Economics Research Paper Sample on Hyperinflation

In modern history, many countries have at least experienced an economic recession. Inflation rates have been on the high end. Nonetheless, few countries such as Germany, Turkey, Hungary, and more recently, Zimbabwe have had the rate of inflation moving to the next level. The extreme rates of inflation in these countries have resulted to hyperinflation. Hyperinflation in purely economic terms refers to a situation where the inflationary actions have spiraled too hight to handle. In this economic time, the currency hugely depreciates, and the prices of goods rise to record heights (Makochekanwa 20). Experts view this situation as one where inflationary cycle does not exhibit any inclination towards equilibrium. Germany is perhaps the best nation that can explain the start of hyperinflation in the 1920s. After World War I, the economic situation in Germany was grave. The currency hugely lost the value in record numbers in beginning of 1923. In context, by the beginning of 1922, Germany had 50, 000 denomination marks (Reinhart et al. 20). However, by October1923, the value soared to 100,000,000,000,000 denomination Marks (Reinhart et al. 20). In fact, the prices were doubling every three days. Similar, hyperinflation situation happened in Zimbabwe, particularly in 2008. The condition became horrible, and one that has seen Zimbabwe abandons the local currency to adopt U.S dollars as its currency. The inflation that began in 2004 rose to its peak in 2008 even though it failed to exceed the Hungary’s world record hyperinflation that happened in 1946. Therefore, this subject is of immense economic significance. A nation with a strong economic backbone is essential to its people, growth, and development. Hyperinflation makes the populace to endure high cost of living, and issues of poverty shall become the standard norm in such a society (Makochekanwa 27). The government must keep the economy strong to prevent the situation that currently grapples Zimbabwe, and what German, Turkey, and Hungary experienced in previous years. The key objective of this analysis is to explain the causes, economic theories, and the consequences of hyperinflation.

Causes of Hyperinflation

Primarily, it is essential to understand that inflation and hyperinflation, while correlated, are somewhat distinct branches stemming from a similar tree. Inflation refers to the upsurge in money supply that results in changes in the aggregate demand (AD) and eventually leads to increased prices of goods. The inflation rate is usually gauged by the change in percentage in the consumer prices every year (CPI). The monetarist model explains this as the situation where prices are related to the increase in money supply. Nonetheless, hyperinflation brings a condition where the value of the currency in that country reduces, and it is typically triggered by the perpetual growth in total money supply, and it causes reduced confidence in the currency. Thus, hyperinflation occurs when the economic engines in that country completely collapse, the regime loses control of the situation, and the population entirely lacks faith in the type of system in place. For example, in Zimbabwe, the government has done less to arrest the situation, making it roll out of control. Some of the key causes of hyperinflation are discussed.

Firstly, hyperinflation is widely caused by a massive increase in money supply, which is not straightly supported by the resultant growth in the provision of goods as well as services. This kind of situation creates uncertainty in the demand and supply for currency, money, and bank deposits (Makochekanwa 20). For example, in neo-classical and Cagan models, sloping points takes place when there exist a surge in supply of money or reduction in monetary base thereby making it intolerable for the administration to enhance its financial condition. In this kind of scenario, it is viewed as if the government itself is making hyperinflation. In classical and monetarist economics, it is the consequence of irresponsible borrowing of money to pay out the expenses. The massive government debt is a huge cause of hyperinflation. Thus, to comprehend how hyperinflation affected the above episodes of Germany, Turkey, and even Zimbabwe, the fundamental causes of inflation must be understood. The external, as well as internal events, must be factored in when explaining the causes of extreme inflation. High inflation originates from both the supply and demand side of the economy. Some of the eternal sources that contribute to hyperinflation may encompass high prices of imported commodities and goods like the crude oil (Reinhart et al. 23).

Secondly, the quantity of money model also explains the causes of hyperinflation. The model suggests that MV=PY, where it is assumed that constant V (velocity of money circulation) and the constant Y gives the accurate picture (Makochekanwa 28). Thus, in perspective, the surge in money supply results in increased prices of goods and services. In reality, the correlation between inflation and money supply may not be simple as the above formula says and thus needs deep thinking to comprehend and analyze how it happens. However, a rough look at the model above is to assume that the money supply grows by 1000 percent and the Real Gross Domestic Product (GDP) remains the same then the rate of inflation shall be 1000 percent.

