Inflation/Hyperinflation

IdleRich

IdleRich

IdleRich
Kind of sparked by what's going on in Zimbabwe at the moment but a general question, I really want someone to explain to me how hyperinflation happens. In fact, I wouldn't mind a decent description of how inflation happens at all but I'm especially bamboozled by a situation where prices are doubling every day - how does the information for these price changes travel fast enough for the changes to occur? How does an economy carry on at all in this manner, how do you get out of this situation once it has started happening?
 
vimothy

vimothy

yurp
Hyperinflation has a lot to do with the expectation of inflation. If people think that the currency is depreciating invalue, thtey will put their prices up. When prices are rising, the government will have to keep printing money so that everyone can afford to keep buying stuff. Because the government keeps printing money, prices will have to go up again. Ad infinitum.

Inflation is a situation in which the money supply increases but productive capacity doesn't, i.e. you have more money but there isn't any more stuff to buy. If you imagine a closed economy, inflation occurs when the money supply increases and you have increased demand but not increased supply. Therefore, prices rise to balance supply and demand. However, lots of prices are said to be "sticky" in that they do not change much in the short term, so that you can "goose" the economy with injections of cash and, in the short term, price will not rise. (This is Bernancke's strategy at present --- abandon price stability for full employment. The ECB is more anti-inflationary).

In macroeconomics this gives rise to an argument between Keynesian and neoclassical economists, where the Keynesians are prepared to tolerate a lot of inflation because inflation is thought to be inversely related to unemployment (according to the Philips Curve), and the neoclassicals want to let markets do their work and reallocate underperforming resources.
 
IdleRich

IdleRich

IdleRich
"Hyperinflation has a lot to do with the expectation of inflation. If people think that the currency is depreciating invalue, thtey will put their prices up. When prices are rising, the government will have to keep printing money so that everyone can afford to keep buying stuff. Because the government keeps printing money, prices will have to go up again. Ad infinitum."
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OK, that I can grasp - but what I don't understand is how people know to double their prices (or whatever) over the course of the day, how it happens in practice basically. What I mean is, markets are often described as an exchange of information which is signalled by the price but can there really be enough information being exchanged for a given shopkeeper to adjust their prices several times a day? Do they just do that because that's what they and other people did yesterday and it's a vicious circle?
Also, slightly related question - I've several times heard people say that inflation can be viewed as a kind of tax - how does that work? Obviously inflation means that a given citizen has less purchasing power than they would have had otherwise but in what other way is it similar to a tax?
Also, is inflation inevitable?
 
vimothy

vimothy

yurp
Yeah, I have no experience of hyperinflation, so don't know how it works in practice. I think that if you work on a market stall and at every price level, your stock clears a lot sooner than you would otherwise expect it to (massive demand), you would keep increasing the price to find the biting point. Otherwise, the money you receive for your goods will not equal the real value that they are worth. It must be guess work, but I think that if prices around you are increasing, then you must raise your own prices or you won't be able to afford to buy anything.

Apparently in Hungary after WWII, prices increased 19,000 percent a month! Also, check this out for unintended consequences.

Re inflation as a tax -- it's not a direct tax, but it does have beneficiaries (net debtors, like the government) and and those who have to pay for government debt relief (anyone holding cash, like most people). There is also the issue of marginal tax rates, where inflation pushes nominal wages higher, placing workers in higher tax brackets despite the fact that real wages have not increased.

Inflation is not inevitable but it is highly likely in a system of fiat currency. Inflation under the historical gold standard was pretty consistently low for a long ass time.
 
vimothy

vimothy

yurp
art.zimbabwe.dollars.gi.jpg
 
IdleRich

IdleRich

IdleRich
"Yeah, I have no experience of hyperinflation, so don't know how it works in practice. I think that if you work on a market stall and at every price level, your stock clears a lot sooner than you would otherwise expect it to (massive demand), you would keep increasing the price to find the biting point. Otherwise, the money you receive for your goods will not equal the real value that they are worth. It must be guess work, but I think that if prices around you are increasing, then you must raise your own prices or you won't be able to afford to buy anything."
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I guess this must be what happens but it seems incredible to me.

