What causes hyperinflation and how can it be avoided in the first place or stopped if it occurs? What characterizes countries which fall victim to hyperinflation? A conversation between show host Gene Tunny and his colleague Arturo Espinoza which explores the economic theory and evidence around hyperinflation, and discusses peculiarities which can arise in hyperinflation-afflicted economies – e.g. pensions denominated in cows in Zimbabwe.
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You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.
Links relevant to the conversation
Current inflation rates around the world (Trading Economics)
What is hyperinflation and should we be worried? (WEF article from June 2022)
Wikipedia entry for Alberto Fujimori
Why a Zimbabwean firm offers pensions denominated in cows | The Economist
The Modern Hyperinflation Cycle: Some New Empirical Regularities (IMF Working paper from 2018)
Chris Edmond’s note on Cagan’s model of hyperinflation
Alberto Alesina and Lawrence H. Summers’ paper Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence
Bitcoin Could Solve Zimbabwe’s Hyperinflation Problem—Instead, The Country Is Telling Impoverished Citizens To ‘Just Buy Gold’ (Forbes article)
Inflation is spiking in Zimbabwe (again). Why high interest rates aren’t the answer (Conversation article by Jonathan Munemo):
Transcript: Hyperinflation: what causes it and what to do about it – EP158
Gene Tunny 00:00
Coming up on economics explored.
Arturo Espinoza Bocangel 00:01
That, of course, affected or negatively affected people’s economic decisions, because my parents are all the people who live at the moment who are subject to new higher prices every day.
Gene Tunny 00:18
Welcome to the economics explored podcast, a frank and fearless exploration of important economic issues. I’m your host Gene Tunny. I’m a professional economist based in Brisbane, Australia and I’m a former Australian Treasury official. This is episode 158 on hyper inflation, what causes it and what to do about it? In this episode, I chat about hyperinflation with my Adept Cconomics colleague, Arturo Espinoza. Please stick around until the end of the episode for some additional thoughts from me on hyperinflation. I’ll be interested in your thoughts on this episode. So please get in touch and let me know what you think. In the show notes, you can find my contact details along with relevant links, info and clarifications. Please note that alas, I made some Clangers by miss speaking at a couple of points in my conversation with Arturo, the Weimar Republic in Germany came after World War One obviously, rather than World War Two, and the so called Fuji shock happened in Peru rather than Japan. Silly me for misspeaking. Righto. Now for my conversation with Arturo about hyperinflation thanks to my audio engineer Josh Crotts for his assistance in producing this episode. I hope you enjoy it. Joining me today is my adept economics colleague, Arturo Espinosa, Arturo, good to be chatting with you.
Arturo Espinoza Bocangel 01:40
Hi, Gene it’s my pleasure to be here.
Gene Tunny 01:44
Excellent. Arturo. So one of the things we’ve been chatting about a lot lately is inflation. And we’ve been looking at inflation and unemployment. And that’s for a project that we’ve been working on. And back a few months ago, we did chat about stagflation, a particular type of it’s a nasty combination of unemployment and inflation. That was episode 143. And I thought, based on what we’ve been looking at, and you showed me, or you alerted me to some data from Peru, in the 1990s, about a hyperinflation they had, I thought it’d be good to chat about hyperinflation is one of those economic calamities, because there are, well, it’s fascinating. It’s not something that happens a lot. And it’s, it’s awful when it happens. And it’s good to know, well, what are the things that lead to hyperinflation? What are the circumstances? How can we avoid it? And if it starts, how can we stop it? So I think it’s an important thing for us to talk about on the show. So yeah, if you’re happy to chat about hyperinflation, I think we should we should get into it. So. Yes. Yep. Let’s start. Okay. Very good. Right. So I guess where this started, was, we had a look at. But what prompted me to do this episode was I forget how it came up. But we were talking about high rates of inflation. You mentioned that in Peru in the early 90s, you had this hyperinflation and caused all sorts of all sorts of problems. And when I looked at the data on macro bond, it had an inflation rate in one year, I think it was over 10,000%. It was huge. It was it was massive. I don’t know the exact rate, I’ll have to put that in the show notes. I can’t recall it off the top of my head, but very high inflation rate. And then that reminded me Okay, well, this is something that happens from time to time, it’s hyperinflation. At the moment in advanced economies, we’ve got inflation rates of, you know, five to 10% or so. So Australia through the year, a bit over 