Hyperinflation: How Do We Fix It?

1879 words (8 pages) Essay in Economics

23/09/19 Economics Reference this

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Hyperinflation: How do we fix it?

In relation to my current event topic that I presented recently, one question I had while doing research throughout was: how does a country stop hyperinflation? Just looking at some of the numbers for certain countries going through this is staggering. For example, back in 2015 Venezuela’s inflation rate was 181%, which was the highest in the world at the time as well as in the country’s history ever. Luckily, I found a couple of interesting ways as how a country could fix it and I believe they are the best methods for doing so. However, there’s a lot more to background information to hyperinflation other than just “prices and goods rising really high.”

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Most people are familiar with the term inflation, but not everyone, myself included, knew what hyperinflation really was off the bat. To make it easier to understand, let’s start off by defining inflation. Inflation is when there is a continuing price increase in goods and services over a period of time in an economy. Now hyperinflation is basically a very fast and extremely high inflation. The problem is that it quickly erodes the real value of the currency as the prices of most or all goods go up. Typically, the general price level will rise even more rapidly than the money supply because people will try to rid themselves of the devaluing currency as fast as they can. In other words, people will spend all their money right away at once because the value of it will be extremely less the next day.

Hyperinflation isn’t typically caused by a single factor but usually the result by a  variety of things: stress to the government budget, sociopolitical disorder, and export prices collapsing. At its core, hyperinflation starts when a country’s government begins printing money to pay for spending, which can tie into war budgets or export prices collapsing as listed. As the money supply increases, prices rise just like in regular inflation. With so much money circulating throughout the economy, it begins to lose value because no one is spending it so vendors end up marking up prices to make up for the amount of currency in the atmosphere. This also leads into another issue where instead of tightening the money supply to stop inflation, the government just keeps on printing more money to pay for the spending. With too much money in the economy, prices end up skyrocketing. When consumers realize what’s going on, they expect inflation to keep going up. This ends up with them buying more to avoid paying a higher price later. It aggravates inflation, especially if they stockpile goods, which in turn creates shortages. A lot of it is a chain-reaction and can be detrimental to an economy if they aren’t prepared.

Some of the effects of hyperinflation include having purchasing power being taken away, a shortage of durable goods, banks and lenders going bankrupt, and unemployment rising. People end up losing their life savings as cash becomes worthless. This also ends up making the elderly the most vulnerable to hyperinflation. Hoarding and stockpiling create shortages of durable goods such as cars and furniture. Even perishable goods aren’t safe such bread and milk and become scarce as the economy falls apart. Banks and lenders go bankrupt because their loans lose value or no longer have value and then people stop making deposits. In addition, government tax revenues fall which gives it trouble providing basic services. As a result, the government prints more money to pay its bills, which worsens hyperinflation.

Two notable examples of hyperinflation happening in countries are Germany and Venezuela. The most well-known example of hyperinflation was during the Weimar Republic in Germany in the 1920s. The German government made a huge mistake and decided to print money to pay for World War I. From 1913 to the end of the war, the number of Germany currency circulating went from 13 billion to 60 billion. The government also printed government bonds, which pretty much has the same effect as printing cash. A bond is a debt security that a government hands out with paying the face value that’s written on there in mind. This made Germany’s sovereign debt go from 5 billion to 100 billion marks. When World War I ended, the Allies tacked Germany with another 132 billion marks in war repayment. This led to production collapsing, which led to a shortage of goods, especially food. Since there was so much excess cash in circulation and few goods, the price of everyday items doubled every 3.7 days. The inflation rate was 20.9 percent per day. Essentially 21% a day. Farmers and others who produced goods managed, but most people either lived in abject poverty or ended up leaving the country.

The second and most recent example of hyperinflation is in Venezuela. Prices rose 41% in 2013, 63 percent in 2014, 121% in 2015, and 481% in 2016. In 2017, the government increased the money supply by 14 times. It is promoting a new crypto-currency, the petrol because the bolivar, it’s original currency, lost 98% of its worth. It now can’t afford the cost of printing new paper currency. The International Monetary Fund expects prices to rise 13,000% in 2018. In response to this, people are using eggs as currency. A carton of eggs is worth 250,000 bolivars. It only cost 6,740 bolivars in January 2017. Unemployment went up to 21%, which is similar to the United State’s unemployment rate during the Great Depression. How did Venezuela get here in the first place? Their president, Hugo Chavez, had instituted price controls for food and medicine. The issue with this was that the mandated prices were so low that it forced domestic companies out of business. As a result, the government paid for imports. In 2014, oil prices plummeted and eroded revenues to the government-owned oil companies. So when the government ran out of cash, they made a huge mistake and started printing more money. Rather than change its dangerous price and wage controls, their current president, Nicolas Maduro continues to hold unsustainable policies.

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Even though I disagree with some of these policies and quick decisions to print money in hopes of paying debt off, I believe there are some ways to help countries who are dealing with hyperinflation. Using Venezuela as an example, the first method would be to rid the bolivar and officially dollarize the economy. Dollarizing the economy means legally using the currency of another country because the other country’s currency value is more stable. A successful example of dollarization is Ecuador in 2001. Countries that are dollarized produce lower and less variable inflation rates and have more stable economic growth compared to those with central banks that issue domestic currencies. For example, the countries of Panama, Ecuador, and El Salvador are dollarized while Peru is only semi-dollarized. Out of those three dollarized countries, real GDP growth has been more stable than the countries that issue their own domestic currencies. The second way of curving hyperinflation would be to adopt a currency board system. A currency board system sends out notes and coins on demand into a foreign anchor currency that is at a fixed rate of exchange. Since it is a reserve, it has low-risk, interesting-bearing bonds that are denominated in the anchor currency. The reserve levels would be set by law and would be equal to 100% or even slightly more of it’s monetary liability. An orthodox currency board issues notes and coins convertible on demand into a foreign anchor currency at a fixed rate of exchange. As reserves, it holds low-risk, interest-bearing bonds denominated in the anchor currency. The reserve levels (both floors and ceilings) are set by law and are equal to 100%, or slightly more, of its monetary liabilities. A currency board generates profits from the difference between the interest it earns on its reserve assets and the expense of maintaining its liabilities. In Venezuela’s case, the bolivar could become a clone of a anchor currency such as the U.S. dollar in this system. The currency board would not issue credit nor act as a lender or make loans. Ultimately, this would impose a hard budget restriction and discipline on the economy. Another pro is that a currency board requires no preconditions for monetary reform and can be handle quickly. The government and state-owned enterprises don’t need to be already reformed for a currency board to begin issuing currency. Countries that have done currency boards have maintained currency conversion and delivered lower inflation rates, smaller fiscal deficits, lower debt levels relative to GDP, and having fewer banking crises.

Interestingly enough, I remember as a kid asking my grandpa why the United States doesn’t just print out more money if bills are so high. I can’t remember what the answer he gave me was, but after doing thorough research I realize how harmful that idea is. It sounds appealing initially and is a lot more convenient to do at the moment, but the effects following that are too dangerous and once it’s started, it becomes very hard to backtrack. By dollarizing or implementing a currency board system, with enough countries will have time to rebuild and stabilize and it’s nearly impossible for them to do it without help. These systems will surely give them time to undo the damage and I think they are the best methods because on their own, it’ll take too long or only make things worse.

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