Recession, Hyperinflation, and Stagflation: Crash Course Economics #13

Summary

Crash Course Economics explores the perils of economic extremes, focusing on hyperinflation in Germany 1923 and Zimbabwe, where currency became worthless. The video explains how governments printing money to pay bills can lead to spiraling prices and velocity of money increasing inflation. It also covers the Great Depression, highlighting the effects of deflation and the challenges of monetary policy in a liquidity trap. Finally, it touches on stagflation, the combination of stagnant growth and inflation, and how it was addressed in the 1980s by Paul Volcker's drastic measures.

Takeaways

• 💥 Economic crashes can have severe consequences, as seen in historical examples like Weimar Germany's hyperinflation and Zimbabwe's inflation crisis.
• 📉 Hyperinflation occurs when a country's inflation rate exceeds 50% monthly, leading to the devaluation of currency, as seen in Germany in 1923 and Zimbabwe in 2008.
• 🔥 In extreme cases, hyperinflation can result in people using money for non-monetary purposes, like wallpapering houses or burning it for heat.
• 📈 The velocity of money, or the frequency at which money changes hands, increases during hyperinflation, causing prices to rise even faster.
• 💸 Hyperinflation erodes wealth, making savings worthless and forcing people to spend quickly rather than save, which further destabilizes the economy.
• 🛑 The end of hyperinflation often requires drastic measures, such as introducing a new currency or abandoning the old one, as seen in Germany and Zimbabwe.
• 📉 Depressions involve prolonged declines in GDP and have severe effects like high unemployment and falling prices, as seen during The Great Depression.
• 🌀 Stagflation, a combination of stagnant economic output and rising inflation, occurred in the U.S. in the 1970s due to supply shocks and low productivity.
• 💼 Government actions, like adjusting the money supply, can either worsen or improve economic conditions, depending on the timing and context.
• 🔍 Understanding the economy requires considering collective decisions and expectations of individuals, as these can significantly impact economic outcomes.

Q & A

What is hyperinflation and how is it defined?

Hyperinflation is an extremely rapid and out-of-control inflation, typically defined as a monthly inflation rate of over 50%, which translates to around 13,000% annually.

What caused hyperinflation in Germany during the 1920s?

Hyperinflation in Germany during the 1920s was caused by the government printing large amounts of currency (the Mark) to pay reparations after World War I, which resulted in a massive increase in prices.

Why did people in Zimbabwe start using U.S. dollars and other foreign currencies after 2009?

After hyperinflation rendered the Zimbabwean dollar virtually worthless, the government abandoned the currency in 2009, leading people to use U.S. dollars and other neighboring countries' currencies, which helped stabilize prices and boost economic growth.

What is the 'velocity of money' and how did it contribute to hyperinflation in Germany and Zimbabwe?

The velocity of money refers to the number of times a dollar is spent per year. In Germany and Zimbabwe, as people expected prices to keep rising, they spent money faster, increasing the velocity and further accelerating inflation.

How did hyperinflation end in Germany and Zimbabwe?

In Germany, hyperinflation ended when the government replaced the worthless mark with a new currency. In Zimbabwe, hyperinflation ended when the country abandoned its currency altogether and adopted foreign currencies like the U.S. dollar.

What are the potential effects of hyperinflation on personal wealth and economic behavior?

Hyperinflation erodes personal wealth, as savings lose their value rapidly. It also changes economic behavior, as people spend money as quickly as possible to avoid losing purchasing power, which further drives up prices.

What is a depression, and how does it differ from a recession?

A depression is a prolonged and severe downturn in economic activity, characterized by a significant fall in GDP and high unemployment. A recession is a less severe economic downturn, and the term 'recession' became more commonly used after The Great Depression to avoid negative connotations.

What role did the Federal Reserve play during The Great Depression, and why was monetary policy ineffective?

The Federal Reserve lowered interest rates to zero during The Great Depression, but continued deflation and falling prices made borrowing unattractive, rendering monetary policy ineffective. The economy only recovered after massive government spending during World War II.