Thirdly, hyperinflation is aggravated by the shortage of supply, and since the essential goods are not in plenty in the market, it becomes easy to increase the market prices and makes the value of goods to go upwards. It gets worst when the government imposes price controls. The cost of production also grows faster than the prices of goods, and thus the suppliers get little incentive thereby making the shortage worse and hyperinflation real.

In addition, printing money has huge effects to causing hyperinflation. In order to conform to meeting the outstanding debts, the administration can begin printing money, and this shall decrease the value of the existing currency. The effect of this is that it brings many consequences where individuals lose faith in the currency and start demanding increased wages. In reality, note printing does not solve the issue at hand and does nothing to improve the Real GDP or real output. From fundamental economic concept, it is a paradox to say that one can get wealthier by printing more amounts of money. However, sometimes, desperate situations call for desperate measures, and that is why such government opts to print more notes. Therefore, increased supply of notes in the market shall lead to enhanced aggregate demands and the prices of commodities shall drastically increase. For example, the inflation in Zimbabwe was stable until 1998 when the government initiated some programs termed land reforms. However, this program mostly concentrated in giving back the land to the locals from the colonialists and this resulted in an interruption in the production of food. It also caused decreased revenues and decline in direct foreign investment. Thus, to finance its expenditures, the government and the Reserve Bank resorted to printing more money with greater face values that ultimately made the inflation to soar in record figures (Makochekanwa 28).

The exchange rate has direct influence in hyperinflation. Hyperinflation creates a rapid decline in the currency value. Higher imports price of goods caused by exchange rates indirectly or directly feeds to the CPI, and this triggers hyperinflation.

Economic Theories Explaining Hyperinflation

Demand-Pull Theory

This theory only suggests that hyperinflation happens when aggregate demand is increasing at a frequency that cannot be sustainable and this eventually results in amplified pressure on the already scarce resources and it exhibits a positive output gap. Primarily, surplus demand leads to higher profits by the producers since the increased demand runs ahead of the decreased supply. The demand-pull inflation appears likely when the resources become at full usage and the short run aggregate supply is inelastic (Reinhart et al. 23). The principal causes of demand-pull inflation encompass plunge in exchange rates, bigger demands from the fiscal stimulus, faster growth in some countries, and monetary impetus to the economy. This theory relates well with the episodes of hyperinflation that have occurred in the modern history. After the First World War, Germany experienced enormous economic casualties, the resources became restrained, and the reduced production meant that available items sell at record prices. The government did little to arrest the situation, and perhaps insufficient knowledge contributed to the dire economic situation; they did not fully understand or appreciate the situation. In fact, the main fear to them then was unemployment. The government feared that joblessness could initiate a Communist Revolution thus; they did not want to lower demand that could perhaps cause an economic recession.

Cost-Push Theory

The cost-push model shows how prices increase because of growing prices of factors of production. The theory elucidates that the prices of goods as well as services go up since companies that possess market power increase the wages (Reinhart et al. 23). An essential factor of production in such countries like Zimbabwe is mainly imported raw materials, and since the shortage of the foreign currency exists due to reduced exports and desiccated foreign exchange, the country has largely financed the imports by the high foreign money. This kind of situation results in an increased output costs and higher prices for consumer goods. In fact, essential goods such as fuel, sugar, and flour recorded higher prices due to their shortage. The theory relates well and explains the hyperinflation in the modern history. Similarly, the additional demand for essential goods as well as services due to fiscal and monetary policy would lead to increased pressure on the general prices of commodities. Anticipations hugely shaped the economic consequences of Germany in 1920s, Hungary, Turkey, and even Zimbabwe. The populace regarded the regime as one that lacks credibility and integrity since they printed more money to tackle the hyperinflation. However, Germany was able to handle the situation after some years in a structured manner. Reichsbank of Germany reacted by establishing a robust structure that hastened the devaluation mark.

Corrected Modern Monetary Theory

This theory breaks everything down in the bid to comprehend the concept of hyperinflation. Based on this model, every government utilizes a newly made currency thereby making money collected from bonds and taxes worthless (Mishkin 25). This model describes that all bonds are now paid using the newly made money in the market. Consequently, if the nation had a lot of debt to finance and the people seize to roll over bonds, the new money would be used to pay the debts as well as fund the bonds. This scenario of bond panic would create a hyperinflation. This theory best explains the episodes modern hyperinflation where the nations did little to handle the situation at hand thereby making prices of goods as well as raising the cost of living. Zimbabwe, for example, authorized the use of U.S dollar since the local currency suffered significantly. Thus, financing imports using foreign exchange is costly, and the prices of essential commodities go high. The usage of new money just creates an extreme inflation situation.

