Controlling Inflation Project

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Inflation basics
1.1 The concept of inflation:
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a
period of time. When the price level rises, each unit of currency buys fewer goods and services;
consequently, inflation is also erosion in the purchasing power of money – a loss of real value in the
internal medium of exchange and unit of account in the economy.
Inflation can have positive and negative effects on an economy. Negative effects of inflation include a
decrease in the real value of money and other monetary items over time; uncertainty about future
inflation may discourage investment and saving, and high inflation may lead to shortages of goods if
consumers begin hoarding out of concern that prices will increase in the future. Positive effects include a
mitigation of economic recessions, and debt relief by reducing the real level of debt.
1.2 How is inflation measured?
Inflation is usually estimated by calculating the inflation rate of a price index, usually the Consumer Price
Index. The Consumer Price Index measures prices of a selection of goods and services purchased by a
"typical consumer". The inflation rate is the percentage rate of change of a price index over time.
Other widely used price indices for calculating price inflation include the following:
Cost-of-living indices (COLI) are indices similar to the CPI which are often used to adjust fixed incomes
and contractual incomes to maintain the real value of those incomes.
Producer price indices (PPIs) which measures average changes in prices received by domestic producers
for their output. This differs from the CPI in that price subsidization, profits, and taxes may cause the
amount received by the producer to differ from what the consumer paid. There is also typically a delay
between an increase in the PPI and any eventual increase in the CPI. Producer price index measures the
pressure being put on producers by the costs of their raw materials. This could be "passed on" to
consumers, or it could be absorbed by profits, or offset by increasing productivity. In India and the
United States, an earlier version of the PPI was called the Wholesale Price Index.
Commodity price indices, which measure the price of a selection of commodities. In the present
commodity price indices are weighted by the relative importance of the components to the "all in" cost
of an employee.
A Wholesale Price Index (WPI) is the price of a representative basket of wholesale goods. India earlier
used it as the central measure of inflation. However, India now reports a producer price index instead.
Producer price indices (PPIs) which measures average changes in prices received by domestic producers
for their output. This differs from the CPI in that price subsidization, profits, and taxes may cause the
amount received by the producer to differ from what the consumer paid. There is also typically a delay
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between an increase in the PPI and any eventual increase in the CPI. Producer price index measures the
pressure being put on producers by the costs of their raw materials.
The effects of inflation:
1.3.1 The negative effects of inflation
High or unpredictable inflation rates are regarded as harmful to an overall economy. They add
inefficiencies in the market, and make it difficult for companies to budget or plan long-term.
With high inflation, purchasing power is redistributed from those on fixed incomes such as pensioners
towards those with variable incomes whose earnings may better keep pace with the inflation.
Cost push inflation: Rising inflation can prompt employees to demand higher wages, to keep up with
consumer prices. Rising wages in turn can help fuel inflation. In the case of collective bargaining, wages
will be set as a factor of price expectations, which will be higher when inflation has an upward trend
Hoarding: People buy consumer durables as stores of wealth in the absence of viable alternatives as a
means of getting rid of excess cash before it is devalued, creating shortages of the hoarded objects.
1.3.2 The positive effects of inflation:
Labor market adjustment: Keynesians believe that nominal wages are slow to adjust downwards. This
can lead to prolonged disequilibrium and high unemployment in the labor market. Since inflation would
lower the real wage if nominal wages are kept constant, Keynesians argue that some inflation is good for
the economy, as it would allow labor markets to reach equilibrium faster.
Debt relief: Debtors who have debts with a fixed nominal rate of interest will see a reduction in the
"real" interest rate as the inflation rate rises.
Monetary policy
2.1 The concept of monetary policy
Monetary policy is the process a government, central bank, or monetary authority of a country uses to
control (i) the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest to
attain a set of objectives oriented towards the growth and stability of the economy. Monetary theory
provides insight into how to craft optimal monetary policy.
Monetary policy is referred to as either being an expansionary policy, or a contractionary policy, where
an expansionary policy increases the total supply of money in the economy, and a contractionary policy
decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in
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a recession by lowering interest rates, while contractionary policy involves raising interest rates to
combat inflation.
The primary tool of monetary policy is open market operations. This entails managing the quantity of
money in circulation through the buying and selling of various financial instruments, such as treasury
bills, company bonds, or foreign currencies. All of these purchases or sales result in more or less base
currency entering or leaving market circulation.
Usually, the short term goal of open market operations is to achieve a specific short term interest rate
target. In other instances, monetary policy might instead entail the targeting of a specific exchange rate
relative to some foreign currency or else relative to gold.
2.2 Various tools in the monetary policy to control inflation:
Repo (Repurchase) Rate
Repo rate is the rate at which banks borrow funds from the RBI to meet the gap between the demands
they are facing for money (loans) and how much they have on hand to lend.
If the RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate;
similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.
Implications on inflation:
If the inflation is rising, reserve bank increases the repo rate so that other banks reduce their borrowings
which are further used for giving loans. Thus in turn reduces the money supply and decreases liquidity.
Thus inflation can be controlled. Also the increase in repo rate fuels the increase in interest rates as the
cost of borrowing increases. This, leads to increase in savings and decrease in investment borrowings.
Reverse Repo Rate
This is the exact opposite of repo rate.
The rate at which RBI borrows money from the banks (or banks lend money to the RBI) is termed the
reverse repo rate. The RBI uses this tool when it feels there is too much money floating in the banking
system.
If the reverse repo rate is increased, it means the RBI will borrow money from the bank and offer them a
lucrative rate of interest. As a result, banks would prefer to keep their money with the RBI (which is
absolutely risk free) instead of lending it out (this option comes with a certain amount of risk)
Consequently, banks would have lesser funds to lend to their customers. This helps stem the flow of
excess money into the economy. Thus, this will control inflation.
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Reverse repo rate signifies the rate at which the central bank absorbs liquidity from the banks, while
repo signifies the rate at which liquidity is injected.
CRR
Also called the cash reserve ratio, refers to a portion of deposits (as cash) which banks have to
keep/maintain with the RBI. This serves two purposes. It ensures that a portion of bank deposits is
totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation by
tying their hands in lending money.
By increasing the CRR reserve bank reduces the money supply and thus keeps a check on the inflation.
SLR
Besides the CRR, banks are required to invest a portion of their deposits in government securities as a
part of their statutory liquidity ratio (SLR) requirements. What SLR does is again restrict the bank’s
leverage in pumping more money into the economy.
SLR has the same implication as CRR has. If SLR is increased the banks have to park more of their funds
in the government securities, reduce lending which in turn reduces the money supply and hence the
inflation.
2.3 Various types of monetary policies:
2.3.1 Inflation targeting
Under this policy approach the target is to keep inflation, under a particular definition such as Consumer
Price Index, within a desired range.
The inflation target is achieved through periodic adjustments to the Central Bank interest rate target.
The interest rate used is generally the interbank rate at which banks lend to each other overnight for
cash flow purposes. Depending on the country this particular interest rate might be called the cash rate
or something similar.
The interest rate target is maintained for a specific duration using open market operations. Typically the
duration that the interest rate target is kept constant will vary between months and years. This interest
rate target is usually reviewed on a monthly or quarterly basis by a policy committee.
It is currently used in Australia, Canada, Chile, Colombia, the Eurozone, New Zealand, Norway, Iceland,
Philippines, Poland, Sweden, South Africa, Turkey, and the United Kingdom.
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2.3.2 Price level targeting
Price level targeting is similar to inflation targeting except that CPI growth in one year is offset in
subsequent years such that over time the price level on aggregate does not move.
2.3.3 Monetary aggregates
In the 1980s, several countries used an approach based on a constant growth in the money supply. This
approach was refined to include different classes of money and credit (M0, M1 etc). In the USA this
approach to monetary policy was discontinued with the selection of Alan Greenspan as Fed Chairman.
This approach is also sometimes called monetarism.
While most monetary policy focuses on a price signal of one form or another, this approach is focused
on monetary quantities.
2.3.4 Fixed exchange rate
This policy is based on maintaining a fixed exchange rate with a foreign currency. There are varying
degrees of fixed exchange rates, which can be ranked in relation to how rigid the fixed exchange rate is
with the anchor nation.
Under a system of fiat fixed rates, the local government or monetary authority declares a fixed exchange
rate but does not actively buy or sell currency to maintain the rate. Instead, the rate is enforced by non-
convertibility measures (e.g. capital controls, import/export licenses, etc)
Under a system of fixed-convertibility, currency is bought and sold by the central bank or monetary
authority on a daily basis to achieve the target exchange rate. This target rate may be a fixed level or a
fixed band within which the exchange rate may fluctuate until the monetary authority intervenes to buy
or sell as necessary to maintain the exchange rate within the band. (In this case, the fixed exchange rate
with a fixed level can be seen as a special case of the fixed exchange rate with bands where the bands
are set to zero.)
2.3.5 Gold standard
The gold standard is a system in which the price of the national currency as measured in units of gold
bars and is kept constant by the daily buying and selling of base currency to other countries and
nationals. (I.e. open market operations cf. above). The selling of gold is very important for economic
growth and stability.
The gold standard might be regarded as a special case of the "Fixed Exchange Rate" policy. And the gold
price might be regarded as a special type of "Commodity Price Index".
2.4 The monetary policy used by India:
India uses multiple indicator approach as their monetary policy. In this policy, the government keeps a
check and controls the value of various indicators such as CPI, WPI etc.
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Fiscal policy:
3.1 The concept of fiscal policy:
In economics, fiscal policy is the use of government expenditure and revenue collection to influence the
economy.
Fiscal policy can be contrasted with the other main type of economic policy, monetary policy, which
attempts to stabilize the economy by controlling interest rates and the supply of money. The two main
instruments of fiscal policy are government expenditure and taxation. Changes in the level and
composition of taxation and government spending can impact on the following variables in the
economy:
Aggregate demand and the level of economic activity;
The pattern of resource allocation;
The distribution of income.
Fiscal policy refers to the overall effect of the budget outcome on economic activity. The three possible
stances of fiscal policy are neutral, expansionary, and contractionary.
3.2 Fiscal policy can controls/prevents inflation:
There are two significant differences between fiscal policies designed to control already existing inflation
and those designed to prevent inflation from afflicting an economy which at the time is free of inflation.
The first difference relates to time horizon and the speed at which a policy measure is carried out.
The second relates to the size of the change required in the relevant variables e.g. government
expenditure, taxes, etc. Policies designed to control inflation have to have an impact now. They must be
