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A Model of Hyperinflation

Listed author(s):
  • T. Christopher Canavan

    (Boston College)

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    Standard models of hyperinflation use a money demand function based on asset-market considerations: households adjust their real balances according to expected inflation, which is the negative of the real rate of return to money. But these models yield inaccurate and sometimes counterintuitive predictions. One is that if a hyperinflation is a price-level bubble, then hyperinflation is possible at any rate of money growth. Another is that, for some equilibria, an increase in a government's reliance on seignorage reduces rather than raises the steady-state inflation rate. This paper proposes an alternative way to look at hyperinflation based on a careful description of the microeconomics of monetary exchange. Money is primarily an institution required to finance consumption and only incidentally a financial asset. The decision to accept money is a decision to engage in monetary exchange, and a hyperinflation occurs when most households choose to abstain from monetary exchange. The macroeconomic implications of this model are more appealing than those of the traditional models. First, while a hyperinflation in my model may have the same properties as a price-level bubble, this "bubble" is very unlikely when money growth is low and inevitable when money grows too quickly. Second, a greater reliance on seignorage increases the rate of inflation, and can ultimately cause a hyperinflation. The model also mimics the non-monotonic path of real balances as inflation accelerates. Finally, the model suggests that it may be very difficult to restore a currency's place in exchange after a hyperinflation.

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    Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 274..

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    Date of creation: Jul 1994
    Handle: RePEc:boc:bocoec:274
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