Hyperinflation is a form of inflation that happens quickly. It erodes the purchasing power of the local currency. During hyperinflation, people buy goods and services as quickly as possible to avoid losing more spending power.
During hyperinflation, businesses raise prices several times throughout the day.
There is no official definition of hyperinflation, the consensus is a 50% monthly increase in the price of goods and services.
In 1956, American economist Phillip Cagan published the first serious book on the subject of hyperinflation. In his research, Cagan used 50% as the official definition of hyperinflation. Most economists use Cagan’s definition when discussing hyperinflation.
What Causes Hyperinflation?
There are many different reasons why hyperinflation occurs in an economy. The most common cause involves excessive spending by government leaders. This is known as deficit spending, which occurs when spending exceeds revenue.
These days, it’s not uncommon for governments to exceed their spending limits. The majority of revenue is collected in the form of taxation. A budget deficit is created when there is a shortfall between spending and taxes. This is the root cause of most hyperinflationary events.
Developing Countries and Hyperinflation
Most hyperinflation involves developing countries. These countries are classified as frontier markets. The Organization for Economic Cooperation and Development (OECD) divides all countries into three different categories.
- Developed Markets
- Emerging Markets
- Frontier Markets
According to the OECD, frontier markets operate in a difficult economic environment.
For example, these countries have:
- Limited access to markets
- Weak regulations
- Poor growth
- Poor infrastructure
- Poor education systems.
The majority of these countries depend on the US Dollar to provide some type of financial stability.
The table includes a partial list of countries in each category.
Government Corruption and Hyperinflation
Frontier market countries are prone to government corruption. These governments are filled with politicians who accept bribes. This type of environment is prime for hyperinflation to occur.
There have been several cases of hyperinflation during the past century. Each hyperinflationary event usually follows the same path. Initially, the country experiences mild levels of inflation. Inflation is manageable for the citizens of the country. The rising prices are considered an inconvenience.
It hasn’t reached the uncontrollable stage yet. Quite often, a country can keep inflation under control for an extended period of time (3 to 5 years). Unfortunately, it’s only a matter of time before rising prices become a problem. Once the level of inflation becomes unmanageable, hyperinflation happens.
There hasn’t been a case where government leaders have been able to reverse hyperinflation. Once it has started, it’s impossible to restore the economy. Economists agree in theory that it is possible to remove hyperinflation from an economy using price controls.
In reality, price controls never work because they lead to shortages and rationing. Most governments attempt to use price controls during hyperinflation. This only worsens the problem.
To prevent hyperinflation, governments have to be responsible when managing their finances. This includes maintaining a balanced budget and avoiding excessive spending programs. These days, the vast majority of governments are experiencing huge budget shortfalls. Hyperinflation will probably become more common within the next decade.
Brief Summary of Hyperinflation
- Hyperinflation is a form of inflation that happens quickly.
- It erodes the purchasing power of the local currency.
- The consensus is that a 50% monthly increase in the price of goods and services is hyperinflation.
- Hyperinflation always involves excessive spending by government leaders.
- This is known as deficit spending, which occurs when spending exceeds revenue.
- A budget deficit is created when there is a shortfall between spending and taxes.
- This is the root cause of most hyperinflationary events.
- The overwhelming majority of hyperinflation involves developing countries.
- According to OECD, developing countries are placed in the category of frontier markets.
- Frontier markets operate in a difficult economic environment.
- The majority of these countries depend on the US Dollar to provide financial stability.
- Countries that experience hyperinflation is often controlled by a corrupt government.
- It’s impossible to stop hyperinflation once it begins.
- Price controls will not solve the problem of hyperinflation.
- Government leaders must remain fiscally responsible to prevent hyperinflation.