HYPERINFLATION

SUBJECT: MACRO-ECONOMICS
LECTURER: MS ARIBAH ASLAM
PRESENTED BY: UMAIMA UMAIR
 Hyperinflation
Table of Contents
1.What is Hyperinflation?

2.What are the causes of

Hyperinflation?

3.Case study on Zimbabwe.

4.Measures suggested to
overcome Hyperinflation.
CAUSES

API120 - Prof. J.Frankel

HYPERINFLATION GRAPH

API120 - Prof. J.Frankel

 The world’s
most recent
hyperinflation:
Zimbabwe,
2007-08
Inflation reached
50% per month
in March 2007,
meeting definition
of hyperinflation.

It reached
2,600% per mo.
in mid-2008.
One estimate: In Nov. 2008, inflation rate p.a. supposedly at 89.7 sextillion (1021)%.
Dec. 2008, inflation p.a. at (6.5 x 10108 %).

In April 2009, printing of the Zimbabwean dollar stopped;

the S.Afr. Rand & US $ became the standard currencies for exchange.
 Cost of
hyperinflation
shoe leather

The central bank

monetized
government debt.
The exchange rate
increased
along with
the price level.
Both increased
far more than
the money supply.
Why?
When the ongoing
inflation rate is
high, the demand
for money is low,
in response.
For M/P to fall,
P must go up
more than M. API120 - Prof. J.Frankel
 How do governments finance spending?
• Taxes
• Borrowing
● Domestic †
● Abroad
• Seigniorage ≡ creating money to finance deficits
Inflation tax ≡ Money creation in excess of
money demand justified by real growth.
† Regarding government borrowing, you may encounter
-- “Ricardian” debt neutrality (Barro):
People know taxes eventually will rise; so Saving ↑ .
-- “Fiscal dominance” (Sargent & Wallace; Woodford): people know
that the debt eventually will be monetized. So P ↑ .
API120 - Prof. J.Frankel
 The inflation tax can be a major source of government finance,
(which is lost if the country gives up its independent currency).
Pre-euro revenues from the inflation tax, Greece, 1845-2000
20
Estimates of the inflation tax as
as percent of GDP
π/(1+π) x Money/GDP Years in external
default
15 are shaded

Based on:
M2 or M3
10
M0 or M1
Percent of GDP

5 [Data not available

during WWII
hyperinflation]

-5

-10
1845 1855 1865 1875 1885 1895 1905 1915 1925 1935 1945 1955 1965 1975 1985 1995

Carmen Reinhart & Christoph Trebesch, 2015, “The Pitfalls of External Dependence: Greece, 1826-2015,”
Brookings Panel on Economic Activity,” September 10
 But a government that relies too much
on seigniorage to raise real resources risks
“killing the goose that lays the golden egg.”

• High money growth eventually gets built into expected

inflation; and so the public reduces money demand
– whether because πe is built into i (Fisher effect)
– or because πe enters the money demand function directly.
• Bond markets often break down in hyperinflations.
– So M/P = L(πe , Y)

• When demand for real money balances

falls, there is less of a “tax base”
that the government can exploit.
API120 - Prof. J.Frankel
 INFLATION TAX

Real money supply = real money demand:

If πe rises, real money demand falls,

as households protect themselves In LR: Y = 𝑌ത , and
against the loss in purchasing power. e
𝑑𝑀/𝑑𝑡
π = π = gM , where gM ≡ ,
In “steady state,” the actual 𝑀
& expected rates of inflation =>
= the rate of money growth.
The fall in real M takes the form of a transitional rise in P > rise in nominal M.

Seignorage = dM / dt 1
The government gets to spend P
at rate dM/dt in nominal terms. dM / dt M

Divide by P to see what that M P
buys in terms of real resources. ത
= gM L(π, 𝑌)

A higher “tax rate” (inflation) lowers “Inflation ↑ ↑

the “tax base” (real money holdings). tax = “tax “tax
revenue” rate” base”
API120 - Prof. J.Frankel
27.2

Where π went the highest, P went up the most,

even relative to the increase in M: M/P ↓.

π
API120 - Prof. J.Frankel
 Inflation tax revenue
is “tax rate” times “tax base.”

API120 - Prof. J.Frankel

 Seignorage revenue
as a function π L(π)
of money growth rate

If inflation is very high,

seignorage is very low.
You have killed the goose
If money The seignorage- that laid the
growth = 0, maximizing rate golden eggs.
seignorage = 0. of money growth

11.7 API120 - Prof. J.Frankel

 For govt. to maximize seignorage,
Seignorage = π L(π,Y)
𝑑𝑆𝑒𝑖𝑔𝑛𝑖𝑜𝑟𝑎𝑔𝑒 𝑑𝐿
= L( , ) + π
𝑑π 𝑑π

E.g., following Cagan (1956), we choose exponential functional form:

Let L( , ) ≡ e a-λπ Y .

=> dL(,)/dπ = - λe a-λπ Y = -λ L(,).

𝑑𝑆𝑒𝑖𝑔𝑛𝑖𝑜𝑟𝑎𝑔𝑒
= L(,) – π λ L(,)
𝑑π
= L( ,) [1– π λ]
Set derivative = 0.
=0 when π = 1/ λ
We thereby find that revenue-
maximizing π is inversely
related to λ, i.e., the sensitivity E.g., if λ=1/2,
of money demand to π. revenue-maximizing π=200%.
Or higher, if in SR λ is lower.
 The seigniorage-maximization approach
doesn’t get to true levels of hyperinflation,
if the revenue curve peaks at lower levels of inflation.

One needs a dynamic process, where

• money-holders respond more adversely to inflation
over time than they do in the short run, and
• the central bank chases a receding seignorage target.
Cagan (1956) modeled adjustment in continuous time.
(Or Romer, 4th ed., pp. 572-576)

API120 - Prof. J.Frankel

 Consider a stylized example of the dynamic process,
which could end up at hyperinflation
• Assume
– Elasticity rises over time from short run to long, and
– Government tells CB to finance budget target by seigniorage (say, 92% GDP).

• In VSR, elasticity is low. Seigniorage target can be reached

with moderate rates of money creation & inflation π1 .
• Then, in SR, elasticity rises.
=> demand for money falls => π1 no longer raises enough real revenue.
 CB raises money growth & inflation to π2 to attain required revenue.
• In MR, elasticity rises more => π2 no longer raises enough revenue.
 CB raises money growth & inflation to π3 .
• In LR, elasticity rises more => π3 no longer raises enough revenue.
 CB raises money growth & inflation to π4 ,
which is now past the revenue-maximizing hump.
A foolish government might chase its target indefinitely.
 Seignorage = π L(π) with functional form L(π) =e a-λπ Y.

VSR
SR
Assume govt. requires

··
seignorage 92% of GDP MR

·
·
LR

?
inflation rate π
API120 - Prof. J.Frankel
 Appendix: Exchange rates in hyperinflations

Increases in the exchange rate

S.Hanke
The exchange rate in Zimbabwe’s hyperinflation

“Parallel rate”
(black market)

Official rate