Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Stopping hyperinflation after it starts

Milton Friedman was right when he said that ‘inflation is always and everywhere a monetary phenomenon’. Hyperinflation is indeed always caused by a massive and sustained increase in the money supply.

But, in the case of hyperinflation, the underlying problem is the government’s fiscal problems: it’s spending more than it earns in tax revenue and is unable to borrow. Therefore, to stop hyperinflation in a country where it has taken

hold, the answer is to attack the problem at its source – by reducing government expenditure substantially or increasing tax revenue. Because the latter is very difficult to do during hyperinflation, the only real option is substantial and massive cuts in government expenditure. Only when the government is again living within its means and doesn’t need to fund its deficit by printing money can it rid itself of the scourge of hyperinflation.


If it doesn’t do so, and quickly, the country’s people will ultimately force the government’s hand by no longer accepting any amount of local currency as payment. When people completely lose faith in the currency, they may switch to using US dollars for example, a phenomenon known as dollarisation. When this happens, even seigniorage isn’t an option, which is sadly exactly what happened to Zimbabwe in the not-so-distant past.


Going Downwards: Deflation

Households, firms and policy makers tend to focus on the dangers of high inflation. Rarely do you hear people worrying about deflation, that is, falling prices, but it can be just as bad as high inflation.

The Japanese economy has been struggling with deflation since 1998. Although Japan is still one of the world’s rich economies, enjoying high living standards, GDP per capita growth from 1998–2014 averaged a fraction of 1 per cent per year. Essentially, average real income in Japan today is very similar to that in 1998!