The CORE Econ website uses essential cookies to make our website work. You may disable these using your browser settings but this may affect website functionality (such as your access to logged-in resources). We would also like to use analytics cookies to help us improve the functionality of our website and improve your user experience. These analytics cookies will be set only if you accept. We do not sell or otherwise transfer personal data or usage data to any third parties or use it for any other purpose. For more detailed information about the cookies we use, see our Privacy policy.

Transcript Paul Segal: The economics of inflation and hyperinflation transcript

0:00:00.240 –> 0:00:05.600 I’m Paul Segal. I’m a professor of economics at  the IAE Business School in Argentina and I’m the

0:00:05.600 –> 0:00:10.400 author of the core insight the sky’s the limit  the economics of inflation and hyperinflation.

0:00:10.400 –> 0:00:14.560 Inflation is a fact of life in capitalist  economies. Low levels of inflation around 2%

0:00:14.560 –> 0:00:20.640 to 5% per year really bother us. But what happens  when inflation gets out of control? In Argentina

0:00:20.640 –> 0:00:27.280 in 2022, inflation averaged nearly 6% per month,  which compounded to nearly 100% over the year.

0:00:27.280 –> 0:00:31.440 And in presidential elections the following  year, the candidate who won did so by promising

0:00:31.440 –> 0:00:36.720 to do whatever it took to bring inflation down  regardless of the costs. But there are also more

0:00:36.720 –> 0:00:41.200 severe cases of countries suffering thousands of  percent inflation in a year. And when a country

0:00:41.200 –> 0:00:47.680 sustains inflation over 50% per month, we call  it hyperinflation. Money loses value so fast that

0:00:47.680 –> 0:00:53.200 people spend it as fast as they can or abandon the  currency altogether. What explains high inflation

0:00:53.200 –> 0:00:58.800 and how can it be stopped? At its heart, inflation  reflects a simple fact. Holding all else equal,

0:00:58.800 –> 0:01:03.200 economic agents would all like to increase the  price they charge for their goods, their services,

0:01:03.200 –> 0:01:08.320 or their labor. But when one agent increases the  price they charge, this implies an increase in

0:01:08.320 –> 0:01:13.600 costs for whoever pays them, their customer or  their employer. And whoever is now facing higher

0:01:13.600 –> 0:01:18.480 costs wants to raise their own prices in turn.  In macroeconomics, we learn that income equals

0:01:18.480 –> 0:01:24.000 expenditure because my spending is your income and  your spending is my income. From the perspective

0:01:24.000 –> 0:01:29.760 of inflation, this means something else. My cost  is your price and your cost is my price. We see

0:01:29.760 –> 0:01:35.360 this at work in different scenarios. In the wage  price spiral, prices go up, workers negotiate a

0:01:35.360 –> 0:01:39.920 higher wage to compensate, and then firms raise  prices again because high wages have raised

0:01:39.920 –> 0:01:45.600 their costs. It also occurs when a country  faces a depreciation of their currency. Now,

0:01:45.600 –> 0:01:51.280 imported goods become more expensive, so importing  firms raise the prices they charge. If these firms

0:01:51.280 –> 0:01:55.440 also supply other firms, then the costs of those  firms go up, so they want to raise their prices

0:01:55.440 –> 0:02:01.280 too. But rising prices in the economy often leads  to another depreciation and then further inflation

0:02:01.280 –> 0:02:06.400 setting off a depreciation inflation spiral.  Economists and policy makers have a standard

0:02:06.400 –> 0:02:12.160 set of tools to combat inflation using demand  management. Put simply, if inflation is too high,

0:02:12.160 –> 0:02:16.800 you raise interest rates or tighten fiscal  policy in order to reduce aggregate demand.

0:02:16.800 –> 0:02:22.160 That creates a recession. It raises unemployment,  which puts downward pressure on wages and cuts

0:02:22.160 –> 0:02:27.680 off any potential wage price spiral. A credible  central bank can help to stabilise expectations

0:02:27.680 –> 0:02:33.280 of inflation because then economic agents build  in low inflation to their contracts. For many

0:02:33.280 –> 0:02:38.480 countries with low levels of inflation, this is  fairly effective. For countries with really high

0:02:38.480 –> 0:02:43.600 levels of inflation, the problem goes far beyond  aggregate demand. In cases of hyperinflation,

0:02:43.600 –> 0:02:48.080 there’s usually a combination of an unsustainable  fiscal deficit and an ongoing depreciation

0:02:48.080 –> 0:02:53.280 inflation spiral. But in these cases, the solution  isn’t a simple fiscal adjustment because the

0:02:53.280 –> 0:02:57.440 fiscal deficit is typically caused by something  beyond the government’s control. Sometimes a

0:02:57.440 –> 0:03:02.960 conflict like a civil war, but most commonly it’s  caused by unsustainable foreign debt. This causes

0:03:02.960 –> 0:03:08.320 hyperinflation through two mechanisms. First,  high debt payments imply a large fiscal deficit.

0:03:08.320 –> 0:03:12.320 And the fact that the government is already  finding it hard to repay its debt means that

0:03:12.320 –> 0:03:17.440 no one will lend to them to cover the deficit.  So, they end up printing money. In this context,

0:03:17.440 –> 0:03:22.240 printing money means the government is adding to  aggregate demand through spending without reducing

0:03:22.240 –> 0:03:27.040 it by borrowing from the private sector. So, it’s  like a supercharged fiscal stimulus right when

0:03:27.040 –> 0:03:32.560 inflation is already too high. And second, the  government is desperately trying to buy foreign

0:03:32.560 –> 0:03:36.400 currency in order to pay the interest on the  foreign debt, which means pushing up demand

0:03:36.400 –> 0:03:41.680 for foreign currency. That raises its price, which  is the same thing as a depreciation, i.e. foreign

0:03:41.680 –> 0:03:46.560 currency gets more expensive relative to domestic  currency. That then pushes up import prices,

0:03:46.560 –> 0:03:52.480 further feeding the depreciation inflation spiral.  Escaping these dynamics is hard. It typically

0:03:52.480 –> 0:03:57.440 requires not just fiscal and monetary tightening,  but also exchange rate controls, convincing people

0:03:57.440 –> 0:04:02.160 that there’s a change in the economic regime in  order to change expectations of high inflation,

0:04:02.160 –> 0:04:07.840 and often debt restructuring to cut unsustainable  debt repayments. Inflation is a complex problem

0:04:07.840 –> 0:04:12.240 involving aggregate demand, expectations,  negotiations between economic agents,

0:04:12.240 –> 0:04:17.280 international trade, and international finance  and debt all interacting at once. Central banks

0:04:17.280 –> 0:04:21.600 in many countries make great efforts to keep  inflation low because it is much less difficult

0:04:21.600 –> 0:04:27.280 and less costly to do that than to bring inflation  down once it gets too high. But the challenge is

0:04:27.280 –> 0:04:32.160 greater for developing and emerging economies that  are dependent on commodity exports because they

0:04:32.160 –> 0:04:36.640 have to contend not just with aggregate demand  and expectations but also with international

0:04:36.640 –> 0:04:41.760 prices that are highly fluctuating and with  foreign debt. In this insight, we’ll see why

0:04:41.760 –> 0:04:46.480 inflation behaves so differently across countries  and why stopping it is ultimately as much about

0:04:46.480 –> 0:04:53.520 politics, institutions, and conflicts between  winners and losers as it is about economics.