What is stagflation, and what caused it in the United States during the 1970s?

Stagflation is a situation where economic output stagnates or declines while prices continue to rise. In the U.S. during the 1970s, stagflation was caused by supply shocks like rising oil prices and a decline in productivity, which the Federal Reserve exacerbated by increasing the money supply.

How did Paul Volcker end stagflation in the United States, and what were the consequences?

Paul Volcker, the Federal Reserve Chairman in the early 1980s, ended stagflation by cutting the money supply and raising interest rates dramatically. This caused output to plummet and unemployment to rise to 10%, but it also stopped inflation and restored economic stability.

Outlines

00:00

💸 Hyperinflation and Its Effects

This paragraph delves into the phenomenon of hyperinflation, using the historical examples of Germany in 1923 and Zimbabwe in the late 2000s. It explains how Germany's need to pay massive reparations after World War I led to an over-printing of the Mark, causing a drastic devaluation of the currency and skyrocketing prices. Similarly, Zimbabwe's rapid inflation in 2007 led to an annual inflation rate of 489 billion percent by 2008, rendering the Zimbabwean dollar nearly worthless. The paragraph highlights the economic confusion, the loss of savings for individuals, and the negative impacts on business funding and foreign investment due to hyperinflation. It also touches on the definition of hyperinflation as a monthly inflation rate over 50% and notes that while Zimbabwe's case was extreme, it was not the worst in history, with Hungary in 1946 experiencing an even more drastic hyperinflation.

05:02

📉 The Great Depression and Economic Downturns

The second paragraph discusses economic downturns, focusing on the Great Depression and the shift in terminology from 'depression' to 'recession' post-1930s to avoid negative connotations. It describes the aftermath of the 1929 stock market crash, which led to widespread panic and a halt in spending, contributing to the Great Depression. The paragraph explores the concept of a liquidity trap, where central banks' efforts to stimulate the economy through expansionary monetary policy are thwarted by consumers' and businesses' expectations of further price declines, leading to a cycle of falling prices and economic stagnation. It also covers the eventual recovery from the Great Depression, which was largely due to the massive government spending during World War II, rather than monetary policy. The paragraph concludes with a brief mention of stagflation, a combination of stagnant economic output and rising prices, and the U.S. experience with it in the 1970s, highlighting the challenges of managing economic expectations and confidence.

Keywords

💡Hyperinflation

Hyperinflation refers to an extremely high and typically accelerating rate of inflation, often exceeding 50% per month. In the video, hyperinflation is illustrated through examples from Germany in the 1920s and Zimbabwe in the late 2000s, where the value of money plummeted, causing prices to skyrocket and currency to become nearly worthless. This concept is central to the video's discussion of economic crashes, showing how excessive money printing by governments can lead to catastrophic economic consequences.

💡Inflation

Inflation is the rate at which the general level of prices for goods and services rises, eroding purchasing power. The video discusses how inflation can become hyperinflation when unchecked, as seen in historical examples like Zimbabwe and Germany. It explains that moderate inflation can result from increased money supply, but when output is maximized and money continues to be printed, inflation spirals out of control, leading to severe economic instability.

💡Velocity of Money

The velocity of money is the frequency at which a unit of currency circulates within the economy in a given period. The video explains that during hyperinflation, the velocity of money increases dramatically as people rush to spend their money before it loses more value. This behavior further accelerates inflation, creating a vicious cycle that exacerbates economic crises.

💡Deflation

Deflation is the decrease in the general price level of goods and services, often associated with reduced economic activity. The video highlights how deflation can lead to a liquidity trap, where falling prices cause people to delay purchases, further slowing the economy. It is mentioned in the context of The Great Depression, where deflation deepened the economic downturn, leading to high unemployment and reduced consumer spending.

