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Hyperinflation

A situation where the prices of goods and services rise uncontrollably over a defined time period

What is Hyperinflation?

In economics, hyperinflation is used to describe situations where the prices of goods and services rise uncontrollably over a defined time period. In other words, hyperinflation is extremely rapid inflation.

 

Hyperinflation

 

Generally, inflation is termed hyperinflation when the rate of inflation grows at more than 50% a month. American economics professor Phillip Cagan first studied the economic concept in his book “The Monetary Dynamics of Hyperinflation.”

 

Causes of Hyperinflation

Hyperinflation commonly occurs when there is a significant rise in money supply that is not supported by economic growth. Simply put, it is caused by dramatically increasing the amount of money in an economy.

The increase in money supply is often caused by the government printing and infusing more money into the domestic economy. As there is more money in circulation, prices rise similar to regular inflation.

 

Effects of Hyperinflation

Hyperinflation quickly devalues the local currency in foreign exchange markets as the prices of goods and services rise in conjunction with the increase in money supply. Such a situation, in effect, causes the holder of the local currency to minimize their holdings and switch to more stable foreign currencies.

In an attempt to avoid paying for higher prices tomorrow due to hyperinflation, individuals will typically begin hoarding durable goods such as equipment, machinery, jewelry, etc. In situations of prolonged hyperinflation, individuals will begin to hoard perishable goods.

However, the practice causes a vicious cycle – as prices rise, people hoard more goods, in turn, creating a higher demand for goods and further increasing prices. If hyperinflation continues, it causes a major economic collapse.

Severe hyperinflation can cause the domestic economy to switch to a barter economy, with significant repercussions to business confidence. It can also destroy the financial system as banks become unwilling to lend money.

 

Famous Example of Hyperinflation in the World

Zimbabwe is one country that experienced significant hyperinflation in the past. The Zimbabwean dollar is no longer actively used nowadays; it is officially suspended by the government due to rampant hyperinflation.

A decade ago, during a financial crisis, Zimbabwe recorded the second highest incidence of hyperinflation in history – the country’s inflation rate for November 2008 was a staggering 79,600,000,000% (essentially a daily inflation rate of 98%).

Inflation in Zimbabwe nearly doubled every day – goods and services would cost twice as much each following day. With the unemployment rate exceeding 70%, economic activities in Zimbabwe virtually shut down and turned the domestic economy into a barter economy.

The cause of Zimbabwe’s hyperinflation was attributed to numerous economic shocks. The national government increased the money supply in response to rising national debt, significant declines in economic output and exports, poor government expectations, political corruption, and a weak economy.

However, hyperinflation in Zimbabwe spiraled out of control, causing a foreign currency (such as the South African rand, Botswana pula, United States dollar, etc.) to be used as a medium of exchange instead of the Zimbabwean dollar.

 

Controlling Inflation in the United States: The Federal Reserve

After talking about the detriments of hyperinflation, we can look to the United States on how they control inflation. In the US, the Federal Reserve controls inflation through monetary policies. The Feds commonly control inflation through a contractionary monetary policy – reducing the money supply in the economy. As there is a decrease in the money supply, those with money tend to favor saving money more. It, in turn, reduces spending, slows down the economy, and decreases the rate of inflation.

Tools used by the Federal Reserve to implement a contractionary policy includes increasing interest rates, boosting the reserve requirements for banks, and directly/indirectly reducing the money supply.

 

Additional Resources

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Bartering
  • Fiat Money
  • Real Economy
  • Supply and Demand

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