6%, US eight to 9%. And we’re not in that sort of hyperinflation and territory, the way that they typically define Hyperinflation is where you have a monthly inflation rate. And this is prices, on average, increasing by 50% a month. So that’s a standard definition of a hyperinflation. I think that comes from an article by us economist, Phillip Kagan, I think in the 50s on hyperinflations. But there’s no commonly or there’s no widely accepted definition. As far as I can tell, I mean, there’s no official definition and Dornbusch and Fischer, so Stanley Fischer and Rudiger Dornbusch, who wrote this great macro economics textbook, back in the 80s. And, and, I used it in the 90s when I was studying, they defined it as a, an annual inflation rate of 1,000%. So whether it’s 50% Monthly, which if you looked at that on a yearly basis, that it’d be nearly 13,000%, or whether it’s 1,000%. Annual, it’s still really bad. So 1,000% annual inflation rate, where prices go up, basically 10x, isn’t it? I mean, that’s, that’s a huge. That’s a huge, impressive inflation rate. So you’re challenging for people to, to deal with? And, yeah, so I’ve got some data on the what inflation rates that we’ve seen at the moment, and it looks like, while in recent history, we have had some hyperinflations in places like Zimbabwe and Venezuela, which we’ll talk about in a moment. When I look at the trading economics websites, I’ll put a link in the show notes to this, we look at inflation rates around the world, the highest at the moment. So in annual terms, it looks like we’ve got well Zimbabwe coming in at looks like 285%. Lebanon 168%. So the very high inflation rates, but not in the hyper inflation range just yet. Okay. But it had they have had that sort of experience in the past. And we might cover that in a moment. So I thought this would be good to talk about, because, I mean, it’s something that people are aware of this can happen. And we all know that there are concerns about government, money printing and all of that. And it’s, if you’re a member of the public, and yet perhaps you haven’t studied economics, it may not be obvious what leads to these hyperinflations I mean, is this a risk for countries such as Australia, or the United States or, or Britain? And you know, what would lead to this eventuality of hyperinflation? And so what what I want to do in this episode, Arturo is just articulate. What are those conditions that lead to hyperinflation and when should we worry about it? There was an interesting article on the World Economic Forum website, what is hyperinflation? And should we be worried? I’ll put a link in the show notes to that I think that provides some interesting stories about inflation, I might kick off by talking about hyperinflation, I might kick off by reading from that. So it notes that it’s, it’s readily accepted that France and you are the world’s first recorded instance of hyperinflation during the French Revolution in the late 18th century, when monthly inflation topped 143%. Okay, so recall, at the moment in advanced economies, were concerned about inflation rates of between well between five and 10%, over through the year over a year, whereas when you’re in hyperinflation, you’re getting monthly inflation of could be 143% in France in the late 18th century. They go on to say that nevertheless perhaps the most well known example of hyperinflation incurred in the night occurred in the 1920s, when following World War One and crippled by reparation debt, Weimar, Germany saw its monthly inflation rate reached 29,500% in 1923, according to the Cato Institute, more recently, Zimbabwe was bound by hyperinflation, recording a staggering monthly inflation rate of about 70,000,000,000, 79,000,000,000% in november, that’s just insane. So I guess what those examples illustrate is that you’re dealing with countries where there’s an underlying problem, there’s some sort of deep crisis and or there’s a big disruption that occurs. So French Revolution, obviously, the end of the ancient regime, the new revolutionary government, executions, people getting detained, the end of the old regime, and huge disruption. And then following World War Two, we’ve got the Weimar Republic. And I mean, there was that you’re familiar with that the peace deal at Versailles that they struck, which was very hard on Germany at the time. So the reparations debt so the the victors the the allies, so well, outside or Britain and Australia and the US. We imposed a very tough, yes. Yeah. And so it meant that they really struggled. The Germans really struggled to pay that back and that meant that, you know, they’ve put a lot of pressure on their budget. And, well, this is where the problem comes from, essentially, your budget is in such dire straits, your deficits are so large, you have to resort to the printing press, you have to basically, well monetize your deficit, you have to create the new money yourself to be able to, to pay the bills. And that’s where you end up with, with really well, really high