Economic Fluctuations: Unemployment and Inflation Inflation Case Study: Behavior During Page 1 of 2

I’ve come to the grocery store to do my shopping during a period of . Hyperinflation is a time in the economy when prices are rising very, very rapidly. In fact, one of the hallmarks of hyperinflation is that prices are changing practically before your very eyes. This happens occasionally in history that an economy will find itself in a period where prices seem to be out of control. Well, how do prices get out of control? How does inflation turn hyper? Usually inflation becomes hyperinflation when the government is printing money like crazy; and the government will be printing money because it’s its only way of paying its bills.

Consider a government that can’t borrow money by issuing bonds, and therefore must print money to cover any deficit spending. That means if the government’s in a bind and has to make payments to its poor people so they can buy bread, or to pay its army to keep peace in the streets, and yet the government is in a situation where it can’t raise taxes because the tax system has broken down, or was never in place to begin with, then the deficit has to be financed by the printing of money. And once money starts to be printed like crazy to finance government deficits, next thing you know, the money becomes worthless and prices are out of control, because it takes a larger and larger and larger amount of this increasingly worthless paper to buy anything you might be interested in. I mean, when I walked into this store, this pineapple only cost $2.00, and now look, it’s $8,000.00. I’d better get it up to the register fast, before I find out that even the money that I brought with me isn’t enough to pay.

There are several examples of hyperinflation in history –Germany after the world wars, or Israel in the 1980s. One notorious example of hyperinflation was – around 1985 prices rising at an annual rate of 30,000% a year, prices changing practically before your eyes. When you’re in a period of hyperinflation, what would happen would be Bolivia would be trying to get rid of their devaluing as quickly as they were handed to them. A worker would take his paycheck, go and buy a month’s worth of rice and noodles, and then as quickly as possibly convert all the remainder to dollars on the black market. And if he got down to the dollar market too late in the day, he might find that the remaining pesos – maybe almost a million pesos – would only buy $20.00 instead of $30.00 that it would have bought in the morning.

So during a period of hyperinflation, people are obsessed with getting rid of money, even if it’s becoming worthless. People will also ask to be paid in the goods they’re producing. When you work at an overall factory, you don’t want pesos, you want overalls, because, then, you can at least barter them for chickens, and the stuff that you need. Everybody finds that changing money can earn a higher return than other forms of productive activity, and that’s exactly what happened in Bolivia. A lot of people left their original occupation making soup, making clothing, and instead wanted to become money changers, because the economy was so overheated with people trying to trade their pesos.

What also happened was Bolivian tin was exploited through Peru, because nobody wanted to hold the Bolivian peso that they would get whenever they traded their tin for money. Therefore, the Bolivian economy began to revert to barter, and the peso was something no one wanted to hold. When people don’t want to hold money in the economy anymore, then they’re subject to transactions costs, and small menu costs; that is, the prices have to be changed several times a day. And all the effort that people will go to, to avoid the money – going to the black market, buying and hoarding goods instead of holding the paper stuff.

Another famous example of hyperinflation occurred in the American colonies and then the new United States around 1776. The U.S. is fighting a war against Britain, and George Washington needs to raise money for his army. The Continental Congress, at that point, had no authority to borrow money. So it paid for its deficit spending by printing Continental dollars, which very quickly became worthless, because there were so many of them printed because of the needs of the army that they were depreciated, and prices in terms of those dollars rose very rapidly. And before long, no one would accept them in payment.

So hyperinflation occurs at a point when government deficits have created so much rapid rise in the price level that people simply don’t want to hold the money anymore, and the economy reverts to barter, as if there were no money at all.

Economic Fluctuations: Unemployment and Inflation Inflation Case Study: Behavior During Hyperinflations Page 2 of 2

A situation in Serbia occurred also when the war there caused the government to have to spend money to raise an army. They couldn’t raise taxes in this war-torn country, so they printed the money they needed to pay for the army, and what happened as a result was that prices began to rise at a rate of 10% a day. Now 10% a day means that prices double every seven days; so that’s an inflation rate in the quadrillions – a practically astronomical inflation rate – so that by the end of the year, prices had become practically meaningless.

How does a country get out of hyperinflation? It gets out of hyperinflation by bringing government spending under control so that the government printing presses no longer have to run to produce the money that’s used to pay the government’s bills. Until the government can get its deficit spending under control, it can’t stop printing money. Then what typically happens, like in Germany after the world wars, is that the government will step in and say, “All right, deficit spending has ended. We’re going to replace this old worthless with a new currency.” And if the public has confidence in it, then prices can be reestablished in the new currency, and people can have confidence that there will be price stability.

As for me, prices are rising so rapidly in my economy that it turns out that even the money I brought in with me isn’t enough to buy the pineapples I came to get. This money is worthless. So what am I going to do? I’m not going to take the money anymore. I’m going to revert to barter, and I’m going to ask to be paid in overalls, so I can bring them in and trade them out the back door for the pineapples that I want. This economy, because of its hyperinflation, has reached the inefficient point that I’m ready to revert to bartering. When my government gets its deficit spending under control, and stops printing money, then maybe I’ll be willing to accept it again.