Hyperinflations and Stabilization

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Hyperinflations and Stabilization

• Programs

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Data Facts

• In 1913, the value of all currency circulating in
  Germany was 6 billion marks. Ten years later, in
  October 1923, 6 billion marks were barely enough
  to buy a one-kilo loaf of bread in Berlin. A
  month later, the price had increased to 428
  billion marks.
•  
• The German hyperinflation of the early 1920s is
  probably the most famous hyperinflation.
  (Hyperinflation simply means very high inflation)
  But it is not the only one.  
•  

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A first set of examples

• The table below summarizes the seven major
  hyperinflations that followed World War I and
  World War II. They share several features. They
  were all short (lasting for a year or so), but
  intense, with monthly inflation running at about
  50 or more.
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More Facts

• The increase in the price was staggering.
• The largest price increase was reached in Hungary
  after WWII. Such rates of inflation had not been
  seen before nor have they been seen since.
• The closest case in the recent past occurred in
  Bolivia. From January 1984 to September 1985,
  Bolivian inflation averaged 40 per month,
  implying a roughly 1000-fold increase in the
  price level over 21 months.

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A second set of examples
More Facts

• Many countries, especially, in Latin America,
  have struggled with prolonged bouts of high
  inflation. Argentina, Brazil, Nicaragua, and Peru
  experienced monthly inflation rates in excess of
  10 for more than a decade (roughly from 1976 to
  early 1990s).
• All four countries have now returned to low
  inflation. (Between 1996-98, average monthly rate
  of inflation was 0.1 in Argentina, 0.6 in
  Brazil and 0.8 in Peru.)?

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• Money growth in these countries was high because
  the budget deficits were high.
• The budget deficits were high because these
  economies were affected by major shocks that made
  it impossible for governments to finance their
  expenditures.

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A government can finance its deficit in two ways

• It can borrow by issuing bonds.
• It can finance the deficit by creating money. It
  can issue bonds and ask the central bank to buy
  these bonds. The central bank then pays the
  government with the money it creates, and the
  government uses that money to finance its
  deficit. This process is called debt
  monetization. The revenues from money creation
  are called seignorage.

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• Seignorage is equal to the product of money
  growth and real money balances . 
• Initially, higher money growth leads to an
  increase in output. It takes time for increases
  in money growth to be reflected in inflation, and
  during that time, the effects of higher money
  growth are expansionary. Initially, the nominal
  and real interest rates decrease, leading to an
  increase in demand and output.
• As inflation becomes very high, the adverse
  effects of inflation dominate.

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How do hyperinflations end?

• Hyperinflations do not end naturally. Rather,
  they have to be stopped through a stabilization
  program.  
• The elements of a stabilization program
• 1) There must be a fiscal reform and a credible
  reduction in the budget deficit. This reform must
  take place on the expenditure and the revenue
  side. 2) The central bank must make a commitment
  that it will not automatically monetize the
  government debt.

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Reform examples

• Reducing subsidies
• obtaining a temporary suspension of interest
  payments on foreign debt
• a change in the composition of taxation
  (replacing inflation tax with other forms of
  tax.)?

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Can stabilization programs fail?

• Yes. They can fail and they often do.
• Argentina went through 5 stabilization programs
  between 1984 and 1989 before succeeding in 1990.
  
• Brazil was more successful in implementing these
  programs.