"but it does have beneficiaries (net debtors, like the government)"
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OK, that makes sense, the real value of what you owe has decreased.

"anyone holding cash, like most people"
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But I don't get that. If you're holding cash and it decreases in value how have you gained?

"There is also the issue of marginal tax rates, where inflation pushes nominal wages higher, placing workers in higher tax brackets despite the fact that real wages have not increased."
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Oh yeah, should have figured that out (or remembered it).

"Inflation is not inevitable but it is highly likely in a system of fiat currency. Inflation under the historical gold standard was pretty consistently low for a long ass time"
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Why and why? Because you can't just increase the money supply with a gold standard I guess.

From wikipedia

"The largest denomination banknote ever officially issued for circulation was in 1946 by the Hungarian National Bank for the amount of 100 quintillion pengő (100,000,000,000,000,000,000, or 1020)."
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P

Pestario

tell your friends
Reading on wikipedia it said somewhere that the exchange rate was broadcast on the radio during hyperinflationary times so I guess that's how people knew.
 
P

Pestario

tell your friends
Also, if you're a public service worker and your pay is increased below the rate of inflation, you are in a way paying a tax to the govt. The recent council strikes were about this.
 
IdleRich

IdleRich

IdleRich
"Reading on wikipedia it said somewhere that the exchange rate was broadcast on the radio during hyperinflationary times so I guess that's how people knew."
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But I thought that in Zimbabwe the rate was changing too fast for the government (and presumably anyone else) to calculate it at any given time. Also, I can't imagine that Mugabe would be too happy with a station reporting how quickly the bottom was falling out of his currency - plus wouldn't that tend to have an inflationary effect in itself?
 
N

noel emits

a wonderful wooden reason
Maybe this is of some interest here. In the US Ron Paul confronted Ben Bernanke wrt inflation in congress last week. Bernanke said this:

“Congressman, I couldn’t agree with you more that inflation is a tax, and that inflation is currently too high.”

 
vimothy

vimothy

yurp
But I don't get that. If you're holding cash and it decreases in value how have you gained?
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No, I mean that people holding cash lose out because the value of that cash is decreasing. In effect, inflation transfers wealth from creditors to debtors.

Why and why? Because you can't just increase the money supply with a gold standard I guess.
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Just different ways of doing monetary policy. Under the current system, central banks have a lot of discretion. Sometimes that's good (no more Great Depressions), sometimes that's bad (more inflation than under a gold standard). The Lawrence White paper I linked to is a pretty good summary/defence of the gold standard.
 
IdleRich

IdleRich

IdleRich
"No, I mean that people holding cash lose out because the value of that cash is decreasing. In effect, inflation transfers wealth from creditors to debtors."
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That makes more sense.
 
Mr. Tea

Mr. Tea

Let's Talk About Ceps
vimothy said:
Yeah -- expectation of inflation is inflationary.
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So if the rate of inflation *increase* were in some way proportional to the level of inflation at the time, you'd get exponential inflation, right? Interestingly (to me), the concept of a brief period of exponential expansion in the early universe, a fraction of a second after the big bang, was first proposed by Alan Guth in 1980 - the name ("cosmic inflation") was inspired by what had been happening to the US's economy in the previous decade.
 
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swears

swears

preppy-kei
Mr. Tea said:
("cosmic inflation") was inspired by what had been happening to the US's economy in the previous decade.
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Really? I always assumed that it came from the idea of the universe expanding in all directions at once, like a baloon being inflated.
 
Mr. Tea

Mr. Tea

Let's Talk About Ceps
swears said:
Really? I always assumed that it came from the idea of the universe expanding in all directions at once, like a baloon being inflated.
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Well the universe is doing that even today - so yes, it is like a balloon being 'inflated' - but what was new about (cosmic) inflation was the idea that certain kinds of energy field can cause exponentially accelerating expansion, so that the bigger the universe gets, the faster it gets bigger. This is where the analogy to economic (hyper)inflation came from, I believe.
 
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