What Is Hyperinflation? Definition, Causes and Effects
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Hyperinflation is uncontrollable increases in the price of goods or services over time. Nations experience hyperinflation because of poor monetary or economic policy, including the uncontrolled release of money into the economy. The solutions to hyperinflation often hurt economies just as much as the hyperinflation itself.
Inflation is at the top of everyone’s minds right now. Prices for goods and services are still up year over year, even if the numbers do not look as bad for November as they did in October.?
But for all the talk of inflation, it could always be worse. Continued inflation can temporarily stifle economic growth and create issues for consumers and businesses alike. But another financial condition, called hyperinflation, is dire. Whereas inflation might cause temporary disruption, hyperinflation can cripple an economy.
What Is Hyperinflation?
Hyperinflation is an explosive increase in the monthly inflation rate. Economists describe hyperinflation as an inflation rate greater than 50 percent each month or 600 percent in a year. In this scenario, an item that costs $1 on Jan. 1 would cost $130 on the same day in the following year.
Hyperinflation vs. Inflation: What’s the Difference?
The simple answer is that hyperinflation is inflation on a massive scale.
A low level of inflation — 2 percent per year — might signify a healthy economy. The slow price increases can encourage people and businesses to spend or invest. People may still notice inflation over time, but it is less drastic or alarming.
When prices spike exponentially — such as a gallon of milk going from $1.50 to $3 over a month — it is hyperinflation.?
Causes of Hyperinflation
No single shock can explain sustained hyperinflation, but it typically occurs because of three main factors:
Drastic Increase in Money Supply
Nations that drastically increase the supply of paper money (printing money) to pay for government spending can induce an increase in prices as regular inflation. As more money enters circulation, the real value of currency decreases.?
Real-world examples of this include:
Post-World War I Germany
One of the 20th century’s most significant and studied hyperinflation events occurred in Germany. After its defeat in World War I, the Weimar government of Germany was saddled with debt and reparations it could not pay with currency. In addition, the Treaty of Versailles placed significant restrictions and pressure on Germany to limit its war-making abilities. These pressures — which included the inability to import goods or to rely on cheap raw materials from former colonies — created a perfect recipe for inflation.
The Weimar government printed more money to pay the reparation debts, which led to hyperinflation — at one point as high as 29,500 percent. German workers would return home with suitcases full of cash that could not even pay for a newspaper.?
Post-World War II Hungary
Hungary also experienced significant hyperinflation in the aftermath of World War II, at an even larger scale than the Weimar Republic. Between August 1945 and July 1946, prices for goods and services rose at a rate of more than 19,000 percent per month (19 percent per day). Hungary’s government increased its money supply by a factor of 1.19 x 1025.
War
The destabilizing nature of war is not a direct cause of hyperinflation. What war does, however, is create conditions that are a breeding ground for it. Wars often paralyze the economies of the nations involved. The economic conditions that led to hyperinflation in Germany were due partly to damaged infrastructure and production capacity during the war and significant debts.
Demand-Pull Inflation
Demand-pull inflation describes the rise in prices when interest in goods (aggregate demand) surges beyond the ability of producers to make it (aggregate supply). The resulting shock drives up the cost of goods and services. Demand-pull inflation tends to occur because of the following factors:
Effects of Hyperinflation
Hyperinflation can have catastrophic effects on households and businesses alike. Hyperinflation leaves consumers unable to pay for necessities and throws companies into chaos. This, in turn, leads to the following problems:
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Supply Shortages and Hoarding
The significant hallmarks of hyperinflation are severe supply shortages and instances of hoarding. As people begin to fear exorbitant prices for perishable goods, they accumulate them in larger quantities. This creates even more increased demand and prices and, eventually, the conditions that lead to hoarding.?
Spending More to Buy Less
Because high inflation severely limits the buying power of individuals, hyperinflation forces consumers to purchase significantly fewer goods with more money. When combined with hoarding and supply shortages, it creates a vicious cycle.
Failing Businesses
As businesses can no longer order replacement products or purchase raw materials to create new products, they will no longer be able to serve their customers. Before long, they may have to pull money from savings or rely on credit to survive.
Increased Unemployment
As businesses lose money, they must cut back on spending. One of the highest costs businesses incur is payroll. Companies layoff or furlough workers to save money.
Banks Unable to Offer Financial Assistance
Banks are not immune from the effects of hyperinflation, either. When banks do not receive deposits and individuals or businesses pull their funds out to weather the inflationary storm, those banks may fail. Banks that go out of business cannot provide loans or services to customers, adding to the cycle.
In many cases, unchecked hyperinflation prefaces economic collapse.?
Resolving Hyperinflation
Once the hyperinflation cycle starts, it is nearly impossible to stop. But governments can combat it with a few critical policy decisions. However, one thing to remember is that no measure to correct hyperinflation is without pain.?
Dramatic Decrease in Government Spending
One of the most common ways to resolve hyperinflation is to slash government spending drastically. Governments cease paying for many things citizens take for granted, including social spending, the military and subsidies to businesses like farms and other producers.
Increase Interest Rates to Slow the Money Supply
Raising interest rates slows the money supply, making it difficult for consumers and businesses to make large purchases (like new homes or cars). High interest rates can also make it difficult for businesses to spend funds on payroll, causing the unemployment rate to rise.
Replace National Currency With Foreign Currency
In some cases, a nation whose national currency has been drastically devalued by hyperinflation may choose to replace that currency with a foreign one. This became the case in Ecuador, whose 1998 economic crisis caused many depositors to conclude that banks had become unsafe. Those depositors began to withdraw vast sums of money. The exchange rate collapsed and led to hyperinflation.
To solve this issue, Ecuador “spontaneously” switched its national currency to the United States dollar in a process called dollarization.
Final Thoughts on Hyperinflation
Even with rising inflation, many economists do not believe the United States is headed toward hyperinflation. Because it remains significantly lower than the 50 percent per month required to meet the definition, most economists are not worried. In addition, the Federal Reserve is actively suppressing the flow of money by raising interest rates.
Even though hyperinflation may be unlikely, investors can still take steps to avoid the impact of inflation on their portfolios. They can build a balanced portfolio that includes assets, real estate and commodities.?
Preparing for inflation is also essential for consumers, who should look closely at their budgets and adjust where possible. Reducing adjustable-rate debt — such as credit cards or home equity lines of credit — or converting it to fixed rates can help consumers save, as can cutting back on purchasing things that are not necessities.
Top Takeaways
(Reporting by NPD)?