inflation and hyperinflation when things get out of control. And in the public, don’t trust the government anymore. They don’t want to hold the currency and the government keeps having to print more and more to try to get enough currency to pay the bills. And it just all ends really badly, you end up with these very high rate well hyperinflation 1000% plus inflation rate per annum. And you need to take really drastic measures to to get that under control. Right. So what causes it? And I think we’ve, we’ve alluded to that it’s the, it’s the fact that there is this, this printing of money to finance deficits that, for some reason or another, the government of the day can’t raise the money it needs via taxation, or it can’t borrow the money from the bond market, it can’t borrow the money from the private sector. So one of the reasons that a country like Australia or the US or Britain, why they don’t usually have to worry about inflation, or why we haven’t had a sorry, a hyperinflation. And why we haven’t had a hyperinflation here is because, well, we generally don’t resort to the printing press to finance deficits at times in the past, we have to a significant extent, but now what we do is we sell bonds into the market, the government sells the bonds, and it gets the money it needs that way. And we also don’t have the big disruption that tends to lead to hyperinflation. So what you have to have really is this combination of, well, you’ve got the there’s the money print ing going on, but that’s, that’s going on, because there’s some underlying disruption, that means that the government can’t get the money it needs, or it’s in some sort of crisis. And it needs to spend a lot of money, such as what the Germans faced in the aftermath of World War One when they had these heavy reparations payments to make. Okay, so what we see Dornbusch and Fisher note in their textbook, that classic hyperinflations took place in the aftermath of of wars. So that’s one thing we know there’s this disruption. And that’s going to affect the government’s ability to to raise money. And one thing that Dornbusch and Fischer noting, in their textbook is that hyperinflationary economies all suffered from large deficits in many cases, that was because of the war, you ended up with this large national debt. And if you end up with a lot of debt, then you’ve got the interest payments associated with that. And also, it just wrecked the country’s ability to raise taxes. Okay, because, you know, it’s destroyed businesses, for example, or perhaps it’s wrecked your, your tax collection capacity. You don’t, you don’t have the, the administrative capacity anymore to be able to collect the tax. So it’s, it ends up being a two way interaction, as they describe it. They talk about how large deficits lead to rapid inflation by causing governments to print money to finance the deficit, and then high inflation then increases the deficit. And that’s because there are two things going on. The nominal interest rates are increasing, because there’s higher inflation expected. And also because if your taxes if you’re calculating them based on what’s happened over the last 12 months or so, and prices have risen since then, then you’re going to lose out in real terms. So there’s this lag in both the calculation and then, the, the collection of the taxes and this is called the Tanzi-Oliveira Effect. So Tanzi, after a famous economist who was at the IMF, Vito Tanzi, okay, so what you have is that you’ve got this two way interaction. You’ve got, you’ve got large budget deficits that have to be monetized. And that ends up being inflationary. But then you have inflation, increasing the deficit that you’ve got, and this thing becomes a vicious circle, or it’s or it’s reinforcing. And this inflation gets a momentum, it gets a life of its own, and you can end up if you’re not careful. And if things get really bad, you can end up in this hyper inflationary situation. Right. And, I mean, the amazing thing is, I mean, we talked about, we talked about Germany, and then that’s the classic, or the infamous case of hyperinflation. And the stories that come out of these periods are just, they’re unbelievable, and they just illustrate the the hardship that’s occurred by people in these in these hyper inflationary periods, which is why we need to really guard against it and why we, we need to ensure that our monetary and fiscal policies are as sound as possible, because this is a this is a pathology, that you get this is a problem you get when you’ve got both bad monetary and fiscal policy, isn’t it? Because you’ve got the fiscal policy, which is there’s a budget deficit. And there’s also the monetary policy, which, which is financing the budget deficit by money printing. So you need the monetary authority, the central bank, or, well, perhaps it’s the Treasury, you need to have this hyperinflation go on, you need them to be doing the wrong thing there, as well as running the budget deficit, you need them to be monetizing it. So there are