fast acting showing their results in a matter of months. This in turn may require big reduction in
government expenditure, large increases in taxes, huge amounts of domestic borrowing etc. Given these
measures successfully implemented over a short period of time aggregate demand will decrease and the
trend of prices to rise will be checked.
How does fiscal policy control inflation:
3.3.1 Reduction in Public Expenditure
It is only when it comes to the public goods and the welfare activities of the government that reduction
in government expenditure becomes a real possibility. But the actual scope of such reduction depends
on the historical path followed by (the increase in) government expenditure. Modern day governments
have shown little ability to reduce expenditure on education and health care. For a developing country
like India reduction in expenditure on education and health care is still the less appealing. The most a
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developing country can manage to do is to prevent expenditure on these items from increasing further.
Reducing the current levels of expenditure on education and health care are no where a real option. In
fact any attempt to do so would be economically disastrous and politically suicidal for the regime.
3.3.2 Increase in Tax Revenues
3.3.3 Increasing the Supply of Goods and Services
Supply of goods and services can be increased to match the demand by spending money in a way that
increases supply of goods and services. This spending does not have to be done by the government
itself, at least not all of it. Tax reduction that encourages private investment may serve the same
purpose. Lowering corporation taxes and lowering or scrapping capital gains taxes, even scaling down
the income taxes may boost production by increasing the incentive to work and the incentive to save.
Another possible measure is to restructure the subsidies, if any, in favour of the intermediate industries
whose products are needed for expanding the production of consumer goods. Building the
infrastructure --- roads, bridges, irrigation systems, electricity and telecommunication, etc. --- at public
cost and making them available to the private sector at affordable prices has also been a policy.
3.3.4 Treasury bills or bonds:
Treasury Bills, or more commonly known as T-Bills, are short term government debt instruments, issued
at a discount to par and mature within 1 year. The largest purchase volumes come from primary dealers
and other large banking or financial institutions.
T-Bill issuance is a form open market operations employed by the Federal Reserve to control the money
supply. Large T-Bill issuances are seen as a means to reduce the money supply, thereby reducing
liquidity to control inflation. When the treasury buys T-Bills back, their aim is to increase the money
supply and decrease interest rates.
Similar to discount notes and zero-coupon bonds, t-bills do not make periodic interest payments and
mature at par. The interest component on the security is paid at maturity, equaling the par value of the
bond minus the purchase price. For example, if you purchased a bond with a par value of $100 at $95,
you would receive $5 of interest.
Additionally, interest income derived from the T-Bill is exempt from state & local taxes but is subject to
federal taxes.
Treasury Bills in India
They are auctioned by Reserve Bank of India at regular intervals and issued at a discount to face value.
On maturity the face value is paid to the holder.
The rate of discount and the corresponding issue prices are determined at each auction. When liquidity
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is tight in the economy, returns on Treasury Bills sometimes become even higher than returns on bank
deposits of similar maturity.
Any person in India including Individuals, Firms, Companies, Corporate bodies, Trusts and Institutions
can purchase Treasury Bills. Treasury Bills are eligible securities for SLR.
Treasury Bills are available for a minimum amount of Rs.25,000 and in multiples of Rs. 25,000
thereafter. They are available in both Primary and Secondary market.
Type of Treasury Bills:
At present, RBI issues T-Bills for three different maturities: 91 days, 182 days and 364 days. The 91 day
T-Bills are issued on weekly auction basis while 182 day T-Bill auction is held on Wednesday preceding
non-reporting Friday and 364 day T-Bill auction on Wednesday preceding the reporting Friday
3.4 Monetary policy v/s Fiscal policy
Time frame required to control inflation:
As far as the monetary policy is concerned, it takes some time before it actually can influence inflation.
The reason for this is that, once the rates are changed, it does not immediately affect the investing and
saving trends amongst the people.
However, as fiscal policy directly involves controlling the taxes collected by the people, changing the
government expenditure, auction of bonds etc, thus the money supply is directly controlled and this
significantly and very rapidly controls inflation.
Long term effect of these polices:
In long run an excessive exercise of monetary policy by increasing the interest rates reduces the
investment and hence the demand. This in turn affects the growth of the economy.
But in fiscal policy only the excess money which causes high demand is removed from the market
through taxes, bonds etc. This does not affect the growth of the economy.
Long term policies to control inflation:
4.1 Control of wages;
4.1.1 Direct wage controls - incomes policies
Incomes policies (or direct wage controls) set limits on the rate of growth of wages and have the
potential to reduce cost inflation. The Government has not used such a policy since the late 1970s, but
it does still try to influence wage growth by restricting pay rises in the public sector and by setting cash
limits for the pay of public sector employees.
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In the private sector the government may try moral suasion to persuade firms and employees to
exercise moderation in wage negotiations. This is rarely sufficient on its own. Wage inflation normally
falls when the economy is heading into recession and unemployment starts to rise. This causes greater
job insecurity and some workers may trade off lower pay claims for some degree of employment
protection.
4.1.2 Long-term labor policies to control inflation
Labour market reforms
The weakening of trade union power, the growth of part-time and temporary working along with the
expansion of flexible working hours are all moves that have increased flexibility in the labour market. If
this does allow firms to control their labour costs it may reduce cost push inflationary pressure.
Supply-side reforms
If a greater output can be produced at a lower cost per unit, then the economy can achieve sustained
economic growth without inflation. An increase in aggregate supply is often a key long term objective
of Government economic policy. In the diagram below we see the benefits of an outward shift in the
long run aggregate supply curve. The equilibrium level of real national income increases and the
average price level remain relatively constant.
4.2 Controlling inflation by giving subsidy to the poor:
Last year (2009), The government, visibly concerned over rising food inflation, has said that it will take
steps to arrest rising prices of essential food items in the country. Finance Minister Pranab Mukherjee
said that the government is already providing subsidy to the poor people of the society through the
public distribution system (PDS) and strengthening the same to ensure its proper utilization.
4.3 Inflation Hedging
Inflation Hedge is an investment with intrinsic value such as oil, natural gas, gold, farmland, and to a
lesser degree commercial real estate. Typically most hard assets are an excellent inflation hedge. In
general, commodities/hard assets are negatively correlated to both stocks and bonds. In other words,
when stocks and bonds decline, commodities tend to appreciate. In addition, during periods of high
inflation/negative real interest rates equities and bonds do poorly.
Controlling food inflation
The food inflation in this year had gone as high as 16%. This food inflation had not gone up due to
increase in demand but due to lack in supply. Some of the measures were suggested by Mr. Kaushik
Basu, the chief economic adviser in the finance ministry.
De-hoarding: This involves bring the excess reserve stock of agro/food based products in the market so
as to increase the supply and hence control inflation of food prices.
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Selective imports: There are a few food items which can be imported from other countries also which
would in turn increase the supply. Such import is not possible in all the commodities but is possible in
quite a few food commodities.
Controlling exports: A good amount of the agro production is exported to other countries. These
exports can be brought down in order to increase the supply of these commodities in the country and
hence control inflation.
Providing food subsidy/food security to the poor.
Control of oil prices:
The Government of India (GOI) decides the basic oil pricing. The oil exploration companies cannot
charge beyond these fixed prices even if they are operating in losses.
In order to compensate for these losses GOI issues oil bonds in the favour of these companies which are
of the equivalent amount of these losses. The following illustration will explain how oil bonds actually
work.
IOC makes loss selling petroleum products due to govt. restrictions on pricing. The govt. of India
compensates this loss by issuing special oil bonds.
IOC shows these bonds as income on its P&L (the IOC P&L for 2007 - 2008 shows an income of Rs.13,943
CR this way), thus converting the loss into a profit.
IOC also shows these bonds as investment on its balance sheet (Schedule G of IOC balance sheet for
2007 - 2008 shows investment worth Rs. 14,308 in these GOI special bonds). This means that without
paying a penny for these bonds, IOC has invested in these GOI bonds. Now, IOC gets a cash flow (around
7% - 8%) from GOI by way of interest payment on these bonds. Also upon maturity, the GOI will have to
redeem these bonds from IOC (maturity periods are anywhere from 2009 to 2026 as per Schedule G).
Instead, what IOC does is, it sells these bonds in the secondary bond market to mutual funds, insurance
companies and other such financial institutions Thus, the bonds are converted into hard cash (Schedule
G says IOC made Rs. 6,503 Cr this way in 2007- 2008). This is how IOC gets hard cash to compensate for
its losses immediately. (Of course, upon maturity the GOI has to still pay cash to whoever holds these
bonds at that time).
Bottom line is, the oil bond is a GOI bond and hence is a govt. debt which has to be repaid some day.
Interestingly, this debt stays off-budget and does not reflect in the revenue or fiscal deficit of the GOI.
This is because these companies are anyway owned by the government.
Thus, care is taken so that the oil prices do not rise beyond a certain extent.
Inflation control in communist countries:
7.1 Inflation in communist countries:
Officially, most Communist governments maintain virtually zero inflation because prices for almost all
goods and services are set by state agencies and changed only rarely. Though workers who over fulfill
production quotas are showered with medals and occasionally cash bonuses, wages, too, are generally
controlled, on the basis of supply of consumer goods available. If supply goes up 5%, say, so do wages.
That way, supposedly, there is no excess cash chasing scarce goods.
Thus theoretically there is no inflation. However, the reality is somewhat different. Basic services such as
housing, medical care and mass transit in the Communist countries are generally cheap, but prices for
many items from cars to quality foods have long been set so high that they remain beyond the reach of
most Russians, as well as Poles, East Germans, Czechs, Rumanians, Hungarians and Bulgarians. Says one
Soviet economist ingenuously: "We do not have inflation — we just have high prices."
Moreover, as a matter of policy, prices for some goods are set below the cost of making them. Vladimir
Sitnin, chairman of the Soviet Union's state price committee, notes: "There is some relation between
production costs and prices, but not necessarily a direct one. Retail prices have a social objective,
varying from low prices for schoolbooks to higher prices for liquor."
Consumers pay dearly in other ways for official price stability. Many goods are offered in only skimpy
variety and threadbare quality because that is all factories can afford to make at state-set prices.
Massive government subsidies must be paid to industries and to Soviet agriculture in order to keep
prices steady despite regular rises in production costs, caused by inefficient use of workers and
machines. The subsidies chew up capital that would otherwise be invested in new plant and equipment
and contribute to the persistent inability of Communist economies to expand fast enough to meet
demands of consumers.
In addition, undisguised inflation exists in sectors not subject to iron-fisted government control—
imports, goods sold on sanctioned free markets and those peddled in widespread black markets. There
is a dramatic increase in the prices of so-called new products. By making the minutest change in any
item—even installing a new car heater —a factory manager can get it classified as new and kick up the
price. That does not count as an "increase" because the product theoretically has just come to the
market. In the Soviet Union, the latest model Volga car costs $12,170, about 68% more than its
predecessor, though only an engineer could see the difference.
7.2 Performance of various communist countries in the last decade:

