Hyperinflation

Hyperinflation represents one of the most extreme forms of macroeconomic instability, characterised by exceptionally rapid and accelerating increases in the general price level. As prices rise at extraordinary rates, the real value of money deteriorates sharply, prompting individuals and businesses to abandon the depreciating currency in favour of more stable foreign monies or non-monetary assets. Episodes of hyperinflation have occurred in numerous countries and are often associated with crises in public finance, political upheaval or major disruptions to national production.

Characteristics and Definitions

Hyperinflation differs from ordinary inflation in both scale and speed. While moderate inflation tends to be gradual and discernible mainly through historical price comparisons, hyperinflation emerges abruptly and intensifies quickly. Nominal prices of goods and services may multiply within days or weeks, and the money supply expands uncontrollably as authorities attempt to meet fiscal demands.
A widely accepted definition originates from the work of economist Phillip D. Cagan, who in 1956 identified hyperinflation as a situation in which the monthly inflation rate exceeds 50 per cent. According to this framework, an episode ends only when monthly inflation falls below the 50 per cent threshold and remains at or below it for at least one year. At a monthly rate of 50 per cent, price levels increase by a factor of approximately 129 over the course of a year.
Although no universal standard exists, the International Accounting Standards Board lists indicators of hyperinflationary conditions, including:

• the public’s preference for foreign currencies or non-monetary assets;
• immediate spending of cash balances to avoid loss of purchasing power;
• quotation of prices in a stable foreign currency;
• credit transactions adjusted for expected inflation;
• widespread indexation of wages, prices and interest rates;
• cumulative inflation over three years approaching or exceeding 100 per cent.

Historical episodes such as Germany in 1923 and Hungary in 1946—where a one-sextillion-pengő note was prepared—demonstrate the extreme depreciation possible under these circumstances.

Economic and Fiscal Causes

Although moderate inflation can arise from various sources, the overwhelming majority of documented hyperinflations stem from unsustainable government budget deficits financed through the creation of new money. Excessive reliance on monetary expansion typically reflects deeper structural problems, including:

• war or its aftermath;
• sociopolitical unrest;
• collapse in aggregate output;
• sharp declines in export revenues;
• severe difficulty in collecting taxes.

When governments cannot borrow sufficiently or raise taxes due to administrative or political constraints, they may turn to the monetary authority to finance expenditure. This practice of monetising deficits increases the money supply rapidly, causing prices to rise in response. As prices escalate, the real value of tax revenue falls, further widening the deficit and necessitating even more money creation. This creates a vicious cycle in which monetary expansion accelerates in tandem with rising prices.
Some episodes have occurred during civil wars when governments attempted to fund military operations despite a shrinking tax base and limited access to credit. The Chinese Nationalist government during the 1939–1945 period provides a classic example of this phenomenon.

Money Supply, Velocity and Loss of Confidence

Monetarist theory emphasises the relationship between money growth and price inflation. When currency creation outpaces real economic output, each unit of money commands fewer goods and services. As the public recognises the diminishing value of money, they attempt to spend it quickly, increasing the velocity of money circulation. The rise in velocity exacerbates price increases, causing inflation to accelerate beyond the rate of money supply growth itself.
Once confidence in the currency erodes severely, the economy may experience behaviour analogous to a bank run. Individuals and firms refuse to hold money except for the shortest possible periods, demanding ever-greater nominal amounts for transactions. Sellers may require prices denominated in foreign currencies or convert to barter-like exchanges. This loss of confidence marks a critical tipping point at which hyperinflation becomes self-reinforcing.

The Role of Fiat Currency and Seigniorage

Hyperinflation nearly always occurs in societies that use fiat money—currency not backed by a commodity such as gold or silver. Fiat systems allow governments to generate revenue through seigniorage, the profit derived from issuing currency. While modest seigniorage can help finance public expenditure, excessive reliance undermines the currency’s value.
Theories of hyperinflation often focus on the interplay between seigniorage and the inflation tax. A government seeking to raise revenue through money creation faces diminishing returns as inflation rises. Beyond a certain threshold, any additional increase in money supply reduces the real value of revenue rather than increasing it. In both classical and neoclassical models, hyperinflation begins when the authorities lose the ability to stabilise finances through taxation or borrowing and must rely heavily on monetary expansion.
In neoclassical analysis, deterioration of the monetary base—meaning the public’s belief in the currency’s store-of-value function—triggers rising risk premiums for holding the currency. Sellers demand larger compensations to accept it, creating a feedback loop that heightens inflation expectations and pushes the inflation rate higher.

Social, Economic and Policy Impacts

Hyperinflation imposes profound costs on society. Real wages fall as nominal incomes fail to keep pace with rising prices, causing hardship for workers and households. Savings denominated in local currency can become worthless within weeks. Businesses face severe planning difficulties due to unstable input prices and uncertain future costs. Credit markets may collapse as lenders cannot accurately price interest rates to offset inflation risks.
Governments typically attempt to halt hyperinflation using a combination of monetary reforms, fiscal consolidation and currency stabilisation measures. These may include:

• introducing strict capital controls;
• adopting a more stable foreign currency (full or partial dollarisation);
• controlling money supply growth;
• enacting sharp reductions in government spending;
• implementing structural reforms to improve tax collection and rebuild confidence.

While such measures can be effective, they often come with significant social and economic costs, including reduced public services, higher unemployment and political unrest.

Complexity and Multiple Interpretations

Although excessive monetary expansion is central to most explanations of hyperinflation, no single theory fully accounts for all historical cases. Some episodes begin with fiscal collapse, others with political turmoil or loss of confidence preceding large monetary increases. Nevertheless, the interplay between falling trust in the currency and the authority’s inability to stabilise the monetary base is a consistent feature across diverse examples.
Hyperinflation ultimately reflects a breakdown in the relationship between money, production and public expectations. It showcases the fragility of fiat currency systems when fiscal discipline, sustainable governance and credible monetary institutions fail, resulting in one of the most destructive economic crises a nation can experience.