a lot of things that have to go wrong before you get into this hyperinflationary situation. And what happens is, you end up with massive hardship. And one thing I find I find extraordinary, there’s that story about the hyperinflation in Austria, after World War One. When, and this was a story that Keynes told, and it’s recounted in Dornbusch, and Fischers textbook. And he, they noted that people would order two beers at a time because they grew stale at a slower rate than the price was rising. So you’d go to a bar and you’d order two beers. Because the next time he went to the bar, the price would, would be high. Prices were rising. So fast, I mean, just terrible. Absolutely extraordinary stories like that. And there’s another story from Zimbabwe, we might tell in the moment, but what I thought would be good to do is we might consider some examples of some hyper inflation’s throughout the world. And because this conversation was motivated, partly by what you’re telling me about what happened in Peru, could you tell me a bit a bit about what happened in Peru in the it was it late 80s, early 90s. And then and then how that was resolved, please,
Arturo Espinoza Bocangel 18:08
In Peru, in my case, my parents, they live through that harsh time, in terms of in terms of economics and social. So basically, in the case of Peru is a particular case where some components, social, economic, and all models converge to this economic result or economic event that you have mentioned about hyperinflation. Let me give you a little bit of context about the Peruvian economy in the decade of 1980s or last decade in Peru, basically was, as I mentioned, marked by hyperstar stagflation, where is the son of hyper inflation plus recession. During those years. In Peru, the government took bad decisions. They started to spend a lot of money printing money, particularly the government of Ireland, Garcia, the first government between 1985 to the end of 80s, 90s.
Gene Tunny 19:31
Was this a socialist government?
Arturo Espinoza Bocangel 19:33
Yes, it was a leftist government. But at that moment, the political decision were the words, they they wanted to do the best. The the results told something different. But during that moment, the Peruvian Economy experience for our unfavourable terms of trade wars credit conditions for public debt and also some work condition, which caused floods, also many economic loss in during that time. So all these factors contributed towards in real economic growth.
Gene Tunny 20:23
Right. So you had this triple whammy, didn’t you? You had the declines in commodity prices, I suppose. So lower commodity prices, which affected your terms of trade, and then you said worse credit conditions for, for debt. So, higher interest rates was it at higher borrowing costs. And then you had the bad weather so, okay, yeah, pretty awful.
Arturo Espinoza Bocangel 20:47
And also is the government of Ireland, Garcia decided not to pay those public depths. So Peru also had some consequences doing that. So in response to that, the Peruvian government implemented a group of heterodox measures. So including the use of price controls, or multiple exchange rates to reduce inflation. So during that decade, Peru faced period of high inflation, so between 20% to 50% K per year, but the wars are pure in September 1988, when Peru faced its first episode of hyperinflation, the second episode of hyperinflation occur between July to August in 1990. So that, of course, affected or negatively affected people’s economic decisions. Because my parents or all the people who live at that moment, were subjected to new higher prices every day. Yeah. So imagine that. So as you mentioned about the viewers, if you want to buy milk, when milk, a jar of milk one day, the next day is, the price is higher also. So imagine that effect. So basically, those relatively poor people were the most affected. Because some of the Peruvians, they started to buy dollars, American dollars in order to avoid all the negative effects of inflationary pressures. Yeah, yeah. So that was the context. Yeah, what happened in Peru.
Gene Tunny 22:48
Um, I might just give you a break there Arturo, because I’ve just found the relevant table in the Dornbusch and Fisher textbook, my old university textbook, and then the estimates they have of the inflation rate in Peru. So if you look at 1985, I mean, it was it would have been higher from our perspective, 163%. And then it got down a little bit in 86, and 87, to 78.86%, in 98 82.5%, 1989 3,399%, 1999 7,482%, before dropping to 410% in 1991, and 88% in 1992. So, you know, just awful numbers would have been difficult for people to plan anything. And if you’re, if you’re holding your wealth in the local currency, I mean, it’s just wiped out. It’s just, you’re just losing all of that, that wealth or if you’re holding government bonds, you’re right. Yeah. You’re in deep trouble. Yeah. Yeah. And so what happened? I mean, the, there was, was there a new government and it implemented new policies.
