WHAT DOES THE ECONOMIC THEORY SAY ABOUT HYPERINFLATION ?

According to the economic theories, the root causes of hyperinflation is a massive and rapid increase in the amount of money, which is not supported by growth in the output of goods and services, the outcome of which is an imbalance between the supply and demand for the money, domestic currency and bank deposits. It also results in loss of confidence in the money, like a bank run, as the value of money declines. Hyperinflation is generally associated with paper money because this can easily be used to increase the money supply. It decreases the purchasing power of the economys public and private savings , and causing people to spend whatever money they get, faster, leading to extreme consumption which increases the velocity of money, and extreme hoarding to real assets, which as a result accelerates prices even more. This altogether also has an adverse affect investment. Economic theories suggest that the need to print more money which eventually leads to excessive increase in money supply, being one of the important reasons behind inflation, is that at times government is either unable or unwilling to finance its debt through taxes and borrowing. Thus, it resorts to printing more money. ECONOMIC MODELS: Economic theories consider hyperinflation as a monetary effect, and apply models to this concept which revolves around for money. As per theory, a rapid increase in Money supply also results in an increase in the velocity of money CRISIS OF CONFIDENCE:. This model looks at an increase in the velocity of money as a cause of hyperinflation . According to this model, as people loose faith in the domestic currency, they wish to sell their notes and demand greater risk premium as compared to the original value. Example of causes of crisis of confidence : War MONETARY MODEL : The model revolves around the idea that hyperinflation is a positive feedback cycle of rapid monetary expansion, and

that the cause of hyperinflation according to this model is increased production of domestic currency to financing increasing costs. Economic theory also says that during times of hyperinflation, larger denominations of money are printed. For eg, 500,000 peso note in Argentina was printe. This happens due to immense decline in value of currency as a consequence of hyperinflation. GOVERNMENT POLICIES TO COUNTER HYPERINFLATION IN ARGENTINA As the side effects of hyperinflation are dramatically damaging to the economy, it was imperative for Argentina to develop policies that could reduce the inflation levels and save the economy from the adverse effects of hyperinflation. Some of the major policies are as follows : Firstly, in order to recover, it was essential for Argentina to restore the faith of the economy in its currency and ensure people that domestic currency will hold its value . Thus, In 1991, a new fixed nominal exchange rate was introduced, accompanied by change in name of currency from Austral to Peso, to create a positive psychological effect. Argentinas currency was pegged to a much stable currency- the US dollar which caused people to become less willing to spend as the central bank had to exchange the local Peso at a fixed ratio, and people now knew that their domestic currency could be converted into USD, leading to a decline in the velocity of money and paused the ever increasing hyperinflation temporarily. As markets began to emerge by 1990s, Aregentinas economy began to uplift due to capital inflows. Imposition of fixed Exchange rate combined with influx of capital led to credit and monetary expansion which facilitated the process of economys recovery. In order to enjoy the long term effects of the exchange rate remedy used, it was important for Argentina to implement policies and reforms that focused on cutting deficit spending and decreased printing of money but funding their activities by tax revenues. Thus, improvements had to be made to tax collection

system and reduce public expenditure. However, Argentina failed to enjoy its initial recovery for long as it lacked a strong fiscal management system. In late 1990s, the failure of strong and disciplined fiscal system led to the government being forced into financing its deficits with debt. As excessive deficits prevailed in the economy, Argentina experienced increasing debt. Another factor that contributed to the crisis in Argentina was the side effects of the Asian and Russian crisis that hindered capital inflow in Argentina, leading to a need of real exchange rate depreciation to adjust Argentinas economy back to equilibrium. However, Argentina being a closed economy, required a very large amount of depreciation in real exchange rate, which led to further financial problems for the economy as a large proportion of its debt was in dollars. Argentinas failure to adjust to this issue created credibility issues that triggered crises even further. Nominal rigidities in the economy were also accused for Argentinas crisis as once Exchange rate is fixed, the economy needs to bare certain costs, that is that inflation continues to rise for sometime for especially non tradable goods. Readjustments are required in nominal exchange rate after time intervals to counter this issue, but the nature of Argentinas currency board system did not allow this. Hence, it had to suffer the consequences. In early 2002, Argentina was forced to currency board system and devaluation of currency policies which led to a massive decline in GDP by 11%, increase in unemployment by 23%, almost bankcruptcy of financial system and large scale public discomfort. . Argentina was on the verge of collapsing but they then underwent a surprising recovery refered to as the Post convertibility macro policy. The steps included In this policy were as follows : 1. Devaluation the currency. 2. Dirty float of the exchange rate that allows real depreciation 3. Government debt renegotiation pointing towards a substantial debt reduction 4. Controls on financial capital inflows to avoid pressure toward the appreciation of the real exchange rate 5. Convert all dollar denominated contracts into Peso, to benefit debtors (e.g. firms and mortgage holders).

6. Freezing of price increases in public utilities by privatization and imposition of export taxes on the main exports of the country (mainly agricultural products) as a way of increasing government revenues at the same time as keeping domestic prices down for products for popular consumption. 7. Generate fiscal surpluses of about 3 percent of GDP as a way of having genuine funds to accumulate foreign reserves and to repay the government debt selectively.

The positive effects of these policies started to pull Argentina out of recession. The impacts of these policies can be summarized as follows : 1. GDP per capita accumulated to a rise of 34% 2. Argentinas current accounts evolved 3. 2002 to 2206, the economic performance showed two twin fiscal surpluses 4. 2004 onwards, the debt restructuring caused a positive effect by declining Argentinas debt from 125% to 73% 5. After about 23% unemployment rate, Argentinas unemployment rate fell down to 10% Argentinas surprising quick recovery was quite a lesson to learn from for other countries experiencing hyperinflation. However, there still did remain some limitations on micro and macro level. In order for Argentina to maintain its discipline is policy making and implementation and needs to have ample knowledge about its economy to facilitate the expectation creating process. As Argentina is considered to be an economy in transition ( from crisis to recovery ), it is prone uncertainty and frequent structural changes. With this kind of volatile environment, it is difficult for economic agents to forecast future trends and make closer to accurate long term decisions. Government policy makers also find it extremely difficult to keep up to date woth changes trends. Frequent structural changes, large and volatile shocks, and lack of sufficient and reliable statistical information make difficult for them to study and estimate the behavior of the economy and its corresponding effects.