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Lecture 11

PM Lecture 11 Hyperinflation

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CAS EC 102
Jay Zagorsky

PM Lecture #11: Hyperinflation Tuesday, April 22, 2014 12:10 PM - Inflation: Overall price level increases continuously - Hyperinflation: Overall price level increases more than 50% per month - called "Cagan Definition" ○ Has existed in the world only since countries switched to fiat currencies  Impossible in money back by commodities  Impossible in commoditymoney  Impossible in barter - Big Idea: Macroeconomicsinstitutions did not exist until the last century ○ Central banks (Fed started 1913) ○ Fiat currency (US switched in 1934) ○ Social Safety Net (Wisconsin 1st UI program 1932) ○ Mistakes have been and continue to be made in learning how to manage modern economy - 4 European hyperinflations from 1920s:Austria, Germany,Hungary, and Poland - Famous Economist:Milton Friedman ○ Studies in the Quantity Theory of Money ○ A MonetaryHistory of the United States 1867-1960 ○ "inflation is always and everywherea monetaryphenomenon. To control inflation, you need to control the money supply." ○ "Inflation is like a drug. Its stimulating effect is temporary.Only larger and larger doses can sustain the stimulus, before the chaos of hyperinflation removesall the gains." - The result of WWI: Axis losing land, gold, human and physical capital, these issues caused hyperinflation in each country that lost the war - Quantity Theory: M x V = P x Y - Expectations:People are expecting increases in the money supply and are raising prices ahead of actual increases - What Happened During The Inflation? ○ Shoe leather costs: German Hyperinflation  Money was worth so little that workers bought anything that was for sale as soon as they got paid ○ Menu cost : German Hyperinflation  Menus in cafes could not be revised quickly enough with the changes in prices - Why Did Countries Choose Hyperinflation? ○ Hyperinflations are often caused by governmentsneeding to finance huge deficits  Deficits caused by war, revolution,end of empires and establishmentsof new states ○ Gov't can fund its spending by: taxing, borrowing or printing money - Another result of WWI was that gov't designed for larger country ○ Austria-Hungary pre-war was a large empire ○ No reserves/savingsto fall back on ○ Fewer factoriesworking to produce goods  Low GDP means low taxes ○ Fewer workersproducing goods ○ High gov't spending ○ Very little revenue - Polish Hyperinflation: Poland could not collect taxes ○ Poland lacked trained gov't officials and had budgetary issues - Once inflation starts, gov't loses the ability to collect enough taxes, even if it has excellent tax - Once inflation starts, gov't loses the ability to collect enough taxes, even if it has excellent tax collectors ○ Lags in collection make real value of all tax collectionsfall  Example: In US, people owe taxes for previous year on April 15th of the following year. No one will pay taxes early in a hyperinflation, and by the time April 15th comes around, the amount of money you owe the gov't is worth very little and buys the gov't very little - Inflation Tax: Gov't raises revenue by printing money ○ Inflation tax is a cost on everyoneholding money  Have $1 today  Gov't prints extra money and receives goods/services  Result: Inflation is 5%  Next year, $1 purchases $0.95 of goods/services  Where did the 5% go? - By-Product: Hyperinflation destroys wealth of bond holders ○ US can wipe out entire debt by having a massive and unexpected inflation ○ Hyperinflations hurt middle class th
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