Hyperinflation

The relationship between money supply and price level lies in the fact that the amount of money in circulation in an economy has a direct impact on the aggregate price level. This is mainly because an abundance of money leads to an increase in demand for goods and services, while a scarcity of money has the opposite effect. In economic terms, this effect is explained by the quantity theory of money, which states that the amount of money in supply in an economy has a direct bearing on the price level (Hubbard & O'Brien.2012). A simple way of looking at the relationship between money supply and price level is to consider the fact that consumers will only spend when they have something to spend. That is to say that when there is a lot of money in the economy, people will have more to spend. This increase in demand also causes a corresponding increase in the price level. Excess liquidity leads to a situation in which a lot of cash will be competing for an often limited supply of goods. This causes the money to gradually lose its value, which consequently leads to price increases (Smith.1998).

Phillip Cagen says in his article, The Monetary Dynamics of Hyperinflation, that “hyperinflations are usually caused by large persistent government deficits financed primarily by money creation (rather than taxation or borrowing).” As such, hyperinflation is often associated with wars, their aftermath, sociopolitical upheavals, or other crises that make it difficult for the government to tax the population. A sharp decrease in real tax revenue coupled with a strong need to maintain the status quo, together with an inability or unwillingness to borrow, can lead a country into hyperinflation (Cagan.1956). Zimbabwe and Israel both encountered hyperinflation in their economies but upon further analysis one could see that they encountered very different outcomes.  Though they began differently, both started slowly and got out of hand in a matter of months.

Some may wonder how bad was inflation in Zimbabwe? Well, consider this: at a supermarket toilet paper costs $417. No, not per roll as 417 Zimbabwean dollars is the value of a single two-ply sheet. A roll costs $145,750 in American currency, about 69 cents. For Zimbabweans, toilet paper and bread, margarine, meat, and a cup of tea have become unimaginable luxuries. All are victims of the hyperinflation that was roaring toward 1,000 percent a year, a rate usually seen only in war zones (Coomer & Gstraunthaler.2011). Zimbabwe has been tormented this entire decade by both deep recession and high inflation, but the economy seems to have abandoned whatever it had left. “The national budget each year was spent within the first quarter and government services were crumbled as a result of the inflation” (Coomer & Gstraunthaler.2011).

Those with spare cash do not deposit it in banks, which pay 4 to 10 percent annual interest on savings, but in investments like bags of corn meal and sugar, which are guaranteed not to lose their value. "If you need something and have cash, you buy it. If you have cash you spend it today, because tomorrow it's going to be worth 5 percent less” (Coomer & Gstraunthaler.2011). This will only worsen inflation, for printing too many worthless dollars is in part what got Zimbabwe into this mess to begin with. Zimbabwe however fell into hyperinflation after the government began seizing commercial farms in about 2000 (Coomer & Gstraunthaler.2011). The government made the situation worse when it seized control of land owned by white farmers, which triggered a sharp drop in production and exports of agricultural goods. Foreign investors fled, manufacturing ground to a halt, goods and foreign currency needed to buy imports fell into short supply and prices shot up. By freezing a significant portion of production, the only way to make money is by printing more of it. The government printed