💡Stagflation

Stagflation is an economic condition characterized by stagnant economic growth, high unemployment, and high inflation. The video uses the U.S. experience in the 1970s as an example, where a combination of supply shocks and poor economic policies led to this situation. Stagflation is particularly challenging because traditional tools for fighting inflation or boosting growth can worsen the other problem.

💡Depression

An economic depression is a prolonged and severe downturn in economic activity, marked by significant declines in GDP, high unemployment, and falling prices. The video references The Great Depression of the 1930s as the most notable example, discussing how it caused widespread economic hardship and required extraordinary government intervention, including massive spending during World War II, to recover.

💡Recession

A recession is a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters. The video explains that recessions are less severe than depressions but can still have significant impacts on employment and economic stability. The term is introduced as a modern replacement for 'depression' to avoid the negative connotations associated with the 1930s.

💡Expansionary Monetary Policy

Expansionary monetary policy involves increasing the money supply or lowering interest rates to stimulate economic activity. In the video, this policy is discussed as a potential response to economic downturns, such as during The Great Depression, where central banks tried to boost spending and investment by making borrowing cheaper. However, the video also warns that in some cases, like during a liquidity trap, this policy can be ineffective.

💡Liquidity Trap

A liquidity trap occurs when interest rates are low, and savings rates are high, rendering monetary policy ineffective in stimulating the economy. The video explains that during The Great Depression, the U.S. fell into a liquidity trap, where even with zero interest rates, people and businesses were reluctant to borrow or spend, leading to persistent deflation and economic stagnation.

💡Supply Shock

A supply shock is an unexpected event that suddenly changes the supply of a product or commodity, leading to sudden price changes. The video discusses the 1970s oil crisis and the die-off of Peruvian anchovies as examples of supply shocks that contributed to stagflation in the U.S. by disrupting production and leading to rising prices amidst a stagnating economy.

Highlights

Introduction to the concept of economic crashes by Jacob and Adriene.

Historical account of hyperinflation in Germany in 1923, where money was used for wallpaper and heating.

Explanation of hyperinflation as a result of Germany printing excessive currency to pay for World War I reparations.

Description of the astronomical inflation rate in Zimbabwe, reaching 489 billion percent in 2008.

Practical implications of hyperinflation, with prices doubling every 24 hours and businesses revising prices daily.

Mention of the largest denomination of currency ever issued, the hundred trillion dollar bill in Zimbabwe.

Definition of hyperinflation as a monthly inflation rate over 50%.

Comparison of Zimbabwe's inflation with the worst in history, Hungary in 1946.

Discussion on the negative effects of hyperinflation, including the erosion of wealth and the discouragement of saving and lending.

The role of government in creating hyperinflation by printing money to pay bills.

The concept of velocity of money and its impact on the cycle of inflation.

How hyperinflation in Germany and Zimbabwe was resolved by currency replacement and abandonment, respectively.

Introduction to the economic term 'depression' and its historical context post-The Great Depression.

Analysis of the causes and effects of The Great Depression, including the stock market crash of 1929 and its ripple effects.

Explanation of the liquidity trap and its role in economic downturns, including The Great Depression.

The role of World War II government spending in ending The Great Depression.

Introduction to 'stagflation', a combination of stagnant economic output and rising prices.

Historical account of U.S. stagflation in the 1970s due to supply shocks and the response by the Federal Reserve.

The impact of Paul Volcker's policies on ending stagflation in the early 1980s.

The importance of understanding and measuring the overall economy to avoid extreme economic circumstances.

The significance of individual expectations in the economy and their role in creating or avoiding recessions.

Conclusion on the importance of policies that address expectations and create confidence in the economy.

Transcripts

Jacob: I'm Jacob Clifford. Adriene: And I'm Adriene Hill.

Jacob: And today, finally, Crash Course, is gonna live up to its name. We're gonna talk

about crashes - economic crashes.

Adriene: Crash Course - we've been waiting for this!

[Theme Music]

Adriene: In Germany in 1923, people were doing strange things like using money to wallpaper

their houses and burning money for heat. What was going on? Had they all gone crazy?

