David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 22 Inflation, expectations and credibility
Table 22.1 The German hyperinflation, 1922-23
Money
Prices
Real money
Inflation % monthly
January 1922 1 1
January 1923 16 75
-
-
July 1923 354 2021
September 1923 227 777 645946
-
-
October 1 923 20 201 256 191 891 890
-
1.00 5
0.21 189
0.18 386
0.35 2532
0.11 29 720
Source: Data adapted from Holtfrerish, C. L. (1 980) Die Deutsche Inflation 1914-23, Walter de Gruyter.
The flight from cash is the
collapse in the demand for
real cash when high inflation
and high nominal interest rates
make it very expensive to hold
cash.
People, paid twice a day, shopped in their lunch hour before the real value of
their cash depreciated too much. Any cash not immediately spent was quickly
deposited in a bank where it could earn interest. People spent a lot of time at the
bank.
What lessons can we draw? First, rising inflation and rising interest rates
significantly reduce the demand for real cash. Hyperinflations are a rare example
in which a real quantity (real cash) changes quickly and by a lot. Second, and as
a result, money and prices can get quite out of line when inflation and nominal interest rates are rising.
Table 22.1 shows that prices rose by six times as much as nominal money between January 1922 and July
1923, reducing the real money supply by 82 per cent, in line with the fall in real money demand - a
flight from cash .
( Inflation, money and deficits
..,_ _ _ _ _
Persistent inflation must be accompanied by continuing nominal money growth. Printing money to
finance a large deficit is a source of inflation. Budget deficits may explain why governments have to print
money rapidly. If so, tight fiscal policy is needed to fight inflation.
The level of GDP affects how much tax revenue the government gets at given tax rates. If government debt
is low relative to GDP, the government can finance deficits by borrowing. It has enough tax revenue with
which to pay interest and repay the debt. For governments with low debt, there may be no relation between
their budget deficit and how much money they print. Sometimes they print money; sometimes they issue
bonds. We do not expect a close relationship between deficits and money creation in a country like the UK.
Nevertheless, many years of deficits may make government debt large relative to GDP. The government
can no longer finance deficits by more borrowing. It then has to tighten fiscal policy to shrink the deficit,
or print money to finance the continuing deficit.
To ensure that the European Central Bank did not face fiscal pressure to print too much money and thus
create inflation, members of the eurozone had to obey the Stability and Growth Pact, which restricts their
budget deficits to less than 3 per cent of GDP, except in severe recession. Of course, when severe recession
arrived in 2009, budget deficits escalated to 10 per cent and beyond. We never quite know how binding a
commitment will be until a crisis occurs. Similarly, the UK's Code for Fiscal Stability committed the UK
government to not keep running big deficits that steadily raise government debt relative to GDP. When it
came to the crunch, this commitment was (wisely) jettisoned.
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