What happens to ties during hyperinflation

Hyperinflation: definition, causes and consequences

In Germany, the experience of hyperinflation is the main argument for the economic policy goal of price level stability. In this article we give you an overview of the definition, causes and costs of hyperinflation.

Hyperinflation:

Currency devaluation, at which the rate of inflation per month is over 50%.

This corresponds to a daily increase of a little more than 1 percent. If one looks at the overall effect over the course of time, this rate causes a very strong increase in the average price level.

A monthly inflation rate of over 50% means a more than a hundredfold increase in the price level in one year. As a result, the velocity of money in circulation increases sharply in the event of hyperinflation, because every consumer now wants to spend his money as quickly as possible. In the event of hyperinflation, money has definitely lost its function as a store of value and a unit of account. Or it is only available to a very limited extent.

Causes of Hyperinflation

Hyperinflation usually has two causes:

  • Too high national debt
  • Expansion of the money supply

Hyperinflation does not arise from one of the three classic causes of inflation. Hyperinflation is often the result of crises, e.g. after wars.

In principle, hyperinflation begins when a state does not have enough tax revenue to finance its expenditures. Even if he finances his expenses for a while by increasing his debt, he will eventually lose his creditworthiness.

In this situation, the state has only one instrument left to cover its deficit: an expansion of the money supply.

Colloquially speaking, the central bank then starts the banknote press and prints the required money, which then increases the price level. This connection, that the state can cover its debts by expanding the money supply and thus ultimately inflation, is also known as an inflation tax.

The result of this process can result in very rapid monetary growth and ultimately hyperinflation. Because the cycle becomes independent from a certain point. The fiscal problems of the state will not be solved by hyperinflation, but will intensify. The reason for this is the delays in collecting the tax. As inflation rises, real tax revenue falls. The state is therefore dependent on the central bank printing more and more and faster new money.

Cost of hyperinflation

A distinction is made between 6 different inflation costs.

The type and amount of costs differ depending on whether the economic agents were able to correctly anticipate inflation or not. In particular with correctly or fully anticipated inflation, many of the 6 types of costs can be avoided or at least reduced.

Inflation costs

  • Shoe sole costs
  • Menu costs
  • Uncertainty (reducible)
  • Misallocation (reducible)
  • Taxes (reducible)
  • distribution

The cost of hyperinflation is the same as the “normal” inflation cost. However, the cost of hyperinflation becomes more apparent.

Hyperinflation is a drastic increase in the average price level. As a result, the associated macroeconomic side effects are also very evident. This is particularly true of the following inflation costs:

1. Shoe sole cost

Inflation leads to a reduction in money holdings among economic agents, i.e. they spend it more quickly for fear of losing money. As a result, they have to go to the bank more often and withdraw new money. The resulting costs are referred to as shoe sole costs. In the event of hyperinflation, these costs will now rise rapidly.

And also on the company side. Because if money is losing money quickly, companies have to invest a lot of time in their cash management. This time is then no longer available to them for strategic production and investment decisions that will bring the company forward in the long term. Hyperinflation leads to overall efficiency losses for the economy via shoe sole costs. Because both sides of the market (supplier and customer) incur a lot of effort.

2. Menu costs or menu costs

Menu costs: Costs that the company incurs as a result of price changes.

Price changes can be part of a strategy in companies, e.g. in the form of price differentiation in order to optimize their sales with different customer groups. But if they have to adjust their prices "unexpectedly" as a result of inflation several times a year, the associated costs have a negative impact. E.g. time and effort required for a new price statement or associated printing costs.

With hyperinflation, these menu costs increase dramatically. Companies have to adjust their prices so frequently that the activities involved mean that there was virtually no time left for normal business activities. Because as soon as you have completed the new price list, new prices will apply again.

An extreme example here is the German hyperinflation in the 1920s for the hospitality industry. There a waiter stood on a table in the restaurants every half hour to announce the new prices.

3. Uncertainty and allocation costs

The uncertainty and allocation costs of inflation have already been described as consequences of the two costs explained above.

