Hyperinflation (Economics) – Definition

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Hyperinflation Definition

Hyperinflation is exceptionally fast or unmanageable increase in prices – a condition largely brought about by disproportionate deficit spending via excessive printing of money. Hyperinflation greatly reduces the value of currency and renders it unusable as a medium of exchange. Statistically, hyperinflation occurs when a country’s inflation rate exceeds 50 percent over the period of a month. Although a rare occurrence, hyperinflation, has already affected major economies several times in the past century.

A Little More on What is Hyperinflation

In the context of economic downturns, hyperinflation is brought about by a substantial increase in the supply of currency on the one hand, and a poor gross domestic product (GDP) growth on the other, thus leading to a huge disparity between supply and demand of currency. Unless controlled, hyperinflation will cause unnatural spike in prices of commodities following the fall of the currency. During hyperinflation, price increases can be measured on a daily basis. This is in sharp contrast to normal inflation, where price increases are measured on a monthly basis.

During military conflicts, hyperinflation may be brought about by diminishing faith in a currency’s capability to preserve its value in the aftermath of the conflict. This is the reason why sellers often mandate the payment of a risk premium (via inflated prices of commodities) to accept payments in terms of the affected currency. This abrupt increase in prices invariably brings about hyperinflation.

Hyperinflation Is a Manufactured Catastrophe

Hyperinflation and the resultant loss in confidence of citizens in a country’s currency results in mass hoarding of commodities that are perceived as essential or invaluable. Hoarding causes scarcity of essential commodities such as food and fuel and results in abrupt increase in their prices. The government’s resultant push to print more currency to balance commodity prices through a steady cash flow only aggravates the problem.

Effects of Hyperinflation

Hyperinflation has several cascading consequences. Hoarding of essential commodities causes an immediate scarcity and as a result, it leads to abrupt increase in prices. People also tend to hoard money instead of depositing it in banks, affecting financial institutions to such an extent that many go bankrupt. The government loses revenue significantly, thus affecting its capability to provide even basic amenities to its citizens.

Examples of Extreme Hyperinflation

Experts attribute hyperinflation to political pandemonium, rather than economic turmoil. One resounding example of extreme hyperinflation would be of the economic mayhem preceding the dissolution of erstwhile Yugoslavia during the end of the 20th century. Annual inflation rates in the country were pegged at a whopping 75 percent, caused mainly by gross financial mismanagement by the political rulers of the then Serbian province. The government’s move to print more currency greatly exacerbated the problem and its treasury was left virtually penniless.

Hyperinflation obliterated the country’s economy, forcing its citizens to barter essential commodities. The inflation rate increased at an unbelievable 300 million percent per month! There was an acute shortage of food, and production, which was now controlled by the government, came to a standstill. It was only after the government dissolved its currency and adopted the then German Mark that the colossal turmoil finally ended. Nevertheless, this did not prevent the breakup of the country.

References for Hyperinflation

Academic Research on Hyperinflation

Rational expectations and the dynamics of hyperinflation, Sargent, T. J., & Wallace, N. (1973). International Economic Review, 328-350.

The forward exchange rate, expectations, and the demand for money: The German hyperinflation, Frenkel, J. A. (1977). The American Economic Review, 653-670. This paper provides further evidence on the role of expectations in affecting the demand for money during the German hyperinflation. This paper examines three measures of expectations that are derived from observed data from the market for foreign exchange. The emphasis on measures of expectations that are based on data from the foreign exchange markets reflects the belief that in an inflationary economy with flexible exchange rates one of the relevant substitutes for holding domestic money is foreign exchange.

On the measurement of Zimbabwe’s hyperinflation, Hanke, S. H., & Kwok, A. K. (2009). Cato J.29, 353. This paper presents Zimbabwe’s experience of hyperinflation, thus being the first country to experience this condition in the 21sr century. The paper presents the government termination of the reporting of official inflation statistics  prior to the final explosive months of Zimbabwe’s hyperinflation. This paper demonstrates that standard economic theory can be applied to overcome this apparent insurmountable data problem. The paper produces the only reliable record of the second highest inflation in world history.