The economic boom in the post-communist region has been extraordinary. In 15 former Soviet republics
average growth for the last nine years has been no less than 9 percent per year. However, these
communist countries are still reeling under high level of inflation.
The increasing public expenditures that led to big budget deficits is said to be the major cause of
inflation.
7.2.1 Kazakhstan
Until 2007, Kazakhstan had a steady growth rate of 9 to 10 percent a year. But its commercial banks
have borrowed too much abroad, boosting inflation to 18 percent. When international interest rates
rose, their debts became untenable. Although none of them has gone under, these banks had to tighten
their belts, and so has the country. Growth in gross domestic product has fallen by half to some 5
percent, but Kazakhstan's abundant oil revenues safeguards such a soft landing.
7.2.2 Estonia and Latvia
Estonia and Latvia have been the greatest economic successes, but even the sun has its spots. They have
fixed their exchange rates to the euro. Therefore, their domestic prices have risen with increasing
productivity in the export sector, and they have imported substantial inflation—currently 18 percent in
Latvia and 12 percent in Estonia.
With their fixed exchange rates, these countries cannot pursue any monetary policy, and their huge
current account deficits have been financed by foreign direct investment and bank loans. Suddenly, the
foreign banks that own the Baltic banks have minimized their loans. Demand, consumption, and real
estate prices have fallen. The double-digit growth rates have plummeted to 2 to 3 percent. The question
is how large bad debts will be revealed, but so far the Baltic States seem to take the hit well. As in
Kazakhstan, their success story is likely to reemerge.
7.2.3 Romania
Romania looks worse. As in the Baltic countries, it has a big current account deficit, but it has
predominantly been financed with foreign bank loans, which are now drying up, and its budget deficit of
some 3 percent of GDP is excessive in 2008. So far, its saviour has been its floating exchange rate and an
independent central bank that pursues a strict monetary policy, but Romania's growth will suffer.
7.2.4 Ukraine
Ukraine looks worst of all. Its inflation has just reached 31 percent a year in 2008, although its state
finances are in excellent shape and its growth rate stays at 7 percent. Ukraine's outsized inflation is
caused by its central bank, which, for some reason, insists on a dollar peg unlike all other countries in
the region. Since the dollar has fallen 13 percent in relation to the euro in a year, Ukraine has imported
about that much inflation.
7.2.5 Czech republic

