The Economist explains - The roots of hyperinflation, by
J.O.s, 2/12/18
Fifty-seven
cases of runaway inflation have been documented. They have common patterns
IN
a country where the annual inflation rate is in four figures, the previous
month can seem like a golden age. Venezuela’s currency, the Bolívar, has lost
99.9% of its value in a short time. It is hard to fathom how a government can
get its economic policy so wrong when the effects of hyperinflation are so
severe. What are its causes?
Start
with a definition. In 1956 Phillip Cagan, an economist working at America’s
National Bureau of Economic Research, published a seminal study of
hyperinflation, which he defined as a period in which prices rise by more than
50% a month. The phenomenon is rare.
Steve
Hanke, of Johns Hopkins University, and his colleagues have documented 57
cases, of which Venezuela is the most recent. Often the backdrop is revolution,
war or political transition.
The
first recorded episode occurred between 1795 and 1796, in revolutionary France.
There was a cluster of hyperinflations in Europe after the first world war,
notably in Germany, and in the early 1990s in countries affected by the
break-up the Soviet Union. Yet war and revolution are not always the
setting, as the recent cases of Venezuela and Zimbabwe show.
Though
each episode of hyperinflation has its unique miseries, there are common
patterns. Often the economy concerned will already have a chronic weakness.
Usually it is an underlying fiscal problem.
There
might be pressure on the budget from, say, the cost of prosecuting a war, or
from welfare spending or from looting by officials. Tax revenue may rely
heavily on a single commodity. Frequently the local currency is pegged at an
over-valued rate, which keeps inflation hidden for a while, only for it to show
up suddenly.
The
problems begin with a “shock” to the economy. It might be a slump in oil
prices, as in the case of Venezuela, or a slump in farming output, as in the
case of Zimbabwe.
The
shock sets off a chain of events. Tax revenues evaporate, leaving a hole in
public finances. The government fills it by printing money. The increase in the
supply of money pushes up inflation. That is bad enough. But what accelerates
this process, turning a jump in prices into hyperinflation, is the impact of
inflation on government revenue.
Because
taxes on income or sales are typically paid after they accrue, a period of high
inflation leads to a fall in their real value. So the government resorts again
to financing its budget deficit by printing more money. That produces yet more
inflation, a still-weaker tax take and further rounds of money creation.
At
some point, the exchange rate collapses. The ascent of inflation quickly becomes explosive, especially in
countries where wages and price rises are indexed.
Hyperinflations
do not last long. They end in one of two ways. With the first, the paper
currency becomes so utterly worthless that it is supplanted by a hard currency.
This is what happened in Zimbabwe at the end of 2008, when the American dollar
took over, in effect.
Prices
will stabilize, but other problems emerge. The country loses control of its
banking system and its industry may lose competitiveness.
With
the second, hyperinflation ends through a reform program. This typically
involves a commitment to control the budget, a new issue of banknotes and a
stabilization of the exchange rate—ideally all backed with confidence-inspiring
foreign loans. Without such reform, Venezuela’s leaders, though scornful
of America, may find that its people are forced eventually to adopt its dollar
anyway.
Norb Leahy, Dunwoody
GA Tea Party Leader
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