Arturo Espinoza Bocangel 24:06
Yes, these new governments implemented heterodox policies like they wanted to control prices. And also they implemented multiple exchange rates. And I remember that impor for example, you want to import something at that moment they were restricted so import was controled as well. It was was a very dark moment in Peru.
Gene Tunny 24:36
Right. Okay, and that so that didn’t go well, that period that the initial that their response was not really the best way to tackle this was
Arturo Espinoza Bocangel 24:45
They wanted to do the best, but they think, they didn’t follow the correct prescription. Yeah, for that moment. Yeah.
Gene Tunny 24:53
And so what happens is a is it Fujimori comes in and then he’s got a different way of resolving it.
Arturo Espinoza Bocangel 24:59
At the beginning of 90s, with a new government for the Fujimori government implemented policies to stabilise the economy. So, basically, that kind of package or general economic package in order to combat the, those economic problems also social problems rely in two pillars. The first was related to cut inflationary fiscal financing. Also, the Peruvian central bank became autonomous in 1993. So there was a good hit for tackling inflation. And the second pillar was related to enhance free market conditions to liberalise the Peruvian market.
Gene Tunny 25:54
Yeah, yeah. So that they’re important, aren’t they? Because, let’s, let’s look at it. So there’s the commitment to cut inflationary fiscal financing. So we’re no longer monetizing the deficits. And I’m not sure exactly the relationship between the finance ministry or the Treasury and the central bank there. The way that deficits are monetized, is going to be different in different countries. But I mean, having this autonomy, having this autonomous Central Bank as well as important because one of the ways that deficits are monetized is that the central bank just buys the bonds from the government issues and just credits them with the money in the government’s bank account of the central bank that’s necessary to that the government wants to pay the bills. So the central bank is important in getting rid of this monetization with the central bank is often part of the monetization. So having an autonomous central bank is important because an autonomous central bank is going to tell the government no, we’re not going to buy your, your bonds, you’ve got to sell into the private market, or you need to borrow from another lender and international lender, for example. And, you know, we’re not going to be part of this money printing and monetization of the, of the deficit. So yeah, that’s incredibly important. And there’s evidence to that this autonomy, or this independence of the central bank, that is correlated with better inflation outcomes. And I mean, that’s, that’s across the whole spectrum of, of inflationary outcomes, right? So it’s going to help you prevent hyperinflation. And even if you’re a country with lower levels of inflation, you don’t have hyperinflations, such as Australia, New Zealand, Britain, US, etc. Having a more independent central bank, you’re going to get better inflation outcomes there. And I think there’s evidence by from Alberto Alesina, that’s a commonly cited study from the late 80s. I’ll put a link about that in the show notes. Okay. Now, this was called the Fuji shock. Is that right?
Arturo Espinoza Bocangel 28:11
Yes. Yes, absolutely. Yeah. The combat. hyperinflation. Yeah.
Gene Tunny 28:18
And so what was it? It was a, like they cut the they, cut the deficit, where the harsh fiscal measures. And this is, this is where it gets really bad. This is why you don’t you want to avoid getting into a hyperinflationary situation in the first place. Because the medicine is harsh. It’s harsh medicine, isn’t it? I mean, really, because you’ve got to just cut that deficit. You can’t monetize it, you’ve got to, you’ve got to either raise the taxes domestically, or you’ve got to borrow domestically. But what if people don’t want to lend to you what if your own citizens don’t want to lend to you or they don’t have the capacity to lend enough money to you then then you might have to go to an international lender, or you might have to borrow from overseas and what we find I think, in stopping a lot of these hyperinflations it’s a it’s a combination of this fiscal austerity or getting your budget under control, not monetizing your deficits are getting better monetary policy and independent central bank, but also often it’s getting a loan getting some foreign investment or getting a borrowing from overseas to to help stabilise your exchange rate, for example, that can be part of the solution.
Arturo Espinoza Bocangel 29:41
To facilitate internationally in foreign investment.