Three countries have successfully withstood the current inflationary test—Slovakia, Poland, and the
Czech Republic. Their annual inflation in 2008 was as moderate 4 to 7 percent, and their high growth
rates continued. These countries all pursue inflation targeting, which means that their independent
central banks focus on keeping inflation within a low target band, while maintaining tight monetary
policy with positive real interest rates. Hence, their floating exchange rates have risen significantly in
relation to the euro.
7.2.6 Russia
Russia's inflation is too high at 15 percent, and its macroeconomic policy is unbalanced. It relies too
much on fiscal policy and too little on monetary and exchange rate policy. The country's inflation is
driven by the large current account surplus, and the Finance Ministry has wisely balanced this surplus
with a sound fiscal surplus to hold back inflation, but currently public expenditures are rising sharply.
For years, the Russian central bank has stated its intention to move to inflation targeting within three
years, but it never does. It still pegs its currency to a basket of euros and dollars, although it should be
floating the ruble, and the central bank maintains a negative real interest rate of 4 percent a year, which
guarantees an excessive monetary expansion. The bank should follow the good Central European
example and move to inflation targeting immediately to escape the dangers of rising inflation.
Floating exchange rates, balanced budgets, and inflation targeting are the current victors, while any
fixed exchange rate is detrimental—worst of all any fixation to the sinking dollar. The lesson for Russia is
to let the ruble float freely and to tighten its monetary expansion to control inflation.
Hyperinflation
Hyperinflation
In economics, hyperinflation is inflation that is very high or "out of control", a condition in which prices
increase rapidly as a currency loses its value.[1] Definitions used by the media vary from a cumulative
inflation rate over three years approaching 100% to "inflation exceeding 50% a month." [2] In informal
usage the term is often applied to much lower rates. As a rule of thumb, normal inflation is reported per
year, but hyperinflation is often reported for much shorter intervals, often per month.
The definition used by most economists is "an inflationary cycle without any tendency toward
equilibrium."[citation needed] A vicious circle is created in which more and more inflation is created with each
iteration of the cycle. Although there is a great deal of debate about the root causes of hyperinflation, it
becomes visible when there is an unchecked increase in the money supply (or drastic debasement of
coinage) usually accompanied by a widespread unwillingness to hold the money for more than the time
needed to trade it for something tangible to avoid further loss. Hyperinflation is often associated with
wars (or their aftermath), economic depressions, and political or social upheavals.
Characteristics
In 1956, Phillip Cagan wrote The Monetary Dynamics of Hyperinflation,[3] generally regarded as the first
serious study of hyperinflation and its effects. In it, he defined hyperinflation as a monthly inflation rate
of at least 50%. International Accounting Standard 1[4] requires a presentation currency. IAS 21 [5]
provides for translations of foreign currencies into the presentation currency. IAS 29 [6] establishes
special accounting rules for use in hyperinflationary environments, and lists four factors which can
trigger application of these rules:
The general population prefers to keep its wealth in non-monetary assets or in a relatively stable foreign
currency. Amounts of local currency held are immediately invested to maintain purchasing power.
The general population regards monetary amounts not in terms of the local currency but in terms of a
relatively stable foreign currency. Prices may be quoted in that foreign currency.
Sales and purchases on credit take place at prices that compensate for the expected loss of purchasing
power during the credit period, even if the period is short.
Interest rates, wages and prices are linked to a price index and the cumulative inflation rate over three
years approaches, or exceeds, 100%.
Root causes of hyperinflation.
The main cause of hyperinflation is a massive and rapid increase in the amount of money that is not
supported by a corresponding growth in the output of goods and services. This results in an imbalance
between the supply and demand for the money (including currency and bank deposits), accompanied by
a complete loss of confidence in the money, similar to a bank run. Enactment of legal tender laws and
price controls to prevent discounting the value of paper money relative to gold, silver, hard currency, or
commodities, fails to force acceptance of a paper money which lacks intrinsic value. If the entity
responsible for printing a currency promotes excessive money printing, with other factors contributing a
reinforcing effect, hyperinflation usually continues. Often the body responsible for printing the currency
cannot physically print paper currency faster than the rate at which it is devaluing, thus neutralizing
their attempts to stimulate the economy. [7]
Hyperinflation is generally associated with paper money because this can easily be used to increase the
money supply: add more zeros to the plates and print, or even stamp old notes with new numbers. [citation
needed]
Historically there have been numerous episodes of hyperinflation in various countries, followed by
a return to "hard money". Older economies would revert to hard currency and barter when the
circulating medium became excessively devalued, generally following a "run" on the store of value.
Hyperinflation effectively wipes out the purchasing power of private and public savings, distorts the
economy in favor of extreme consumption and hoarding of real assets, causes the monetary base,
whether specie or hard currency, to flee the country, and makes the afflicted area anathema to
investment. Hyperinflation is met with drastic remedies, such as imposing the shock therapy of slashing
government expenditures or altering the currency basis. An example of the latter occurred in Bosnia-
Herzegovina in 2005, when the central bank was only allowed to print as much money as it had in
foreign currency reserves. Another example was the dollarization in Ecuador, initiated in September
2000 in response to a massive 75% loss of value of the Sucre currency in early January 2000.
Dollarization is the use of a foreign currency (not necessarily the U.S. dollar) as a national unit of
currency.
The aftermath of hyperinflation is equally complex. As hyperinflation has always been a traumatic
experience for the area which suffers it, the next policy regime almost always enacts policies to prevent
its recurrence. Often this means making the central bank very aggressive about maintaining price
stability, as was the case with the German Bundesbank, or moving to some hard basis of currency such
as a currency board. Many governments have enacted extremely stiff wage and price controls in the
wake of hyperinflation but this does not prevent further inflating of the money supply by its central
bank, and always leads to widespread shortages of consumer goods if the controls are rigidly enforced.
As it allows a government to devalue their spending and displace (or avoid) a tax increase, governments
have sometimes resorted to excessively loose monetary policy to meet their expenses. Inflation is
effectively a regressive consumption tax, [8] but less overt than levied taxes and therefore harder to
understand by ordinary citizens. Inflation can obscure quantitative assessments of the true cost of living,
as published price indices only look at data in retrospect, so may increase only months or years later.
Monetary inflation can become hyperinflation if monetary authorities fail to fund increasing government
expenses from taxes, government debt, cost cutting, or by other means, because either
during the time between recording or levying taxable transactions and collecting the taxes due, the
value of the taxes collected falls in real value to a small fraction of the original taxes receivable; or
government debt issues fail to find buyers except at very deep discounts; or
a combination of the above.
Theories of hyperinflation generally look for a relationship between seigniorage and the inflation tax. In
both Cagan's model and the neo-classical models, a tipping point occurs when the increase in money
supply or the drop in the monetary base makes it impossible for a government to improve its financial
position. Thus when fiat money is printed, government obligations that are not denominated in money
increase in cost by more than the value of the money created.
From this, it might be wondered why any rational government would engage in actions that cause or
continue hyperinflation. One reason for such actions is that often the alternative to hyperinflation is
either depression or military defeat. The root cause is a matter of more dispute. In both classical
economics and monetarism, it is always the result of the monetary authority irresponsibly borrowing
money to pay all its expenses. These models focus on the unrestrained seigniorage of the monetary
authority, and the gains from the inflation tax. In Neoliberalism, hyperinflation is considered to be the
result of a crisis of confidence. The monetary base of the country flees, producing widespread fear that
individuals will not be able to convert local currency to some more transportable form, such as gold or
an internationally recognized hard currency. This is a quantity theory of hyperinflation. [citation needed]
In neo-classical economic theory, hyperinflation is rooted in a deterioration of the monetary base, that is
the confidence that there is a store of value which the currency will be able to command later. In this
model, the perceived risk of holding currency rises dramatically, and sellers demand increasingly high
premiums to accept the currency. This in turn leads to a greater fear that the currency will collapse,
causing even higher premiums. One example of this is during periods of warfare, civil war, or intense
internal conflict of other kinds: governments need to do whatever is necessary to continue fighting,
since the alternative is defeat. Expenses cannot be cut significantly since the main outlay is armaments.
Further, a civil war may make it difficult to raise taxes or to collect existing taxes. While in peacetime the
deficit is financed by selling bonds, during a war it is typically difficult and expensive to borrow,
especially if the war is going poorly for the government in question. The banking authorities, whether
central or not, "monetize" the deficit, printing money to pay for the government's efforts to survive. The
hyperinflation under the Chinese Nationalists from 1939-1945 is a classic example of a government
printing money to pay civil war costs. By the end, currency was flown in over the Himalayas, and then
old currency was flown out to be destroyed.
Hyperinflation is regarded as a complex phenomenon and one explanation may not be applicable to all
cases. However, in both of these models, whether loss of confidence comes first, or central bank
seigniorage, the other phase is ignited. In the case of rapid expansion of the money supply, prices rise
rapidly in response to the increased supply of money relative to the supply of goods and services, and in
the case of loss of confidence, the monetary authority responds to the risk premiums it has to pay by
"running the printing presses."
In the United States of America, hyperinflation was seen during the Revolutionary War and during the
Civil War, especially on the Confederate side. Many other cases of extreme social conflict encouraging
hyperinflation can be seen, as in Germany after World War I, Hungary at the end of World War II and in
Yugoslavia in the late 1980s just before break up of the country.
Less commonly, inflation may occur when there is debasement of the coinage — wherein coins are
consistently shaved of some of their silver and gold, increasing the circulating medium and reducing the
value of the currency. The "shaved" specie is then often restruck into coins with lower weight of gold or
silver. Historical examples include Ancient Rome, China during the Song Dynasty, and the United States
beginning in 1933. When "token" coins begin circulating, it is possible for the minting authority to
engage in fiat creation of currency.
Models of hyperinflation
Since hyperinflation is visible as a monetary effect, models of hyperinflation center on the demand for
money. Economists see both a rapid increase in the money supply and an increase in the velocity of
money if the (monetary) inflating is not stopped. Either one, or both of these together are the root
causes of inflation and hyperinflation. A dramatic increase in the velocity of money as the cause of
hyperinflation is central to the "crisis of confidence" model of hyperinflation, where the risk premium
that sellers demand for the paper currency over the nominal value grows rapidly. The second theory is
that there is first a radical increase in the amount of circulating medium, which can be called the
"monetary model" of hyperinflation. In either model, the second effect then follows from the first —
either too little confidence forcing an increase in the money supply, or too much money destroying
confidence.
In the confidence model, some event, or series of events, such as defeats in battle, or a run on stocks of
the specie which back a currency, removes the belief that the authority issuing the money will remain
solvent — whether a bank or a government. Because people do not want to hold notes which may
