Hyperinflation is often defined as inflation that exceeds 50 percent per month, which is just over 1 percent per day. Compounded over many months, this rate of inflation leads to very large increases in the price level. An inflation rate of 50 percent per month implies a more than 100-fold increase in the price level over a year and a more than 2-million-fold increase over three years. Here we consider the costs and causes of such extreme inflation.

Although economists debate whether the costs of moderate inflation are large or small, no one doubts that hyperinflation extracts a high toll on society. The costs are qualitatively the same as those we discussed earlier. When inflation reaches extreme levels, however, these costs are more apparent because they are so severe.

The shoeleather costs associated with reduced money holding, for instance, are serious under hyperinflation. Business executives devote much time and energy to cash management when cash loses its value quickly. By diverting this time and energy from more socially valuable activities, such as production and investment decisions, hyperinflation makes the economy run less efficiently.

Menu costs also become larger under hyperinflation. Firms have to change prices so often that normal business practices, such as printing and distributing catalogs with fixed prices, become impossible. In one restaurant during the German hyperinflation of the 1920s, a waiter would stand up on a table every 30 minutes to call out the new prices.

Similarly, relative prices do not do a good job of reflecting true scarcity during hyperinflations. When prices change frequently by large amounts, it is hard for customers to shop around for the best price. Highly volatile and rapidly rising prices can alter behavior in many ways. According to one report, when patrons entered a pub during the German hyperinflation, they would often buy two pitchers of beer. Although the second pitcher would lose value by getting warm over time, it would lose value less rapidly than the money left sitting in the patron’s wallet.

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Tax systems are also distorted by hyperinflation—but in ways that are different from the distortions of moderate inflation. In most tax systems there is a delay between the time a tax is levied and the time it is actually paid to the government. In the United States, for example, taxpayers are required to make estimated income tax payments every three months. This short delay does not matter much under low inflation. By contrast, during hyperinflation, even a short delay greatly reduces real tax revenue. By the time the government gets the money it is due, the money has fallen in value. As a result, once hyperinflations start, the real tax revenue of the government often falls substantially.

Finally, no one should underestimate the sheer inconvenience of living with hyperinflation. When carrying money to the grocery store is as burdensome as carrying the groceries back home, the monetary system is not doing its best to facilitate exchange. The government tries to overcome this problem by adding more and more zeros to the paper currency, but often it cannot keep up with the exploding price level.

Eventually, these costs of hyperinflation become intolerable. Over time, money loses its role as a store of value, unit of account, and medium of exchange. Barter becomes more common. And more stable unofficial monies—cigarettes or the U.S. dollar—start to replace the official money.

Why do hyperinflations start, and how do they end? This question can be answered at different levels.

The most obvious answer is that hyperinflations are due to excessive growth in the supply of money. When the central bank prints money, the price level rises. When it prints money rapidly enough, the result is hyperinflation. To stop the hyperinflation, the central bank must reduce the rate of money growth.

This answer is incomplete, however, for it leaves open the question of why central banks in hyperinflating economies choose to print so much money. To address this deeper question, we must turn our attention from monetary to fiscal policy. Most hyperinflations begin when the government has inadequate tax revenue to pay for its spending. Although the government might prefer to finance this budget deficit by issuing debt, it may find itself unable to borrow, perhaps because lenders view the government as a bad credit risk. To cover the deficit, the government turns to the only mechanism at its disposal—the printing press. The result is rapid money growth and hyperinflation.

Once the hyperinflation is under way, the fiscal problems become even more severe. Because of the delay in collecting tax payments, real tax revenue falls as inflation rises. Thus, the government’s need to rely on seigniorage is self-reinforcing. Rapid money creation leads to hyperinflation, which leads to a larger budget deficit, which leads to even more rapid money creation.

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The ends of hyperinflations almost always coincide with fiscal reforms. Once the magnitude of the problem becomes apparent, the government musters the political will to reduce government spending and increase taxes. These fiscal reforms reduce the need for seigniorage, which allows a reduction in money growth. Hence, even if inflation is always and everywhere a monetary phenomenon, the end of hyperinflation is often a fiscal phenomenon as well.9

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