Gene Tunny 29:45
Yeah, because there was a paper that you found where you pulled out inflation and the cost of stabilisation, historical and recent experiences and policy lessons by Andre Solimano. World bank research observer in July 1990. And, and in that paper, the author writes that the experiences of stopping hyperinflation provide examples of both rapid disinflation achieved through restrictive monetary and fiscal policies. Yep. So getting your money supply under control by not monetizing deficits, getting your fiscal policy under control. And then he goes on to say, and the key role played by stabilisation of the exchange rate in successful stabilisation. So you need to get your exchange rate stabilised so that you’re not getting inflation through the exchange rate. So if your exchange rate is deteriorating, and then the cost of imports is rising, that’s contributing to inflation, so you need to get that under control. Last but not least, the history of economic stabilisation has amply shown that the availability of adequate foreign financing as a support to the stabilisation effort is a crucial ingredient in the success of stabilisation plan. So I thought that was really fascinating on and that’s an important finding, right? So it just goes to show what you need to get in place to correct a hyperinflation if it if it occurs if you’re in that unhappy situation. Right. And it looks like Peru ended up getting some it ended up borrowing from overseas as part of that if I if I recall, there was a or the IMF ended up guaranteeing loan funding for Peru according to the Wikipedia entry on Fujimori. Fujimori, is it? Yeah, I’ll put it. I’ll put a link in the show notes. And what’s fascinating about him. So he’s, he has Japanese ancestry, and he became President of Peru. But he’s a controversial figure in the end, wasn’t he? There’s a story there’s
Arturo Espinoza Bocangel 31:54
a story about the birth certificate. Well, because in order to be a Peruvian President, you need to be born in Peru. But apparently he will. He was born in Japan, but something strange okay with her with his birth certificate. Yep.
Gene Tunny 32:15
Right. Yes. I mean, he got they seem to have got it under control. But I should know that he was accused of corruption wasn’t a Oh, yes, yes. Yeah,
Arturo Espinoza Bocangel 32:28
there is. He’s considered one of the wards, precedent or corrupted precedent in the world. Yeah.
Gene Tunny 32:38
Okay, we’ll take a short break here for a word from our sponsor.
Female speaker 32:43
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Gene Tunny 33:13
Now back to the show. So I think we’ve talked a bit about how you stop hyperinflation. It’s, it’s harsh medicine, it’s austerity, and that’s going to deliver pain, getting your monetary policy under control. And also stabilising your exchange rate, possibly through some foreign borrowing. Okay. The other example I wanted to talk about was, was Zimbabwe, because that’s an example of D monetization, isn’t it? So one of the one of the points that you made I remember when we were preparing for this conversation is that one thing you see in Hyperinflation is that people start avoiding the currency don’t they try not to use the currency, they might switch to US dollars, for example, if they’re available, they don’t want to use the local currency. or, in extreme cases, they might even use us commodities as as items at those units of account. So this is this this bizarre story. This is from the Economist magazine, I’ll put a link to it in the show notes and this was from earlier this year, and so may 14 2022. And the headline was wire Zimbabwe and firm offers pensions denominated in cows, okay. And there’s this this actuary, Mr. Chimp, Chairman, Norway, and an actuary trained in Britain started a company, the hacker life insurance, so apologies of mangled those pronunciations instead Out of this company to sell inflation proof pensions to Zimbabweans. The Pensions are not denominated in Zimbabwe dollars, since they quickly evaporate nor in American dollars since many Zimbabweans are struggling to obtain any. Instead, they are denominated in cows, which the government can’t print. This is what I love about the economist. I love these really clever, witty, witty lines in there. That’s great, isn’t it? So say there’s typically wage earners such as teachers, they chip in cash, which NACA immediately turns into cattle. So he, okay, the the assets grow by breeding, when a policy matures, clients can demand payment in cows or the cash equivalent, right? So, look, this is a sort of quirky thing that happens when you’ve got this really disruptive hyperinflation, you see people ordering multiple beers at the bar to avoid having to pay higher prices later. And you see things like this where you’ve got contracts denominated in capital. So it’s just an extraordinarily disruptive economic phenomenon that you really need to avoid, if you can, well, it can end up being incredibly costly to get under control, but you need to do it or otherwise you just end up with? Well, societal breakdown. Really. I mean, Hyperinflation is not something that that you can you can live with, you’ve got to get it under control. Okay. So there are a few other papers I just wanted or a few other studies I wanted to mention, before we wrap up, because I think they help illustrate