IN 2008, THE AFRICAN NATION OF Zimbabwe achieved a dubious distinction: it exhibited one of the highest inflation rates ever recorded, peaking at around 500 billion percent. Although the government kept introducing ever-larger denominations of the Zimbabwe dollar—for example, in May 2008 it introduced a half-billion-dollar bill—it still took a lot of currency to pay for the necessities of life: a stack of Zimbabwean cash worth $100 weighed about 18 kilograms. Zimbabwean currency was worth so little that some people withdrawing funds from banks brought suitcases along, in order to be able to walk away with enough cash to pay for ordinary living expenses. In the end, the Zimbabwe dollar lost all value—literally. By October 2008, the currency more or less vanished from circulation, replaced by U.S. dollars and South African rands.

Zimbabwe’s experience was shocking, but not unprecedented. In 1994 the inflation rate in Armenia hit 27 000%. In 1991 Nicaraguan inflation exceeded 60 000%. And Zimbabwe’s experience was more or less matched by history’s most famous example of extreme inflation, which took place in Germany in 1922–1923. Toward the end of the German hyperinflation, prices were rising 16% a day, which—through compounding—meant an increase of approximately 500 billion percent over the course of five months. People became so reluctant to hold paper money, which lost value by the hour, that eggs and lumps of coal began to circulate as currency. German firms would pay their workers several times a day so that they could spend their earnings before they lost value (lending new meaning to the term hourly wage). Legend has it that men sitting down at a bar would order two beers at a time, out of fear that the price of a beer would rise before they could order a second round!

Canada has never experienced that kind of inflation. Canada’s worst inflation in the past 60 years occurred in the early 1980s, reaching, at its highest peak, an annual rate of almost 13% in 1981. Yet even that rate of inflation was profoundly troubling to the Canadian public, and the policies the Bank of Canada pursued to get Canada’s inflation back down to an acceptable rate contributed to the deepest recession since the Great Depression.

What causes inflation to rise and fall? In this chapter, we’ll look at the underlying reasons for inflation. We’ll see that the underlying causes of very high inflation, the type of inflation suffered by Zimbabwe, are quite different from the causes of more moderate inflation. We’ll also learn why disinflation, a reduction in the inflation rate, is often very difficult. Finally, we’ll discuss the special problems associated with a falling price level, or deflation.