Hyperinflation - Causes

Causes

Hyperinflation occurs when there is a continuing (and often accelerating) rapid increase in the amount of money that is not supported by a corresponding growth in the output of goods and services.

The price increases that result from the rapid money creation creates a vicious circle, requiring ever growing amounts of new money creation to fund government activities. Hence both monetary inflation and price inflation proceed at a rapid pace. Such rapidly increasing prices cause widespread unwillingness of the local population to hold the local currency as it rapidly loses its buying power. Instead they quickly spend any money they receive, which increases the velocity of money flow; this in turn causes further acceleration in prices.

This results in an imbalance between the supply and demand for the money (including currency and bank deposits), causing rapid inflation. Very high inflation rates can result in a loss of confidence in the currency, similar to a bank run. Usually, the excessive money supply growth results from the government being either unable or unwilling to fully finance the government budget through taxation or borrowing, and instead it finances the government budget deficit through the printing of money.

Governments have sometimes resorted to excessively loose monetary policy, as it allows a government to devalue its debts and reduce (or avoid) a tax increase. Inflation is effectively a regressive tax on the users of money, but less overt than levied taxes and is therefore harder to understand by ordinary citizens. Inflation can obscure quantitative assessments of the true cost of living, as published price indices only look at data in retrospect, so may increase only months later. Monetary inflation can become hyperinflation if monetary authorities fail to fund increasing government expenses from taxes, government debt, cost cutting, or by other means, because either

• during the time between recording or levying taxable transactions and collecting the taxes due, the value of the taxes collected falls in real value to a small fraction of the original taxes receivable; or
• government debt issues fail to find buyers except at very deep discounts; or
• a combination of the above.

Theories of hyperinflation generally look for a relationship between seigniorage and the inflation tax. In both Cagan's model and the neo-classical models, a tipping point occurs when the increase in money supply or the drop in the monetary base makes it impossible for a government to improve its financial position. Thus when fiat money is printed, government obligations that are not denominated in money increase in cost by more than the value of the money created.

From this, it might be wondered why any rational government would engage in actions that cause or continue hyperinflation. One reason for such actions is that often the alternative to hyperinflation is either depression or military defeat. The root cause is a matter of more dispute. In both classical economics and monetarism, it is always the result of the monetary authority irresponsibly borrowing money to pay all its expenses. These models focus on the unrestrained seigniorage of the monetary authority, and the gains from the inflation tax.

In neo-classical economic theory, hyperinflation is rooted in a deterioration of the monetary base, that is the confidence that there is a store of value which the currency will be able to command later. In this model, the perceived risk of holding currency rises dramatically, and sellers demand increasingly high premiums to accept the currency. This in turn leads to a greater fear that the currency will collapse, causing even higher premiums. One example of this is during periods of warfare, civil war, or intense internal conflict of other kinds: governments need to do whatever is necessary to continue fighting, since the alternative is defeat. Expenses cannot be cut significantly since the main outlay is armaments. Further, a civil war may make it difficult to raise taxes or to collect existing taxes. While in peacetime the deficit is financed by selling bonds, during a war it is typically difficult and expensive to borrow, especially if the war is going poorly for the government in question. The banking authorities, whether central or not, "monetize" the deficit, printing money to pay for the government's efforts to survive. The hyperinflation under the Chinese Nationalists from 1939 to 1945 is a classic example of a government printing money to pay civil war costs. By the end, currency was flown in over the Himalayas, and then old currency was flown out to be destroyed.

Hyperinflation is regarded as a complex phenomenon and one explanation may not be applicable to all cases. However, in both of these models, whether loss of confidence comes first, or central bank seigniorage, the other phase is ignited. In the case of rapid expansion of the money supply, prices rise rapidly in response to the increased supply of money relative to the supply of goods and services, and in the case of loss of confidence, the monetary authority responds to the risk premiums it has to pay by “running the printing presses.”

Nevertheless the immense acceleration process that occurs during hyperinflation (such as during the German hyperinflation of 1922/23) still remains unclear and unpredictable. The transformation of an inflationary development into the hyperinflation has to be identified as a very complex phenomenon, which could be a further advanced research avenue of the complexity economics in conjunction with research areas like mass hysteria, bandwagon effect, social brain and mirror neurons.