become valueless, they want to spend them in preference to holding notes which will lose value. Sellers,
realizing that there is a higher risk for the currency, demand a greater and greater premium over the
original value. Under this model, the method of ending hyperinflation is to change the backing of the
currency — often by issuing a completely new one. War is one commonly cited cause of crisis of
confidence, particularly losing in a war, as occurred during Napoleonic Vienna, and capital flight,
sometimes because of "contagion" is another. In this view, the increase in the circulating medium is the
result of the government attempting to buy time without coming to terms with the root cause of the
lack of confidence itself.
In the monetary model, hyperinflation is a positive feedback cycle of rapid monetary expansion. It has
the same cause as all other inflation: money-issuing bodies, central or otherwise, produce currency to
pay spiralling costs, often from lax fiscal policy, or the mounting costs of warfare. When businesspeople
perceive that the issuer is committed to a policy of rapid currency expansion, they mark up prices to
cover the expected decay in the currency's value. The issuer must then accelerate its expansion to cover
these prices, which pushes the currency value down even faster than before. According to this model
the issuer cannot "win" and the only solution is to abruptly stop expanding the currency. Unfortunately,
the end of expansion can cause a severe financial shock to those using the currency as expectations are
suddenly adjusted. This policy, combined with reductions of pensions, wages, and government outlays,
formed part of the Washington consensus of the 1990s.
Whatever the cause, hyperinflation involves both the supply and velocity of money. Which comes first is
a matter of debate, and there may be no universal story that applies to all cases. But once the
hyperinflation is established, the pattern of increasing the money stock, by whichever agencies are
allowed to do so, is universal. Because this practice increases the supply of currency without any
matching increase in demand for it, the price of the currency, that is the exchange rate, naturally falls
relative to other currencies. Inflation becomes hyperinflation when the increase in money supply turns
specific areas of pricing power into a general frenzy of spending quickly before money becomes
worthless. The purchasing power of the currency drops so rapidly that holding cash for even a day is an
unacceptable loss of purchasing power. As a result, no one holds currency, which increases the velocity
of money, and worsens the crisis.
That is, rapidly rising prices undermine money's role as a store of value, so that people try to spend it on
real goods or services as quickly as possible. Thus, the monetary model predicts that the velocity of
money will rise endogenously as a result of the excessive increase in the money supply. At the point
when ordinary purchases are affected by inflation pressures, hyperinflation is out of control, in the sense
that ordinary policy mechanisms, such as increasing reserve requirements, raising interest rates or
cutting government spending will all be responded to by shifting away from the rapidly dwindling
currency and towards other means of exchange.
During a period of hyperinflation, bank runs, loans for 24 hour periods, switching to alternate currencies,
the return to use of gold or silver or even barter become common. Many of the people who hoard gold
today expect hyperinflation, and are hedging against it by holding specie. There may also be extensive
capital flight or flight to a "hard" currency such as the U.S. dollar. This is sometimes met with capital
controls, an idea which has swung from standard, to anathema, and back into semi-respectability. All of
this constitutes an economy which is operating in an "abnormal" way, which may lead to decreases in
real production. If so, that intensifies the hyperinflation, since it means that the amount of goods in "too
much money chasing too few goods" formulation is also reduced. This is also part of the vicious circle of
hyperinflation.
Once the vicious circle of hyperinflation has been ignited, dramatic policy means are almost always
required, simply raising interest rates is insufficient. Bolivia, for example, underwent a period of
hyperinflation in 1985, where prices increased 12,000% in the space of less than a year. The government
raised the price of gasoline, which it had been selling at a huge loss to quiet popular discontent, and the
hyperinflation came to a halt almost immediately, since it was able to bring in hard currency by selling
its oil abroad. The crisis of confidence ended, and people returned deposits to banks. The German
hyperinflation (1919-Nov. 1923) was ended by producing a currency based on assets loaned against by
banks, called the Rentenmark. Hyperinflation often ends when a civil conflict ends with one side
winning. Although wage and price controls are sometimes used to control or prevent inflation, no
episode of hyperinflation has been ended by the use of price controls alone. However, wage and price
controls have sometimes been part of the mix of policies used to halt hyperinflation.
Examples of hyperinflation
Angola
Angola went through its worst inflation from 1991 to 1995. In early 1991, the highest denomination was
50,000 kwanzas. By 1994, it was 500,000 kwanzas. In the 1995 currency reform, 1 readjusted kwanza
was exchanged for 1,000 kwanzas. The highest denomination in 1995 was 5,000,000 readjusted
kwanzas. In the 1999 currency reform, 1 new kwanza was exchanged for 1,000,000 readjusted kwanzas.
The overall impact of hyperinflation: 1 new kwanza = 1,000,000,000 pre 1991 kwanzas.
Argentina
Argentina went through steady inflation from 1975 to 1991. At the beginning of 1975, the highest
denomination was 1,000 pesos. In late 1976, the highest denomination was 5,000 pesos. In early 1979,
the highest denomination was 10,000 pesos. By the end of 1981, the highest denomination was
1,000,000 pesos. In the 1983 currency reform, 1 Peso argentino was exchanged for 10,000 pesos. In the
1985 currency reform, 1 austral was exchanged for 1,000 pesos argentinos. In the 1992 currency reform,
1 new peso was exchanged for 10,000 australes. The overall impact of hyperinflation: 1 (1992) peso =
100,000,000,000 pre-1983 pesos.
Austria
In 1922, inflation in Austria reached 1426%. From 1914 to January 1923, the consumer price index rose
by a factor of 11836. With the highest banknote in denominations of 500,000 Austro-Hungarian krones.
[13]
Belarus
Belarus went through steady inflation from 1994 to 2002. In 1993, the highest denomination was 5,000
rublei. By 1999, it was 5,000,000 rublei. In the 2000 currency reform, the ruble was replaced by the new
ruble at an exchange rate of 1 new ruble = 1,000 old rublei. The highest denomination in 2008 was
100,000 rublei, equal to 100,000,000 pre-2000 rublei.
Bolivia
Bolivia went through its worst inflation between 1984 and 1986. Before 1984, the highest denomination
was 1,000 pesos bolivianos. By 1985, the highest denomination was 10 Million pesos bolivianos. In 1985,
a Bolivian note for 1 million pesos was worth 55 cents in US dollars, one-thousandth of its exchange
value of $5,000 less than three years previously. [14] In the 1987 currency reform, the Peso Boliviano was
replaced by the Boliviano at a rate of 1,000,000 : 1.
Bosnia-Herzegovina
Bosnia-Herzegovina went through its worst inflation in 1993. In 1992, the highest denomination was
1,000 dinara. By 1993, the highest denomination was 100,000,000 dinara. In the Republika Srpska, the
highest denomination was 10,000 dinara in 1992 and 10,000,000,000 dinara in 1993. 50,000,000,000
dinara notes were also printed in 1993 but never issued.
Brazil
From 1986 to 1994, the base currency unit was shifted three times to adjust for inflation in the final
years of the Brazilian military dictatorship era. A 1967 cruzeiro was, in 1994, worth less than one
trillionth of a US cent, after adjusting for multiple devaluations and note changes. In that same year,
inflation reached a record 2075.8%. A new currency called real was adopted in 1994, and hyperinflation
was eventually brought under control.[15] The real was also the currency in use until 1942; 1 (current)
real is the equivalent of 2,750,000,000,000,000,000 of old reals (called réais in Portuguese).[dead link][16]
Bulgaria
During 1996 the Bulgarian economy collapsed due to the BSP's slow and mismanaged economic
reforms, its disastrous agricultural policy, and an unstable and decentralized banking system, which led
to an inflation rate of 311% and the collapse of the lev, with an exhange rate $1:Lev reaching 1:3000.
When pro-reform forces came into power in the spring 1997, an ambitious economic reform package,
including introduction of a currency board regime and pegging the Bulgarian Lev to the German
Deutsche Mark (and consequently to the euro), was agreed to with the IMF and the World Bank, and the
economy began to stabilize.
Chile
Beginning in 1971, during the presidency of Salvador Allende, Chilean inflation began to rise and
reached peaks of 1,200% in 1973. As a result of the hyperinflation, food became scarce and overpriced.
A 1973 coup d'état deposed Allende and installed a military government led by Augusto Pinochet.
Pinochet's free-market economic policy ended the inflation and except for an economic depression in
1981 the economy has recovered. Overall impact of the inflation: 1 current Chilean Peso = 1,000
Escudos.
China
As the first user of fiat currency, China has had an early history of troubles caused by hyperinflation. The
Yuan Dynasty printed huge amounts of fiat paper money to fund their wars, and the resulting
hyperinflation, coupled with other factors, led to its demise at the hands of a revolution. The Republic of
China went through the worst inflation 1948-49. In 1947, the highest denomination was 50,000 yuan. By
mid-1948, the highest denomination was 180,000,000 yuan. The 1948 currency reform replaced the
yuan by the gold yuan at an exchange rate of 1 gold yuan = 3,000,000 yuan. In less than 1 year, the
highest denomination was 10,000,000 gold yuan. In the final days of the civil war, the Silver Yuan was
briefly introduced at the rate of 500,000,000 Gold Yuan. Meanwhile the highest denomination issued by
a regional bank was 6,000,000,000 yuan (issued by Xinjiang Provincial Bank in 1949). After the renminbi
was instituted by the new communist government, hyperinflation ceased with a revaluation of 1:10,000
old Renminbi in 1955.
Free City of Danzig
Danzig went through its worst inflation in 1923. In 1922, the highest denomination was 1,000 Mark. By
1923, the highest denomination was 10,000,000,000 Mark.
Georgia
Georgia went through its worst inflation in 1994. In 1993, the highest denomination was 100,000
coupons [kuponi]. By 1994, the highest denomination was 1,000,000 coupons. In the 1995 currency
reform, a new currency lari was introduced with 1 lari exchanged for 1,000,000 coupons.
Germany
Main article: Inflation in the Weimar Republic
Germany went through its worst inflation in 1923. In 1922, the highest denomination was 50,000 Mark.
By 1923, the highest denomination was 100,000,000,000,000 Mark. In December 1923 the exchange
rate was 4,200,000,000,000 Marks to 1 US dollar. [17] In 1923, the rate of inflation hit 3.25 × 10 6 percent
per month (prices double every two days). Beginning on 20 November 1923, 1,000,000,000,000 old
Marks were exchanged for 1 Rentenmark[17] so that 4.2 Rentenmarks were worth 1 US dollar, exactly the
same rate the Mark had in 1914.
Greece
Greece went through its worst inflation in 1944. In 1942, the highest denomination was 50,000
drachmai. By 1944, the highest denomination was 100,000,000,000,000 drachmai. In the 1944 currency
reform, 1 new drachma was exchanged for 50,000,000,000 drachmai. Another currency reform in 1953
replaced the drachma at an exchange rate of 1 new drachma = 1,000 old drachmai. The overall impact of
hyperinflation: 1 (1953) drachma = 50,000,000,000,000 pre 1944 drachmai. The Greek monthly inflation
rate reached 8.5 billion percent in October 1944.
The 100 million b.-pengő note was the highest denomination of banknote ever issued, worth 10 20 or 100
quintillion Hungarian pengő (1946).
Hungary
Hungary went through the worst inflation ever between the end of 1945 and July 1946. In 1944, the
highest denomination was 1,000 pengő. By the end of 1945, it was 10,000,000 pengő. The highest
denomination in mid-1946 was 100,000,000,000,000,000,000 pengő. A special currency the adópengő -
or tax pengő - was created for tax and postal payments [1]. The value of the adópengő was adjusted
each day, by radio announcement. On 1 January 1946 one adópengő equaled one pengő. By late July,
one adópengő equaled 2,000,000,000,000,000,000,000 or 2×10 21 pengő. When the pengő was replaced
in August 1946 by the forint, the total value of all Hungarian banknotes in circulation amounted to one-
thousandth of one US dollar. [18] It is the most severe known incident of inflation recorded, peaking at 1.3
× 1016 percent per month (prices double every 15 hours) [19] . The overall impact of hyperinflation: On 18
August, 1946 400,000,000,000,000,000,000,000,000,000 or 4 × 1029 (four hundred octillion (short scale))
pengő became 1 forint.
One source [2] states that this hyperinflation was purposely started by trained Russian Marxists in order
to destroy the Hungarian middle and upper classes. The 1946 currency reform changed the currency to
the forint. Earlier, between 1922 and 1924, inflation in Hungary had reached 98%.
Israel
Inflation accelerated in the 1970s, rising steadily from 13% in 1971 to 111% in 1979. From 133% in 1980,
it leaped to 191% in 1983 and then to 445% in 1984, threatening to become a four-digit figure within a
