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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 all 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. The increase in money supply is often caused by a government printing and injecting more money into the domestic economy or to cover budget deficits. When more money is put into circulation, the real value of the currency decreases and prices rise.

 

Effects of Hyperinflation

Hyperinflation quickly devalues the local currency in foreign exchange markets as the relative value in comparison to other currencies drops. This situation, will drive  holders of the domestic 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 typically begin investing in durable goods such as equipment, machinery, jewelry, etc. In situations of prolonged hyperinflation, individuals will begin to accumulate perishable goods.

However, that practice causes a vicious cycle – as prices rise, people accumulate more goods, in turn, creating higher demand for goods and further increasing prices. If hyperinflation continues unabated, it nearly always 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.

 

Recent Example of Hyperinflation in the World

Zimbabwe is a country that experienced significant hyperinflation in the past. The Zimbabwean dollar is no longer actively used as it was 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%).

Prices 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, there were significant declines in economic output and exports, and political corruption was coupled with a fundamentally weak economy.

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

In the U.S., the Federal Reserve controls inflation through monetary policies. The Fed commonly dampens 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 reduces spending, slows down the economy, and decreases the rate of inflation.

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

However, the opposite occurred following the Global Financial Crisis of 2008, the Fed increased the money supply dramatically in an attempt to boost the economy.

 

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 CFI resources below:

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

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