Capítulo 23

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CHAPTER 23
CHAPTER23
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High Inflation
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High Inflation
Hyperinflation simply means very high inflation.
Inflation ultimately results from nominal money growth.
Countries that have suffered from hyperinflation have high nominal money growth because the budget deficit is high. Governments cannot finance its expenditures in any way other than money creation.
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High Inflation
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High Inflation
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Budget Deficits
and Money Creation
A government can finance its budget deficit either by:
Borrowing (issuing bonds), or by creating money.
Debt monetization is the process by which the government issues bonds and asks the central bank to buy them; then, the central bank pays the government with money it creates, and the government uses that money to finance the deficit. 
23-1
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Budget Deficits
and Money Creation
The start of a hyperinflation takes place when there is budget crisis,
and the government is unable to borrow from the public or from abroad.
Seignorage is the amount of real revenue the government can generate from money creation.
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Budget Deficits
and Money Creation
The rate of nominal money growth required to generate a given amount of seignorage is:
In words, seignorage is the product of the rate of nominal money growth and real money balances.
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Inflation and
Real Money Balances
What determines the amount of real money balances people will hold?
Real money balances depend (positively) on income and (negatively) on the nominal interest rate.
A higher nominal interest rate increases the opportunity cost of holding money and leads people to reduce their real money balances.
23-2
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Inflation and
Real Money Balances
In times of hyperinflation, the amount of money balances people will hold depends primarily on expected inflation.
When the expected rate of inflation is very high, people will try to get rid of their money holdings as soon as possible.
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Inflation and
Real Money Balances
Barter is the exchange of goods for other goods rather than for money.
During hyperinflations:
Barter increases.
Wage payments are more frequent.
People rush to stores to buy goods.
People shift to foreign currencies as stores of value. The shift to dollars worldwide is an event now called dollarization—the use of dollars in another country’s transactions.
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Inflation and
Real Money Balances
Inflation and Real Money Balances in Hungary, November 1922 to February 1924.
At the end of the Hungarian hyperinflation, real money balances stood at roughly half their prehyperinflation level.
Figure 23 - 1
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Inflation and
Real Money Balances
Panel (a) plots real money balances and the monthly inflation rate from November 1922 to February 1924. 
Panel (b) presents the same information as Panel (a), but in the form of a scatter diagram. 
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Deficits, Seignorage,
and Inflation
We have derived two relations:
The relation between seignorage, nominal money growth, and real money balances
The relation between real money balances and expected inflation
23-3
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Deficits, Seignorage,
and Inflation
Combining the two equations gives:
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The Case of Constant Nominal
 Money Growth
Nominal money growth has two opposite effects on seignorage:
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The Case of Constant Nominal
 Money Growth
Seignorage and Nominal Money Growth
Seignorage is first an increasing function, then a decreasing function of nominal money growth.
Figure 23 - 2
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The Case of Constant Nominal
 Money Growth
The Laffer curve is the relation between tax revenues and the tax rate. It looks similar to figure 23-2.
A simple analogy can be made between the Laffer curve and inflation versus money balances. Inflation can be thought of as a tax on real money balances.
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The Case of Constant Nominal
 Money Growth
In all seven hyperinflations, the actual average nominal money growth far exceeded the rate of nominal money growth that maximizes seignorage.
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Dynamics and Increasing Inflation
In the short run, an increase in nominal money growth may lead to little change in real money balances.
But over time, the same rate of nominal money growth yields less and less seignorage.
Therefore, the government cannot finance a deficit at a constant rate of nominal money growth.
The Tanzi-Olivera effect looks at the impact of inflation on the real value of taxes collected.
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Hyperinflations and Economic Activity
In the short run, the effects of higher nominal money growth are expansionary:
But as inflation becomes very high, the adverse effects of hyperinflation dominate:
The transaction system works less and less well.
Price signals become less and less useful.
Swings in the inflation rate become larger.
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How Do
Hyperinflations End?
Hyperinflation do not die a natural death. Rather, they have to be stopped through a stabilization program. What follows are the elements of a stabilization program.
23-4
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The Elements of a
 Stabilization Program
Hyperinflation needs to be stopped through a stabilization program, which may include the following elements:
Fiscal reform and credible budget deficit reduction.
Taking credible steps that will demonstrate the commitment of the central bank to no longer monetize the debt.
Some economists argue that incomes policies – that is, wage and/or price guidelines or controls - should be used, in addition to fiscal and monetary measures.
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The Elements of a
 Stabilization Program
Stabilization programs that do not include income policies are called orthodox; those that do are called heterodox (because they rely on both monetary– fiscal changes and incomes policies.
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Can Stabilization Programs Fail?
Can stabilization programs fail? Yes, they can fail, and they often do.
Sometimes failure comes from a botched or half-hearted effort at stabilization.
Failure can also come from the anticipation of failure. 
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The Costs of Stabilization
We argued that there were three reasons why inflation might not decrease as fast as nominal money growth, leading to a recession:
Wages are typically set in nominal terms for some period of time, and, as a result, many of them are already determined when the decision for disinflation is made
Wage contracts are typically staggered, making it difficult to implement a slow-down in all wages at the same time.
The change in monetary policy may not be fully and instantaneously credible.
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Conclusions
Although output fluctuates around its natural level in the short run, it tends to return to this natural level in the medium run. But it does not always happen this way:
Sometimes, the adjustment mechanism that is supposed to return the economy to its natural level of output breaks down.
Monetary and fiscal policy may prove unable to help.
Governments may lose control of both fiscal policy and monetary policy.
23-5
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The stabilization plan was organized around the elimination of the budget deficit. Its main features were:
Fiscal policy
Monetary policy
Reestablish international creditworthiness
The Bolivian Hyperinflation of the 1980s
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Figure 1
The Bolivian Hyperinflation of the 1980s
Bolivian Monthly Inflation Rate, January 1984 to April 1976
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Key Terms
hyperinflations
debt monetization
seignorage
barter
dollarization
Laffer curve
inflation tax
Tanzi-Olivera effect
stabilization program
income policies
orthodox stabilization program, heterodox stabilization program