what sort of economies end up in, in hyperinflation. And, you know, what are those characteristics? And why? When we consider that we start thinking, Well, okay, we’re probably not there yet. It’s not yet a concern for countries like Australia, or the US, or the UK. I mean, we’ve got, we certainly have issues in our countries, but it’s, we’re nowhere near the situation where you could end up in some sort of hyperinflation, you need to have some sort of massive political turmoil, a government that just loses control of things and starts turning on the printing press to finance this deficit. So if we think about mid 80s, Bolivia, this is an example that Dorn bush and Fisher Fisher given their textbook, they had a budget deficit of 26.5% of GDP in 1984 10.8%, and 85. And inflation in those years was 1,282%, and 11,750%, in 84, and 85. So you’ve got very large deficits, like crazily high deficits, and then there’s money growth associated with that, because you’re financing it by the printing press. And you end up with the high inflation, too much money chasing too few goods. Right? Oh, they do give an example of how the sharp cut in the deficit, the fiscal austerity can stop the hyperinflation, but at a high costs, so Dornbusch and Fischer go on, they talk about how, as a result of austerity, and and poor export prices, again, in economics is multiple factors at any one time, you can you can’t run control experiments. If you listen to the show regularly, you’re aware of that Bolivian per capita income in 1992 was 30%, less than it had been 10 years earlier. So they really suffered, again, the lesson is avoid hyperinflation in the first place. have made sure you don’t have that societal disruption and, and you avoid the political turmoil that could lead to a government that, you know, enacts policies that are well, not good and need to be financed with, with money printing, right? So yeah. Okay, so there was a study that was done by the IMF. It’s an IMF working paper from 2018, the modern hyperinflation cycles and new empirical regularities. And I thought this was an interesting study, they looked at multiple countries, they had a data set 62 variables, 496 countries over 57 years, they were looking at what are the characteristics of countries that ended up having hyperinflation, and the three big ones were depressed economic freedoms, deteriorated socio economic conditions and rule of law as well as high levels of debt. aesthetic conflict tivity and government instability. Okay. So it’s when you’ve got lots of political turmoil really and, and that’s why it’s, it’s more common or it has been more common in the last well over the last 50 years or so in either Latin American countries, or in some sub Saharan African countries where there’s just been more political strife for various reasons, whereas countries that have been more fortunate countries where there’s there’s been more established democratic norms, and we haven’t had populist governments generally that on either side, I mean, I guess there have been some But largely, we’ve avoided the the extremes in particularly in Australia. And I suppose in US and UK. What’s that? What that has meant is that we haven’t ended up in a situation where we’d have to worry about hyperinflation. But again, something to be conscious of, we want to guard against it, we want to make sure we know the lessons of history and know the lessons of economics. Right. Finally, I’ll also link to a paper by Well, it’s a note on Kagan’s model of hyperinflation. It’s a note by Chris Edmund, who’s a Queenslander who I went to UQ with really bright guy ended up getting a Fulbright scholarship studied at UCLA then worked at the NYU Stern School of Business, he wrote a paper while he was at stern Kagan’s model of hyperinflation, and he talks about the conditions under which you end up with a hyperinflation. So he goes into the maths behind inflation. And its relationship with the amount of money that that people in the economy want to hold. So it’s very technical paper. But a good one, it’s worth reading, if you can, if you can get through the all of the math there, I’d recommend it. And what he, what he concludes is that one of the important messages that economists take away from Kagan’s paper, so this is the famous paper which introduced the concept of hyperinflation, or defined it in the 50s. Or maybe it was early 60s, I’ll link to it in the show notes. One of the important messages that economists take away from Kagan’s paper is the need one for fiscal discipline, and or an independent central bank to prevent monetize deficits that can allow a hyperinflation to get started, and to the need for individuals inflation expectations to be anchored, and thereby relative Lee unlikely to lead to a momentum driven inflation breakout. Okay, so what Chris is driving out here is that when things get really bad, and no one wants to hold the local currency, no one trust the government, the government just keeps printing more and more currency to try to buy the goods and services it needs. And that leads to more and more inflation. And that leads to higher expectations of inflation. And you just end up with this vicious circle, that just reinforces itself, things get out of control, it gets explosive. Okay, so that’s what he’s driving out there. And then he concludes, of course, part