The hyperinflation model of money demand revisited, Taylor, M. P. (1991). Journal of money, Credit and Banking23(3), 327-351. This paper proposes a test of the hyperinflation model of money demand which is valid under any assumption concerning agents’ expectations, subject only to the restriction that forecasting errors are stationary. It also demonstrates that highly efficient parameter estimates can be obtained, and restrictions on them tested, under the same weak assumption. The paper also shows how these first-stage estimates can be utilized to test the stronger assumption of rational expectations.

Budget deficits, stability, and the monetary dynamics of hyperinflation,, Kiguel, M. A. (1989). Journal of Money, Credit and Banking21(2), 148-157. In this paper, the authors explores the claim that hyperinflation processes usually occur in countries with extremely large budget deficits. They however show that in models of inflationary finance with rational expectations, the above case would not hold.  The purpose of this paper is to reconcile the standard theoretical model with the stylized facts. The paper also provides an explanation for the ineffectiveness of moderate reductions in the deficit in reducing inflation and argues that fiscal lags can be destabilizing.

Money demand during hyperinflation, Abel, A., Dornbusch, R., Huizinga, J., & Marcus, A. (1979). Journal of Monetary Economics5(1), 97-104.

Rational bubbles during Poland’s hyperinflation: implications and empirical evidence, Funke, M., Hall, S., & Sola, M. (1994). European Economic Review38(6), 1257-1276. This paper investigates the argument that the Polish hyperinflation at the end of the eighties was too excessive to be attributed to market fundamentals only. In this paper a range of indirect non-structural and structural tests for rational, exploding deterministic and stochastic bubbles are carried out. The study adopts a new strategy which allows for the possibility of switching regimes in the time series properties of the data to allow for both indirect tests and structural tests for the presence of stochastic bubbles.

The Hungarian hyperinflation and stabilization of 1945-1946, Bomberger, W. A., & Makinen, G. E. (1983).. Journal of Political Economy91(5), 801-824. This paper focuses on the most intense hyperinflation in world history, which is that of Hungary after the World War II. It also explores the reforms of August 1946 which led to a successful stabilization of prices. This paper describes and analyzes the unique policies and institutions that produced these phenomena

Exchange rate rules, black market premia and fiscal deficits: the Bolivian hyperinflation, Kharas, H., & Pinto, B. (1989). The Review of Economic Studies56(3), 435-447.

 

Further evidence on expectations and the demand for money during the German hyperinflation, Frenkel, J. (1978). This paper provides further evidence on the role of expectations in effecting the demand for money during the German hyperinflation. This paper examines three measures of expectations that are derived from observed data from the market for foreign exchange. The emphasis on measures of expectations that are based on data from the foreign exchange markets reflects the belief that in an inflationary economy with flexible exchange rates one of the relevant substitutes for holding domestic money is foreign exchange.

 

 

Cointegration and Cagan’s model of hyperinflation under rational expectations, Engsted, T. (1993). Journal of Money, Credit and Banking25(3), 350-360. In this paper, the author argues that the Cagan’s model of hyperinflation is unjustified when calculating the German Inflation. Based on a straightforward extension of the cointegrated VAR-approach suggested by John Y. Campbell and Robert J. Shiller (1987), a method to evaluate the Cagan model under rational expectations and no bubbles is proposed and implemented to the German data.

 

The demand for money during hyperinflation under rational expectations: II, Salemi, M. K., & Sargent, T. J. (1979). International Economic Review, 741-758. In the recent literature Sargent and Wallace (IER, June, 1973) have estimated the demand equation for money in hyperinflation under the restriction that the adaptive formula of Phillip Cagan yields rational inflation expectations in the sense of John Muth. The present paper finds evidence to reject for the Germany case the proposition that adaptive expectations are rational. The paper also puts forward and applies a two-step procedure to estimate the important money demand elasticity in hyperinflation.

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