choose to anticipate the consumption of durable goods (those that can be used often over time). If the consumption part is actually in advance, less money will be allocated to savings and investment.

How do you get out of hyperinflation?

Certainly, the solutions for hyperinflation episodes in the world were not always the same. This is due to the fact that the circumstances in which a country is at the time of dealing with the crisis are different in each case. However, there istwo objectivesGovernments tend to pursue these situations.

The first is to reach thefiscal balance. Since the budget deficit is usually the source of the problem, in an episode of hyperinflation, the authorities try to reduce their expenditure and increase their revenue. The most common measures aim to reduce the state plant, increase taxes and improve the efficiency of the tax system.

The second is to reach theIndependence of monetary authority. An independent central bank means that the government can no longer be supported in issuing notes to cover its fiscal deficit. For this purpose, it is prohibited for the central bank to perform cash benefits without government support. Even so, governments can obtain benefits as long as they can support them in gold or other strong currencies. In addition, achieving this goal can also influence the demand for money. By noting that money is no longer printing without support, people can change their expectations about future inflation and have more confidence in the local currency, increasing the demand for money.

The importance of fiscal balance in solving economic problems

Historically, these two objectives have always been accompanied by other measures accorded to each situation. For example, while some countries that fell into World War II managed to negotiate the suspension of compensation to the winning countries, other governments needed to show political stability to the people before they even thought of a stabilization plan.

Either way, history indicates that the first step to solve a problem of these characteristics is to end the fiscal imbalance that motivates a disproportionate emission of money to be financed. Finally, although the hyperinflationary situation is, at any time, something undesirable, it is also the perfect opportunity to undertake a rigorous plan that can solve the root problem.

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julian ramos

julian ramos

Advanced Bachelor of Bachelor of Economics, University of San Andrés

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