Neo-Classical Model

The neo-classic model explains the causes of hyperinflation to the reduction of the monetary value and confidence is gained on a view that its value shall be commanded later by the currency. The theory makes a clear risk of withholding money to make it rise then allow the sellers to require huge premiums to agree on the prices. This kind of situation brings tremendous fear that the local currency may plunge and result in even increased premiums. Usually, that sort of scenario takes place during times of conflicts or violent civil war. Nonetheless, explanation to understanding hyperinflation might not be relevant to every case because extreme inflation is a multifaceted phenomenon. Periods of rapid money supply result to an equivalent surge in prices comparative to the supply of services and goods (Mishkin 36). The situation makes hyperinflation a reality and can be used to explain some of the world known examples of extreme inflation.

Economic Consequences of Hyperinflationary Periods

Hyperinflation results in various economic consequences. During the tough times, it is practically hard to find low prices of goods and populace feels the real pinch of extreme inflation. Some of the economic consequences of the hyperinflationary times have been discussed.

Firstly, the value of every savings falls during the periods of hyperinflation. Majorly, in the contemporary economy, the interest rates are normally higher than the rates of inflation. A situation where an individual has some savings in times of extreme inflation would just be pathetic. For instance, if inflation is 6 percent then the interest rate can somewhat be 8 percent. Hence, someone with money in the bank or even some insurance funds shall maintain the exact value of the savings at the above understandable rates. Nonetheless, when hyperinflation occurs, the rate of inflation becomes higher compared to any probable interest rates. The real value of saving eventually becomes wiped out. An interesting example that explains this is the case of some few Germans who started a saving scheme in around 1903 and for 20 years, they injected 10 percent of their earnings to the plan (Mishkin 25). Hyperinflation of 1923 made them cash out the money and what they received was just enough to pay a cup of tea. This shows how cruel hyperinflation can be.

Secondly, hyperinflation leads to reduced confidence in the financial sector. It makes the populace to lack credibility of the government and the finance agencies at large. With some of the measures taken such as printing more cash and introducing new currencies, the experience of hyperinflation can make people aggrieved on their thoughts and start to question the bankers, financiers, as well as general economic structures. It is not a surprise that the Nazi party embarked on radical policies to quell these suspicions.

Thirdly, it leads to plummeting in economic growth and lack of investment. Practically, every person feels economic situation during the times of extreme inflation and hardly would investment takes place during the period. Poverty and hunger take toll of many people since the cost of production or meeting the prices of essential commodities is not attainable. Thus, hyperinflation eventually causes people to reduce the spending and companies lose faith in making any investment. The cost of living also goes up (Mishkin 29).

Finally, it can make the government replace the inflated currency. Some steps encompass making new currency that is pegged to some international index. For instance, Germany led this route in the 1920s and adopted the Rentemark as the newly established currency pegged to a universal market value of gold since most of the European nations had also suffered in World War I. Similarly, the government may decide to adopt another county’s currency. For example, Zimbabwe switched to U.S dollars after Zimbabwe dollars became ineffective.

Conclusion

In conclusion, hyperinflation, just as demonstrated in the analysis above, is detrimental to any economy. The modern history of hyperinflation episode reaffirms the same situation. Germany, Hungary, Turkey, and more recently Zimbabwe experienced enormous economic plunge. Factors that range from government debts, massive money supply, to printing more notes have a huge influence on extreme inflation. Thus, theories such as cost-push model, demand-pull model, modern monetary theory, and neo-classical model help to explain the causes of hyperinflation. The government must remain focused on fighting the high inflation just as Germany and other countries did to fix the situation. This is essential because the consequences that come with hyperinflation are dire. Insufficient confidence in the financial sector, reduced economic growth, and no investment are some of the situations that a country finds itself in during hyperinflation.

Works Cited

Makochekanwa, Albert. A dynamic enquiry into the causes of hyperinflation in Zimbabwe. London: Routledge, 2007. Print.

Mishkin, Frederic S. The economics of money, banking, and financial markets. London: Pearson education, 2007. Print.

Reinhart, Carmen, and Miguel Savastano. “The realities of modern hyperinflation.” (2003): p. 20-23.