Clearly, hyperinflation diminishes the ability of relative prices to indicate economic scarcity. In principle, the rapidly changing prices override the price functions. As a result, prices and the market lose their allocation function and are no longer efficient. The uncertainty about future price developments also plays a major role here.

On the demand side, this uncertainty means that it is hardly possible for them to find the cheapest price. Simply because prices change so quickly. You can no longer make well-founded purchasing decisions with it. Strongly fluctuating and rapidly rising prices can therefore influence demand behavior in many ways.

4. Distribution costs - tax system

The tax system is also being disrupted by hyperinflation. However, there is a difference in cost between normal inflation and hyperinflation.

In a tax system, there is usually a delay between when the tax liability arises and when the tax is received by the tax authorities (see e.g. the annual income tax return).

If inflation is lower, this time lag hardly plays a role. In the event of hyperinflation, on the other hand, it leads to a reduction in the real tax revenue received. Because by the time the state receives the money, it has already lost value again.

As a result, hyperinflation leads to real tax revenues falling.

5. "Everyday costs" and consequences

Finally, one can quantify the so-called everyday costs of hyperinflation. These costs represent the effects of hyperinflation on everyday life.

They arise, for example, from the inconveniences for business subjects resulting from the explained shoe sole costs. On the one hand from the frequency with which money has to be withdrawn. And on the other hand from the amount of money withdrawn. As the money loses value, more money has to be withdrawn. The monetary system thus loses its exchange function. Or no longer implements this function efficiently. The state reacts to this by printing more zeros on the banknotes.

However, in the event of hyperinflation, it cannot keep up with the speed of price increases. At some point there will come a point when the overall cost of hyperinflation is no longer acceptable.

At this point money finally loses its function as a store of value, as a unit of account and as a medium of exchange. Barter in kind and alternative unofficial currencies are beginning to displace official money (e.g. cigarettes or another foreign currency).

Disintegration of hyperinflation


Hyperinflation can only be successfully combated through economic and currency reform.

A currency reform can basically take place in two ways:

  1. A completely new currency is being introduced. The state provides every citizen with an initial amount.
  2. A new currency is introduced. Citizens can exchange their original money for the new currency at a high exchange ratio.

Effects of a currency reform

So far, two currency reforms have taken place in Germany, in 1923 and 1948. In both reforms, many savers lost their wealth. This is due to two effects of a currency reform:

Income effect: Under certain assumptions, this effect of a currency reform can be zero and therefore have no negative effects. If, as a result of the exchange ratio of the old and new currencies, prices adjust, i.e. fall, there is no income effect. Because the purchasing power of incomes in the new currency corresponds to that of the old currency.

Wealth effect: Financial wealth does not increase in the course of inflation. It remains constant in terms of amount, but loses real value. In the course of the currency reform, this constant amount will now be exchanged for the new currency. This reduces the amount and consequently also the purchasing power. The real loss of wealth due to the past inflation is now shown and fixed by the currency reform.

As a result, a currency reform leads to a redistribution, particularly through the wealth effect: debtors are favored and property owners are disadvantaged.

This also shows the difference between one Currency reform and a currency conversion:

No one is directly favored or disadvantaged when the currency is changed. The introduction of the euro was a currency changeover. According to the usual definitions, there was no inflation here.

For these reasons, currency reform must go hand in hand with economic reform. This can increase acceptance and mitigate negative consequences.

They can include the following measures, among others:

  • Credible budget deficit reduction
  • Central bank independence
  • Dissolution of hyperinflation through currency reform. Either new currency with “start-up capital” or an exchange ratio.
  • Link your own currency to another currency (stabilization of the exchange rate)

Even if inflation is always a monetary phenomenon, the end of hyperinflation is often also a fiscal phenomenon.

  • The main causes of hyperinflation are excessively high national debt. The state tries to devalue its debts by expanding the money supply and the associated inflation.
  • Inflation costs are correspondingly high in the event of hyperinflation. The functions of money can be completely lost.
  • Dissolution of hyperinflation through currency reform. Either new currency with “start-up capital” or an exchange ratio.
  • Currency reform leads to redistribution: property owners lose, debtors gain.

Finally, test your knowledge of inflation!