year or two. In 1985 Israel froze all prices by law. That same year, inflation more than halved, to 185%.
Within a few months, the authorities began to lift the price freeze on some items; in other cases it took
almost a year. By 1986, inflation was down to 19%.
Japan
After WW II, Japan went through the highest denomination at that time, which was a 75,000,000,000
Yen bank cheque. The Japan wholesale price index (relative to 1 as the average of 1930) shot up to 16.3
in 1943, 127.9 in 1948 and 342.5 in 1951. In the early 1950s, after achieving independence from USA,
Japan controlled its own money. Through its rapidly growing export trade, Japan stabilized the Yen
quickly.
Krajina
Krajina went through the worst inflation in 1993. In 1992, the highest denomination was 50,000 dinara.
By 1993, the highest denomination was 50,000,000,000 dinara. Note that this unrecognized country was
reincorporated into Croatia in 1998.
Madagascar
The Malagasy franc had a turbulent time in 2004, losing nearly half its value and sparking rampant
inflation. On 1 January 2005 the Malagasy ariary replaced the previous currency at a rate of one ariary
for five Malagsy francs. In May 2005 there were riots over rising inflation, although falling prices have
since calmed the situation.
Mozambique
Mozambique was one of the world's poorest countries when it became independent in 1975.
Mismanagement and a brutal civil war from 1977-92 led to continued inflation. The highest
denomination in 1976 was 100 meticals. By 2004, it was 500,000 meticals. In the 2006 currency reform,
1 new metical was exchanged for 1,000 old meticals.
Nicaragua
Nicaragua went through the worst inflation from 1987 to 1990. From 1943 to April 1971, one US dollar
equalled 7 córdobas. From April 1971 to early 1978, one US dollar was worth 10 córdobas. In early 1986,
the highest denomination was 10,000 córdobas. By 1987, it was 1,000,000 córdobas. In the 1988
currency reform, 1 new córdoba was exchanged for 10,000 old córdobas. The highest denomination in
1990 was 100,000,000 new córdobas. In the 1991 currency reform, 1 new córdoba was exchanged for
5,000,000 old córdobas. The overall impact of hyperinflation: 1 (1991) córdoba = 50,000,000,000 pre-
1988 córdobas.
Peru
Peru went through its worst inflation from 1988 to 1990. In the 1985 currency reform, 1 inti was
exchanged for 1,000 soles. In 1986, the highest denomination was 1,000 intis. But in September 1988,
monthly inflation went to 132%. In August 1990, monthly inflation was 397%. The highest denomination
was 10,000,000 intis by 1991. In the 1991 currency reform, 1 nuevo sol was exchanged for 1,000,000
intis. The overall impact of hyperinflation: 1 nuevo sol = 1,000,000,000 (old) soles.
Philippines
The Japanese government occupying the Philippines during the World War II issued fiat currencies for
general circulation. The Japanese-sponsored Second Philippine Republic government led by Jose P.
Laurel at the same time outlawed possession of other currencies, most especially "guerilla money." The
fiat money was dubbed "Mickey Mouse Money" because it is similar to play money and is next to
worthless. Survivors of the war often tell tales of bringing suitcase or bayong (native bags made of
woven coconut or buri leaf strips) overflowing with Japanese-issued bills. In the early times, 75 Mickey
Mouse pesos could buy one duck egg[20]. In 1944, a box of matches cost more than 100 Mickey Mouse
pesos.[21].
In 1942, the highest denomination available was 10 pesos. Before the end of the war, because of
inflation, the Japanese government was forced to issue 100, 500 and 1000 peso notes.
Poland
Poland went through inflation (second time) between 1989 and 1991. The highest denomination in 1989
was 200,000 zlotych. It was 1,000,000 zlotych in 1991 and 2,000,000 zlotych in 1992; the exchange rate
was 9500 zlotych for 1 US dollar in January 1990 and 19600 zlotych at the end of August 1992. In the
1994 currency reform, 1 new zloty was exchanged for 10,000 old zlotych and 1 US$ exchange rate was
ca. 2.5 zlotych (new).
Previously, between 1922 and 1924, Polish inflation reached 275% and exchange rate in 1923 was
6,375,000 Polish marka (mkp) for 1 US dollar (before the inflation there was only 9 mkp for 1US$ in
1918), and the highest denomination was 10,000,000 mkp. In the 1924 currency reform there was new
currency introduced: 1 zloty = 1,800,000 mkp.
Republika Srpska
Republika Srpska was the breakaway region of Bosnia. As with Krajina, it pegged its currency, the
Republika Srpska dinar, to that of Yugoslavia. Their bills were almost the same as Krajina's, but they
issued fewer and did not issue currency after 1993.
Romania
Romania is still working through steady inflation. The highest denomination in 1990 was 100 lei and in
1998 was 100,000 lei. By 2000 it was 500,000 lei. In early 2005 it was 1,000,000 lei. In July 2005 the leu
was replaced by the new leu at 10,000 old lei = 1 new leu. Inflation in 2005 was 9%. In 2006 the highest
denomination is 500 lei (= 5,000,000 old lei).
Russian Federation
Between 1921 and 1922 inflation in Soviet Russia reached 213%.
In 1992, the first year of post-Soviet economic reform, inflation was 2,520%. In 1993 the annual rate was
840%, and in 1994, 224%. The ruble devalued from about 40 r/$ in 1991 to about 5,000 r/$ in late 1997.
In 1998, a denominated ruble was introduced at the exchange rate of 1 new ruble = 1,000 pre-1998
rubles. In the second half of the same year ruble fell to about 30 r/$ as a result of financial crisis.
Taiwan
As the Chinese Civil War reached its peak. Taiwan also suffered from the hyperinflation that has ravaged
China in late 1940's. Highest denomination issued was 1,000,000 Dollar Bearer's Cheque. Inflation was
finally brought under control at introduction of New Taiwan Dollar in 15 June 1949 at rate of 40,000 old
Dollar = 1 New Dollar
Turkey
Throughout the 1990s Turkey dealt with severe inflation rates that finally crippled the economy into a
recession in 2001. The highest denomination in 1995 was 1,000,000 lira. By 2005 it was 20,000,000 lira.
Recently Turkey has achieved single digit inflation for the first time in decades, and in the 2005 currency
reform, introduced the New Turkish Lira; 1 was exchanged for 1,000,000 old lira.
A 100,000 Ukrainian karbovantsi (used between 1992 and 1996). In 1996, it was taken out of circulation,
and was replaced by the Hryvnya at an exchange rate of 100,000 karbovantsi = 1 Hryvnya (approx. USD
0.50 at that time, about USD 0.20 as of 2007). This translates to an average inflation rate of
approximately 1400% per month between 1992 and 1996
Ukraine
Ukraine went through its worst inflation between 1993 and 1995. In 1992, the Ukrainian karbovanets
was introduced, which was exchanged with the defunct Soviet ruble at a rate of 1 UAK = 1 SUR. Before
1993, the highest denomination was 1,000 karbovantsiv. By 1995, it was 1,000,000 karbovantsiv. In
1996, during the transition to the Hryvnya and the subsequent phase out of the karbovanets, the
exchange rate was 100,000 UAK = 1 UAH. This translates to a hyperinflation rate of approximately
1,400% per month. And to this day Ukraine holds the world record for most inflation in one calendar
year, which was set in 1993.[22]
United States
During the Revolutionary War, the Continental Congress authorized the printing of paper currency called
continental currency. The easily counterfeited notes depreciated rapidly, giving rise to the expression
"not worth a continental."
Between January 1861 and April 1865, the Lerner Commodity Price Index of leading cities in the eastern
Confederacy states increased from 100 to over 9000. [23] As the U.S. Civil War dragged on the
Confederate States of America dollar had less and less value, until it was almost worthless by the last
few months of the war.
A 500 billion Yugoslav dinar banknote circa 1993, the largest nominal value ever officially printed in
Yugoslavia, the final result of hyperinflation.
Yugoslavia
Yugoslavia went through a period of hyperinflation and subsequent currency reforms from 1989 to
1994. The highest denomination in 1988 was 50,000 dinars. By 1989 it was 2,000,000 dinars. In the 1990
currency reform, 1 new dinar was exchanged for 10,000 old dinars. In the 1992 currency reform, 1 new
dinar was exchanged for 10 old dinars. The highest denomination in 1992 was 50,000 dinars. By 1993, it
was 10,000,000,000 dinars. In the 1993 currency reform, 1 new dinar was exchanged for 1,000,000 old
dinars. But before the year was over, the highest denomination was 500,000,000,000 dinars. In the 1994
currency reform, 1 new dinar was exchanged for 1,000,000,000 old dinars. In another currency reform a
month later, 1 novi dinar was exchanged for 13 million dinars (1 novi dinar = 1 German mark at the time
of exchange). The overall impact of hyperinflation: 1 novi dinar = 1 × 10 27~1.3 × 1027 pre 1990 dinars.
Yugoslavia's rate of inflation hit 5 × 1015 percent cumulative inflation over the time period 1 October
1993 and 24 January 1994.
Zaire (now the Democratic Republic of the Congo)
Zaire went through a period of inflation between 1989 and 1996. In 1988, the highest denomination was
5,000 zaires. By 1992, it was 5,000,000 zaires. In the 1993 currency reform, 1 nouveau zaire was
exchanged for 3,000,000 old zaires. The highest denomination in 1996 was 1,000,000 nouveaux zaires.
In 1997, Zaire was renamed the Congo Democratic Republic and changed its currency to francs. 1 franc
was exchanged for 100,000 nouveaux zaires. The overall impact of hyperinflation: 1 franc = 3 × 10 11 pre
1989 zaires.
Zimbabwe
Main article: Hyperinflation in Zimbabwe
The 100 trillion Zimbabwean dollar banknote (1014 dollars), equal to 1027 pre-2006 dollars
At Independence in 1980, the Zimbabwe dollar was worth about USD 1.25. Since then, rampant inflation
and the collapse of the economy have severely devalued the currency, causing many organisations to
favour using the US dollar or South African rand instead. Inflation was stable until Robert Mugabe began
a program of land reforms that primarily focused on taking land from white farmers and redistributing
those properties and assets to black farmers; this in turn sent food production and revenues from export
of food plummeting.[24][25][26] Though inflation in Zimbabwe was a monetary phenomena (the result of
Mugabe's government printing money) as can be seen by the appearance of ever higher face value
printed notes (whose face value exceeded the sum of all previously existing notes).
Early in the 21st century Zimbabwe started to experience chronic inflation. Inflation reached 624% in
2004, then fell back to low triple digits before surging to a new high of 1,730% in 2006. During that time,
the Reserve Bank of Zimbabwe revalued its currency on 1 August 2006 at a rate of 1,000 old
Zimbabwean dollars to 1 revalued Zimbabwean dollar. In June 2007 inflation in Zimbabwe had risen to
11,000% year-to-year from an earlier estimate of 9,000%. On 5 May 2008 the Reserve Bank of
Zimbabwe issued bank notes or "bearer cheques" for the value of ZWD 100 million and ZWD 250 million.
[27]
. Ten days later on 15 May, new bearer cheques with a value of ZWD 500 million (then equivalent to
about USD 2.5) were issued.[28] Five days later on 20 May a new series of notes in the form of "agro
cheques" were issued in denominations of ZWD 5 billion, ZWD 25 billion and ZWD 50 billion. An
additional agro cheque was issued for ZWD 100 billion on 21 July. [29] Meanwhile inflation has officially
surged to 2,200,000%[30] with some analysts estimating figures surpassing 9,000,000 percent. [31] As of 22
July 2008 the value of the ZWD had fallen to approximately 688 billion per 1 USD, or 688 trillion pre-
August 2006 Zimbabwean dollars. [32] On 1 August 2008, the Zimbabwe dollar was redenominated by
removing 10 zeroes. ZWD 10 billion became 1 dollar after the redenomination. [33]. On 19 August 2008,
official figures announced for June estimated the inflation over 11,250,000 percent. [34] Zimbabwe's
annual inflation was 231,000,000% in July [35] (prices doubling every 17.3 days). For periods after July
2008, no official inflation statistics were released. Prof. Steve H. Hanke overcame the problem by
estimating inflation rates after July 2008 and publishing the Hanke Hyperinflation Index for Zimbabwe. [36]
Prof. Hanke’s HHIZ measure indicates that the inflation peaked at an annual rate of 89.7 sextillion
percent (89,700,000,000,000,000,000,000%) in mid-November 2008. The peak monthly rate was 79.6
billion percent, which is equivalent to a 98% daily rate, or around 7× 10108 percent yearly rate. At that
rate, prices were doubling every 24.7 hours. Note that the last figure is mostly theoretic, since the
hyperinflation did not proceed at that rate a whole year. [37]
At its November 2008 peak, Zimbabwe’s rate of inflation approached, but failed to surpass, Hungary’s
July 1946 world record.[37] On 16 January 2009, Zimbabwe issued a ZWD100 trillion bill. [38] The
hyperinflation officially ended in January 2009 when official inflation rates in USD were announced. [37]
Worst Hyperinflations in World History
Highest Monthly Inflation Rates in History[37]
Month with highest Highest monthly Equivalent daily Time required for
Country Currency name
inflation rate inflation rate inflation rate prices to double
Hungarian
Hungary July 1946 4.19 × 1016 % 207 % 15 hours
pengő
Zimbabwe
Zimbabwe November 2008 7.96 × 1010 % 98 % 24.7 hours
dollar
Yugoslavia Yugoslav dinar January 1994 3.13 × 108 % 64.6% 1.4 days
German
Germany October 1923 29,500 % 20.9 % 3.7 days
Papiermark
Greece Greek drachma October 1944 13,800 % 17.9 % 4.3 days
Old Taiwan
China May 1949 2,178 % 11% 6.7 days
dollar
Units of inflation
Inflation rate is usually measured in percent per year. It can also be measured in percent per month or in
price doubling time.
Example of inflation rates and units