of the trick to anchoring inflation expectations is for government policy to be credibly anti inflation, right. So and this is often why you need a change of regime, you need a new government that comes in a new broom sweeps clean, big shock, Fuji shock, for example, in Japan, it’s tough medicine, but sometimes it has to be done to get hyperinflation. Well to to get rid of it to reduce that inflation over over the coming years. And, look, there’s a bit of a debate in economics. I don’t think we’ll have time to cover it today. But it’s about how quickly you can stop these hyperinflations. And there was a famous paper by Thomas Sargent the end, the end of for big inflation’s, or the ends of for big inflation’s, I think it is Yep. And he argues that you can actually stop these hyperinflations relatively quickly. So it’s not it doesn’t have to be a drawn out process over over several years, where you’re losing all this GDP, you can stop it quickly, if you do have a very sharp and credible change in the policy regime. So there must be an abrupt change in the continuing government policy or strategy for setting deficits now and in the future that is sufficiently binding us to be widely believed. And this is related to his rational expectations theory. So if people believe that the There’s a new credible policy, then there are expectations of future inflation can drop massively, very quickly. And that therefore, that means inflation itself drops very quickly. And you save yourself a lot of pain by having to have a slower economy and higher unemployment for several years to get rid of it. Okay. Anything else? Arturo I know, we might have to wrap up soon.
Arturo Espinoza Bocangel 45:28
I think the these topical Hyperinflation is very complex. But you have provided a good summary. I think my final message is any government around the world must be aware of that it’s important to monitor inflation to target the inflation because that putting these this or that potential economic event would bring a lot of suffer, especially for poor people. Absolutely.
Gene Tunny 46:10
Okay. Tara, it’s been great chatting with you about hyperinflation. So thanks so much for your time.
Arturo Espinoza Bocangel 46:17
Thank you, Jim. Thank you for having me.
Gene Tunny 46:21
Okay, I hope you found the conversation about hyperinflation interesting and useful. As with many of the episodes I record, I feel I could explore this topic a lot more, and I hope to come back to it in the future, it may be useful to do a deep dive on some specific instances of hyperinflation, possibly the 1920s, German hyperinflation or more recent hyperinflations in Venezuela or Zimbabwe. I’d like to delve into exactly what went wrong in the first place. How did these countries end up with big government budget deficits that needed to be monetized in the first place? Please let me know if there’s a specific hyperinflation that you’d like to learn more about, and I’ll see what I can do. I should note that one point I think I could have covered better in this episode relates to D monetization. One way a hyperinflation can end is if the government abandons the currency and replaces it with a currency that people trust such as the US dollar. When this occurs, not only is there D monetization that is declaring that a currency is no longer legal tender, but there is so called dollarization as well. This happened in Zimbabwe in 2009. Eventually, the Zimbabwe government tried to reintroduce a new local currency in 2018 19. And hyperinflation started again. Governments of course, would prefer to have their own currency as it means they can partly finance themselves via the printing press A found a good article on what happened in Zimbabwe on the conversation website, and I’ll put a link to it in the show notes so you can check that out. One other issue I would have liked to have covered in this conversation is whether hyperinflation affected economies could abandon their currencies and adopt a cryptocurrency such as Bitcoin. There was an intriguing Forbes article in July titled Bitcoin could solve Zimbabwe’s hyperinflation problem. I’ll link to it in the show notes. If you’re a regular listener, you’ll know that I’m sceptical about the potential for cryptocurrencies to replace traditional currencies, particularly given the huge degrees of volatility in their values. But I will acknowledge that crypto advocates are right about the potential for fiat currencies to be debauched. Hyperinflation is the outcome of the most extreme divorcement of currencies. As always, I’m trying to be open minded and plan to come back to cryptocurrency and other crypto assets such as non fungible tokens in a future episode. I’m also keen to have a closer look at the concept of smart contracts which are enabled by Aetherium. Right, I better finish up now. I’d love it. If you could join me again next week for some more explorations in economics. Ciao. Okay, that’s the end of this episode of economics explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a writing on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact at economics explore.com And we’ll aim to address them in a future episode. Thanks for listening. Till next week, goodbye.
Thanks to Josh Crotts for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.
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