Nope! In the early 1920's, Germany was in the grip of something called hyperinflation.

In order to pay massive reparations to the Allies after World War I, Germany printed

a lot of their currency - the Mark.

One result of all this additional money was higher and higher prices. By November 1923,

it took a trillion marks to buy one U.S. dollar.

There were one thousand billion mark notes in circulation. The mark was effectively meaningless.

A similar situation developed in Zimbabwe a few years ago. Starting in 2007, inflation

grew rapidly, like really really rapidly. By September 2008, the International Monetary

Fund estimated the annual inflation rate at 489 billion percent.

In practical terms, the Zimbabwean dollar lost 99.9% of its value between 2007 and 2008.

It's hard to even imagine what that looks like. Prices nearly doubled every 24 hours

and businesses revised prices several times a day.

In June 2008, The Economic Times reported that, "A loaf of bread now cost what 12 new cards did a decade ago."

The government issued currency in huge denominations to keep up with rising prices. The million

dollar bill, the billion dollar bill, and finally in 2009, the hundred trillion dollar

bill - the largest denomination of currency ever issued. The good news

was that everyone was a billionaire. But the bad news was that those dollars were virtually worthless.

Jacob: One definition of hyperinflation is when a country experiences a monthly inflation

rate of over 50% or around 13,000% annual inflation.

But believe it or not, Zimbabwe's recent inflation isn't unique, and it's not the worst inflation in history.

In fact the worst was in Hungary in 1946. Between July 1945 and August 1946, the price

level in Hungary rose by a factor of three times ten to the twenty-fifth. And yes, any

time you have to express your inflation rate using scientific notation, that's a bad thing.

Besides the obvious confusion over what prices to charge for things, why is hyperinflation so bad?

Well inflation, and especially hyperinflation, erodes wealth. In Zimbabwe, people who had

worked their whole lives and saved up for retirement, saw their savings just wiped out.

Extreme inflation also forces people to spend as quickly as possible rather than save or

lend, so there is no money available to fund new businesses. And all that uncertainty limits

foreign investment and trade.

So, hyperinflation is bad. But how does it happen? Let's go to the Thought Bubble.

Adriene: So, we're simplifying this stuff a lot. But the root of the problem in both Weimar Germany

and Zimbabwe was that the government was paying their bills by printing new money.

An increase in the money supply can have two effects. It can increase output or increase

prices or some combination of the two. Inflation starts when output is pushed to capacity and

can't rise much further, but policy makers continue to increase the money supply.

In theory, once output is maximized, the more money you print, the more inflation you'll get. Simple, right?

Well, that doesn't fully explain why Germany's or Zimbabwe's inflation rose exponentially.

Was the government really printing that much money? Not exactly.

After a couple years of doubling prices, people started to expect high inflation, and that

changed their behavior. Say you're planning to buy a new refrigerator, and you expect

prices to rise quickly. You buy it as soon as possible before the price has had a chance

to change. But with everyone following that logic, dollars start to circulate faster and

faster and faster.

Economists called the number of times a dollar is spent per year the velocity of money. When

people spend their money as quickly as they get it, that increases velocity, which pushes

inflation up even faster.

You get a vicious cycle of higher prices, which lead to expectations of higher prices,

which lead to higher prices.

The hyperinflation in Germany ended when the government replaced the worthless mark with

a new currency. Zimbabwe ended its hyperinflation by abandoning its currency altogether. Now,

its citizens use U.S. dollars or currencies from neighboring countries.

The good news is that prices have since stabilized and real GDP has begun to increase.

Jacob: Thanks Thought Bubble.

So, if you ever control a national economy, try to avoid hyperinflation. You might also

want to stay away from depressions.

A depression is kind of a hard thing to define, but basically it's when real GP falls and

keeps falling for a long period of time. This has all sorts of terrible effects like high

unemployment and falling prices.