When first bought, an item cost 1 currency unit. Later, the price rose...
(Annu Price Zero

Old Monthly
New price 1 New price 10 New price 100 al) doubling add
pric inflation
year later years later years later inflati time time
e [%]
on [%] [years] [years]
1 .001 .01 .11 0.1 .00833 2300
1 .003 .03 .35 0.3 .0250 769
1 .01 .10 .70 1 .0830 .7 231
1 .03 .34 .2 3 .247 .4 77.9
1 .1 .5913800 10 .797 .27 24.1
1 1024 1.27 × 1030 100 .95 3.32
10 100
1 900 .2 .301 (3⅔ months) 1
0.671
(8
1 8.20 × 1014 1.37 × 10149 3000 .8 .202 (2½ months)
months
)
0.0833
12 120 1,200 14
1 10 900 .0251 (9 days) (1
month)
0.0137
73 732 7,322 1.67 ×
11.67 × 10 1.69 × 10 1.87 × 10 1.26 × 108 .00411 (36 hours) (5
1075
days)
0.0003
2,637 26,370 1.89 × 1.05 ×
11.05 × 10 1.69 × 10 263,702
5.65 × 10221 .000114 (1 hour) 79 (3.3
102,639
hours)
Often, at redenominations, three zeroes are cut from the bills. It can be read from the table that if the
(annual) inflation is for example 100%, it takes 3.32 years to produce one more zero on the price tags, or
3 × 3.32 = 9.96 years to produce three zeroes. Thus can one expect a redenomination to take place
about 9.96 years after the currency was introduced.
One more way to control hyperinflation is by getting help from IMF or world bank as the stand by
sources.

