Definition of hyperinflation

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What is hyperinflation?



Hyperinflation, also known as galloping inflation, is an economic situation where there is an extreme rise in the inflation rate within a geographical area.We're talking about inflation of at least 50% per month, according to Phillip Cagan's commonly accepted definition.However, according to the European Union accounting standard, hyperinflation is defined as cumulative inflation over 3 consecutive years exceeding 100%.Increases in the price of goods and services is sudden and uncontrolled.In a hyperinflationary economy, the phenomenon is self-sustaining.Economic agents change their behaviour to adapt to this situation, which has the effect of amplifying it even further.

What are the causes of hyperinflation?



Hyperinflation often has multiple causes and each case is different.However, here are the main causes of this economic phenomenon:

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War:

In the event of a major conflict such as a civil war or an international war, public spending increases very sharply.The deficit widens and the authorities are then forced to resort to monetary creation to pay their debts.

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Major economic crisis

: When a crisis is long-lasting and profound, we talk about economic depression.The affected country needs to undertake very costly structural reforms (spending increases sharply) while taxes collected decrease (revenues decrease).This contributes to the widening of the public deficit.To get out of this situation, the authorities then turn the printing presses to full capacity, which has the effect of significantly devaluing the currency and can thus create hyperinflation.

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Deficit

: If there is a large recurring budget deficit, or a high level of public debt, a country may not be able to honour its debts to its creditors.To avoid default, the concerned country’s central bank can then significantly increase the level of money supply.The deficit is then financed by money creation.This leads to a sharp devaluation of the currency and galloping inflation.

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Trade balance

: If the level of imports is far too high compared to exports, then the trade balance is in sharp deficit.There are then more capital outflows than inflows.As a result, the currency depreciates permanently and this can cause hyperinflation.

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Lack of regulation

: To avoid facing excessive inflation, there are several mechanisms.The first is central bank’s control of the exchange rate.For example, it may decide to intervene in the markets if the level of inflation exceeds a certain threshold.The second mechanism is the temporary closure of banks when there is a crisis of confidence, to avoid a bank run and a drop in the level of savings.Other emergency regulatory measures can be taken to avoid falling into a major economic crisis (stopping quotations, etc.)

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Wage indexing on inflation

: In a hyperinflationary economy, wages increase very sharply to avoid a fall in household purchasing power.There is then an increase in temporary consumption that causes a sudden increase in prices.A vicious circle develops and, to cover the public deficit, this leads to a sharp increase in the money supply and therefore in the level of inflation.

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Exchange rates

: If the value of the currency depreciates sharply against other currencies, the cost of imports becomes much higher.On the contrary, with strong currency appreciation, the level of exports collapses.Exchange rate volatility can then create a large trade balance deficit.The deficit widens and the authorities have no choice but to turn the printing presses to meet their expenses.

What are the consequences of hyperinflation?



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Fall in savings level

: Due to the sharp rise in the price of goods and services, households are no longer able to save.All their income is consumed instantly in an attempt to maintain their standard of living.For the poorest households, income is used to pay for the basic necessities of food and housing.Hyperinflation causes people to empty their bank accounts.This is what we call a bank run.There is a total loss of confidence in the economic circuit.We can see the occurrence of the hoarding phenomenon.

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Increase in poverty

: Hyperinflation causes a collapse in household purchasing power.The cost of living rises sharply.The poorest households are the first to be affected.The increase in poverty is also fuelled by a very high unemployment rate.

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Loss of confidence in the currency

: The currency has almost no value due to its sharp depreciation on the foreign exchange market.All economic agents try to sell that currency to buy other currencies.There is a significant capital flight.Within the affected country, currency loses its role as a means of exchange in favour of barter.

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Deep and lasting economic crisis

: The fall in consumption linked to rising prices leads to a collapse in production and investment.The country is then hit by economic depression (prolonged recession).To get out of the crisis, painful structural reforms are needed.The whole economic system is called into question.

Example of hyperinflation



The best known example is German hyperinflation.At the end of the First World War, Germany was crippled with debts and experienced a major economic crisis.Its budget deficit was very high and its massive use of borrowing during the War forced the central bank to significantly increase the money supply (banknote printing technique).The inflation rate exploded and wages were indexed on it, so the price increase was severe between 1921 and 1923.A peak was reached in 1923 with a monthly inflation peak of 23,000%.At that time, prices increased by 20% per day.That year, the value of the Mark against the Dollar plummeted from 49,000 in January to 4,200 billion Marks in November 1923.

Other examples of hyperinflation include Hungary in 1946 (150% price increase per day), Zimbabwe in 2008 (100% daily inflation and 100,000% annual inflation) and Venezuela in 2016 (800% annual inflation).

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