Before the 1930's, economists use the term depression to describe sustained falls in

GDP. But after The Great Depression, economists started using the word recession for downturns

to avoid association with the 1930's.

I guess calling it a depression was just too depressing.

When the stock market crashed in 1929, it didn't just cause problems for stock brokers.

Everyone freaked out and stopped spending, and the economy ground to a halt.

Of course, that's not the only reason for The Great Depression. Actually, there's still

a lot of debate about the causes.

Anyway, when economies fall into deep recessions, there are more workers than there are jobs

and more output than consumers want to buy. So both income and prices fall.

Central banks can try to use Expansionary Monetary Policy to speed up the economy. So

for example, in the U.S. The Federal Reserve can lower interest rates. This encourages

consumers and businesses to take out loans, and hopefully, get the economy going again.

But if people start changing their expectations and anticipate further price declines, they'll

change their behavior in ways that work against the central bank.

Like, if you're planning to buy a refrigerator and you expect prices to fall, you're gonna

wait to get a lower price. But, if everyone follows that same logic, then spending declines

and so does the velocity of money.

That leads to further price declines and a vicious cycle of falling prices, which leads

to expectations of lower prices, which actually leads to lower prices. It also leads to layoffs

at the refrigerator factory and so on and so on and so on.

This is called a liquidity trap and some economists believe it's a worsening factor in economic

downturns including The Great Depression.

Adriene: Speaking of The Great Depression, after the initial crash of 1929, The Federal

Reserve dropped interest rates to zero, output and prices fell, and regular people started

to expect further price declines. Unemployment rose to 25%, and the average family income

dropped by around 40%.

This is...not great. Once interest rates hit zero, and prices were still falling, the central

bank was in a bind. Continuing deflation meant that borrowing money was a bad deal, even with no interest.

The money you pay back in the future would have more buying power than the money you

originally borrowed. This discouraged people from buying homes or cars and discouraged

businesses from borrowing to expand capacity.

In fact, getting out of The Depression took nearly a decade. And it wasn't really monetary

policy that put an end to it. It was the massive government spending of World War II.

Okay, you don't want hyperinflation. You don't want depressions. You also don't want stagflation.

That's when output slows down or stops or stagnates at the same time that prices rise.

So, stagnant economy plus inflation equals stagflation. Get it? It's a portmanteau.

Jacob: The U.S. experienced stagflation starting in the 1970's, after a series of supply shocks

including a rise in oil prices and, believe it or not, a die-off of Peruvian anchovies, which were important

for animal feed and fertilizers. This combination of events meant the economy couldn't produce as much.

The Fed tried to address this by boosting the money supply and cutting interest rates,

but output couldn't rise much because of low productivity and the oil shortage. So, all

that extra money just triggered inflation.

It got even worse when people began to adjust their inflation expectations. Businesses started to expect

costs to rise even further, so they laid off workers, and that put the economy back into a recession.

When The Fed boosted the money supply again, that raised inflation expectations even more.

This ended in the early 80's when a new Federal Reserve Chairman took over. His name was Paul

Volcker. He actually cut the money supply and raised interest rates dramatically.

Output plummeted, and unemployment reached ten percent, but prices stopped rising and

so did inflation expectations.

The economy gradually recovered, and Paul Volcker got the credit for ending stagflation.

So hyperinflation, deflation, depression, stagflation - they're all extreme economic

circumstances, but these extremes show us why it's so important to measure and understand the overall economy.

In some cases, government action or inaction made things worse. And in other cases, the

government helped the economy get back on its feet.

But it's important to keep in mind that the economy is made up of collective decisions of individuals.

It's people like us, our expectations matter. If enough people fear a recession, they're

gonna decrease their spending, and that's gonna cause a recession.

Adriene: Next week, we're gonna look at different economic schools of thought. But regardless

of philosophy, policies designed to steer the economy need to address expectations and

focus on creating confidence.

Jacob: Thanks for watching. We'll see you next week.

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Thanks for watching! DFTBA