Controlling Inflation Project

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Controlling Inflation Project

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Inflation control 1

1.1 The concept of inflation:

1.2 How is inflation measured?

The effects of inflation:

1.3.1 The negative effects of inflation

1.3.2 The positive effects of inflation:

2.1 The concept of monetary policy

2.2 Various tools in the monetary policy to control inflation:

Repo (Repurchase) Rate

Reverse Repo Rate

This is the exact opposite of repo rate.

2.3 Various types of monetary policies:

2.3.1 Inflation targeting

2.3.2 Price level targeting

2.3.3 Monetary aggregates

This approach is also sometimes called monetarism.

2.3.4 Fixed exchange rate

2.3.5 Gold standard

2.4 The monetary policy used by India:

3.1 The concept of fiscal policy:

Aggregate demand and the level of economic activity;

The pattern of resource allocation;

The distribution of income.

3.2 Fiscal policy can controls/prevents inflation:

How does fiscal policy control inflation:

3.3.1 Reduction in Public Expenditure

3.3.2 Increase in Tax Revenues

3.3.3 Increasing the Supply of Goods and Services

3.3.4 Treasury bills or bonds:

Treasury Bills in India

Type of Treasury Bills:

3.4 Monetary policy v/s Fiscal policy

Time frame required to control inflation:

Long term effect of these polices:

Long term policies to control inflation:

4.1 Control of wages;

4.1.1 Direct wage controls - incomes policies

4.1.2 Long-term labor policies to control inflation

Labour market reforms

4.2 Controlling inflation by giving subsidy to the poor:

4.3 Inflation Hedging

Controlling food inflation

Providing food subsidy/food security to the poor.

Control of oil prices:

Inflation control in communist countries:

7.1 Inflation in communist countries:

7.2 Performance of various communist countries in the last decade:

7.2.2 Estonia and Latvia

7.2.5 Czech republic

Root causes of hyperinflation.

a combination of the above.

Free City of Danzig

Main article: Inflation in the Weimar Republic

Between 1921 and 1922 inflation in Soviet Russia reached 213%.

Zaire (now the Democratic Republic of the Congo)

Main article: Hyperinflation in Zimbabwe

Worst Hyperinflations in World History

Highest Monthly Inflation Rates in History[37]

Greece Greek drachma October 1944 13,800 % 17.9 % 4.3 days

Example of inflation rates and units

(Annu Price Zero

1 .001 .01 .11 0.1 .00833 2300

1 .003 .03 .35 0.3 .0250 769

1 .01 .10 .70 1 .0830 .7 231