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THE REALITIES OFMODERN
HYPERINFLATION
NEETA NAINANI
MMS-B
122
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How different are the modern hyperinflation episodes from the one experienced
after World War I?
Ans) Modern episodes of hyperinflation are different from those that followed World War I. The
following points highlight the difference:
The hyperinflations of the 1920s sprang up swiftly and were rapidly brought to an end,withoutmuch cost to employment and output, after governments implemented drastic fiscal and monetary
reforms that restored currency convertibility and gave central banks independence to conductmonetary policy.
In contrast, modern hyperinflations have not been short and swift. In most cases, they have beenpreceded by years of chronic high inflation. In Argentina, Brazil, and Peru, for example, year-over-
year inflation remained consistently above 40 percent for 1215 years before the peak of the
hyperinflation.
Chronic high inflation does not necessarily degenerate into hyperinflation. But, in the fivecountries reviewed here, hyperinflation did ensue, triggered by an uncontrolled expansion in the
money supply that was fueled by endemic fiscal imbalances. Nor has price stability been restored
overnight in modern hyperinflations. It took 14 months in Bolivia and more than 3 years in Peru
for inflation rates to fall below 40 percent. It took even longer to reach single-digit inflation
ratesthree and a half years in Argentina and about seven and a half years in Bolivia. In Brazil,failure to put in place the needed fiscal and monetary reforms in 198990 caused the country to
experience a second, borderline hyperinflation in 1994.
Another difference is that full currency convertibility and strict institutional constraints onmonetary policy have not characterized the end of all modern hyperinflations. Except for
Argentina, which adopted a currency board in early 1991, countries have relied on hybrid
monetary and exchange regimes to bring high inflation under control. Bolivia and Peru relied on
money targets and heavy foreign exchange intervention (dirty floats); Brazil and Ukraine
retained de jure dual exchange rates for most of the 1990s.
2. How did hyperinflation affect the Latin American economies?
Latin American countries were plagued with inflation over several decades without parallelism.
There have been several episodes of extreme inflation with. Bolivian Inflation, for instance,between May and August of 1985 reached an annualized rate of 60,000 percent, the seventh
worst case of hyperinflation in history.
Hyperinflation reduced the size of the financial sector and gradually erodes the efficiency of theprice system and the usefulness of domestic money as a store of value, unit of account, and
medium of exchangetaking the economy, in the extreme, to a near state of barter. In Bolivia,
bank deposits fell to a low of 2 percent of GDP the year after hyperinflation began. Although deposits and monetary aggregates do recover after hyperinflation ends, intermediation
remains extremely low by international standards. For instance, the ratio of bank deposits to GDP
in the four Latin American countries ranged from 9 percent to 20 percent three years after the
hyperinflation, which is between one third and one-half the comparable ratio for middle-income
countries with no history of high inflation.
Owing to the collapse of financial intermediation, banking crises have been a feature of all modernhyperinflations. The large-scale deposit withdrawals and sharp increases in nonperforming loans
that accompanied economic contraction made these banking crises extremely costly. The Latin
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American countries had already defaulted on their foreign currency bank debt when
hyperinflation began, and hyperinflation triggered new defaults.
The run-up to hyperinflation has been characterized by a broad array of economic distortions,including capital controls, many forms of financial repression, segmented foreign exchange
markets, and outright corruption. Although many of these distortions are hard to measure, the
parallel exchange rate market premium has been found to be a useful proxy. The parallel market
premium during the hyperinflation or the run-up to the hyperinflation has consistently remained
above 50 percent, and premiums in the hundreds and even thousands have not been uncommon.
The following chart represents hyperinflation occurring in various Latin American countries
between 1981 to 2000.
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3. Was the monetary policy effective enough to control hyperinflation? Substantiate
your answer with valid reasons.
Ans) Yes. Inflation stabilization programs adopted by many Latin American countries in the early 1990s
and the historically low rates of inflation attained by the region in recent years, falling from an average of
over 400% in 1989 to below 10% at the beginning of the millennium.Easing or lifting capital controls and unifying exchange markets have been critical to reducing some of
these distortions during stabilization. These measures together with strict fiscal policieshave usually
led to dramatic declines in parallel market premiums. The following table shows the drastic decline of
hyperinflation owing to the measures adopted by the government.
Evolution of the Rate of Inflation Before and After Stabilization
Year Bolivia Mexico Argentina Brazil
1980 24
1981 25 28
1982 296 59
1983 329 102
1984 2177 66 211
1985 8170 64 385 228
1986 66 106 82 58
1987 11 159 175 366
1988 52 388 9931989 20 4924 1765
1990 30 1833 2360
1991 19 84 421
1992 12 18 989
1993 8 7 2086
1994 4 2312
1995 1,6 75
1996 0,1 11
1997 8
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4. What role did the government play in controlling hyperinflation?
Bolivia: In 1985 the elected government of Victor Paz Estensoro implemented a stabilization plan (in
September inflation had reached 56% per month) The government declared a moratorium of Debt Service (accepted by the IFI) The exchange rate was fixed The government implemented a deep fiscal reform (sharp increase in public sector prices,
reduction of subsidies to the mining industry and public sector wage freeze)
By 1986 inflation reached 66% (from 8.178% in 1985
Mexico: In 1987 the government announced the Economic Solidarity Pact, which was followed by the Pact
for Economic Stability in 1989. Strong adjustment of the peso was followed by smalls and decreasing over time adjustments in the
exchange rate.
Guidelines for wage and price adjustments (voluntary agreements monitored by the three parties:business, labour and the government)
Tariff reduction and trade liberalization was adopted. Inflation diminished slowly and the costs in terms of output were low.
Argentina: In 1991, the convertibility plan was launched by the government and approved by the congress. Convertibility of the peso at 1-to-1 rate with the US dollar and obligations of the monetary
authority to maintain full backing of the monetary base in foreign reserves were mandatory.
The law also banned any kind of automatic price adjustment linked to domestic prices andcontracts in foreign currency were allowed.
The programme was complemented with a massive privatisation of public utilities (which solvedpartially the fiscal problem). The government implemented deep trade and financial liberalization
Brazil: Advocated by then finance minister Fernando Henrique Cardoso, the Real Plan was launched in
June 1994. It had three phases.
Phase one of the plan was an attempt to secure fiscal stability through tax increases, expenditurecuts and the reduction of compulsory transfers to local administrations. Phase two, contemplated the creation of the Unit of Real Value (URV), a stable unit of account
whose nominal value increase daily according to the rate of inflation (of cruzeiros reais).
Phase Three, was the transformation of URV into the Real . In took place in June after relativeprices were aligned.