Hyperinflations Are Rare, but a Breakup of the Euro Area Could Prompt One

This is the title of a nice paper by Anders Aslund of PIIE.

He says hyperinflations happen rarely. However, collpase of currency unions is one very strong reason for hyperinflations in the past. This could be true in case of Eurozone collapse as well. Hence the collapse has to be averted at all cost:

Hyperinflation—usually 1,000 percent or more a year—occurs only under very special circumstances: in a disorderly breakup of a currency zone; after wars or revolutions, when monetary or fiscal authorities lack control; and when wild populism prevails. Åslund reviews the historical record and shows that hyperinflation does not arise by mistake but because of major dysfunction or mismanagement. Responsible countries with reasonable governance may default, but they do not have hyperinflation. The danger of hyperinflation, therefore, is an irrelevant concern for ordinary monetary policy.

However, the fact that collapse of a large currency union with substantial imbalances usually causes hyperinflation raises concerns for the euro area. Large uncleared payments balances have accumulated between the member countries as the private interbank market has stopped functioning. On the one hand, the uncleared balances have grown massively and, on the other, the creditor countries demand that balances be capped, which would mean disruption of the currency zone. It is critical to prevent a disorderly collapse of the euro area at almost any price, and the most obvious measure is vigorous monetary expansion, even more so than at present. There is no historical evidence of monetary easing or even quantitative easing leading to hyperinflation. The second measure should be more rigorous fiscal austerity in the troubled countries.

The paper draws hugely from this excellent note by Cato Institute econs on hyperinflation. It says there have been 58 episodes of hyperinf so far. What are the common causes?

1. The most common cause is the collapse of a multinational  currency union with competitive currency issue and large  uncleared payments balances. No less than half (28) of the  hyperinflations pertain to this category, notably to the collapse of the Soviet Union, Yugoslavia, and Austria-Hungary. 

2. The second most common and the most natural cause is war or civil war, resulting in profound state dysfunction. Many  hyperinflations have occurred during or more commonly in the wake of a war with unclear consequences, notably World War I, World War II, the Yugoslav wars, and Congo’s civil war. Iran is suf ering from hyperinl ation because of rigorous international sanctions, which amount to a kind of warfare.

3. Another economic dysfunction is revolution—a time when any ordinary laws, whether of economics or gravity, are considered rrelevant. h ose were the times of the French Revolution, the Russian Revolution (Mau and Starodubrovskaya 2001), Salvador Allende’s Chile, and Daniel Ortega’s Nicaragua.

4. A peculiar folly was the populism in Latin America, primarily in the 1980s. h e outstanding example was the indexation to very high rates of inl ation as in Brazil in the latter half of the 1980s, when average annual inl ation was 516 percent (Rabello de Castro and Ronci 1991, 156).

5. Finally, there is the odd case of hyperinl ation that started  due to the sheer madness of an authoritarian ruler. Zimbabwe’s hyperinl ation in 2007–08 stands out as such. North Korea is  arguably another case.

EMU should heed the advice..

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