Runaway Inflation

Runaway Inflation November 1st, 2010 By Matthew Cali

What is Runaway Inflation? • AKA Hyperinflation • Inflation that is High or Out of Control • General price level within a specific economy increases rapidly while currency loses its value very quickly

Causes of Hyperinflation • Rapid growth in the supply of paper money • This is a result of the need for countries to repay expenditures • Inflation can be a form of taxation in which the government gains from those who hold money while its value is declining • Hyperinflations can be very large taxation schemes

Causes of Hyperinflation (cont.) • “Real Quantity of Money” is ratio of amount of money held to price level • Measures the goods a household could buy with money they have • During low inflationhigh real money balance because convenient (Save Money) • During high inflation lower real money balance to avoid inflation “tax” (Spend Money) • Purchase Physical commodities which in turn raises the prices higher and inflation increases!

Germany 1919-1923

Vicious Circle of Hyperinflation • Hyperinflation is SPIRAL INFLATION that causes Higher Inflation • An example: MASSIVE INCREASE in GOVERNMENT DEBT due to SPENDING • GOVERNMENT pays down the debt by PRINTING MORE MONEYINCREASED INFLATION • INFLATION people SPEND money  convert FINANCIAL to PHYSICAL (use CREDIT) • SAVINGS is LOW and government cannot handle DEBTPRINT MORE MONEY!!!

Visual of Vicious Circle

Models of Hyperinflation: Confidence • Large event to cause populace to withdraw money • Belief that entities giving money will not be capable of reaching everyone’s needs • People do not hold notes because they become valueless so spend them and they lose value • Sellers see higher risk for the currency, demand a greater premium over the original value

Confidence Model (cont) • To End, change the backing of the currency, i.e.: issuing a completely new currency • This model usually due to War (losing a War) • In this view, the increase in the circulating medium is the result of the government attempting to buy time without addressing the main cause of the lack of confidence

Models of Hyperinflation: Monetary • An authoritative entity issues money to pay off costs (from war or Lax fiscal Policy) • Businesses see more money is and will continue to be producedso mark up prices • These marked up prices cover expected decrease in the money’s value • Money Issuers must issue more to keep up with rising prices

Monetary Model (cont) • Currency value decreases even more • Only way to stop this is by the issuer stopping the issuing of money • Unfortunately, the end of expansion can cause a severe financial shock to those using the currency as expectations are suddenly adjusted.

Summary of Models • Regardless of cause, hyperinflation involves velocity of money • Velocity is average frequency with which a unit of money is spent in a certain period of time • Many ways to get into Hyperinflation but tough to escape • When supply of money increases without demand increasing, price of money falls with respects to other countries • People spend money before the value goes to zero (even one day could be too long) • Therefore, no one holds onto their currency and the velocity of the money increases and the crisis continues on!!

Historical Hyperinflation: Germany • Causes • Reparations from WWI • Treaty of Versailles • Collapse in Industrial Economy • Loss of Confidence • Printing Unbacked Money

Peak of German Hyperinflation • 1923 June Nothing could stop the marks • Strikes due to collapsing wages • Unemployment skyrocketed • Shattered confidence = all savings disappeared, • All income consumed to prevent starvation • Printing presses running day and night to keep up with inflation • December 1923, the mark had lost all value

German Unemployment

Results of Hyperinflation • Search and desire for stability • Massive and capricious distribution of wealth took place from the old middle classes to the speculators and profiteers created bitterness and disaffection • Provided a background for which the Nazi political appeal for order and stability could flourish. • Hjalmar Schacht’s Rentenmark

Hyperinflation Prices • During two weeks from July 24th to August 7th, 1923, the Reichsbank increased the note issue by more than 2 milliard (a thousand million) marks. The wholesale price index was 1:0 in 1913 and was 2:8 million on September 4th 1923 and 2:1,374,400 million on November 20th 1923. • 2:1,374,400,000,000!!!!!!!!

Inflation and Cost of Living

Everyday Items • At the end of November 1923, bread cost 428 milliard marks, a kilogram of butter was 5,600 milliard marks, a newspaper cost 200 milliard marks, and a postage stamp was 100 milliard marks. • Children Playing with marks because cheaper to play with than buying toys

Works Cited • Griffiths, Brian. Inflation: The Price of Prosperity. New York: Holmes & Meier, 1976. Pps 139-164 • O'Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 341, 404. ISBN 0-13-063085-3. Found at Wikipedia.com • http://www.wordiq.com/definition/Hyperinflation • http://en.wikipedia.org/wiki/Treaty_of_Versailles#Impositions_on_Germany • http://www.youtube.com/watch?v=IoXCvwVO1J4 • http://en.wikipedia.org/wiki/Hyperinflation#Models_of_hyperinflation • http://www.econlib.org/library/Enc/Hyperinflation.html • http://en.wikipedia.org/wiki/File:Vicious_circle_in_macroeconomics.svg

Runaway Inflation