How does a new currency stop inflation?

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Apparently, every time a currency falls victim to hyper inflation, sooner or later the country is gonna introduce a new currency to solve the problem.

But how does that help? If let’s say the us dollar lost 90% of it’s value every day, and you introduced a new currency, one of which is equal to 5 us dollars, wouldn’t that new currency, as it’s value is bound to the dollar, instantly lose 90% of it’s value every day as well?

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18 Answers

Anonymous 0 Comments

I’m from Brazil, and we’re a success story in beating hyperinflation. No, just replacing the currency is not enough. We replaced the currency and adopted a number of economic policies, including cutting government spending and raising interest rates, which are the most common tools for countering inflation.

But (in my opinion) the most ingenious part of the plan was the realization that hyperinflation is psychological. Businesses start preemptively raising prices because they know prices are going up anyway, as well as raising wages every month to keep up. This creates a snowball effect

What the government did was create a symbolic currency called URV (real value unit). All prices were shown in URV and you converted that to Cruzeiro Real when you paid. I was 9 years old, I remember going to the ice cream shop and seeing the prices in URV. So, for example, if 1 URV = CR$ 2000, then if the ice cream cost 5 URV, I’d pay CR$ 10,000 for it.

_But I knew that an ice cream cost 5 URV._

That was the intended effect. People had months to get used to what things actually cost, regardless of their value in the old currency. After the transition period, the government introduced the new currency and called it real. One real = one URV. It was a Sunday. Everybody who woke up and went to buy bread at the bakery knew what kind of prices to expect.

EDIT: As /u/TwentyninthDigitOfPi pointed out, one important aspect of this scheme was that the conversion rate from URV to Cruzeiro Real was constantly adjusted according to inflation. That way, even though prices continued to rise in CR$, in URV they remained constant.

Anonymous 0 Comments

Short answer is a lot of the effects are related to confidence, or lack thereof, in a currency. changing the currency in question and using a new one (especially one thats backed by outside agency or currency) can break the cycle somewhat by restoring confidence in the currency.

however, your right in that this doesn’t solve any underlying issues that were driving inflation in the first place, so ON ITS OWN, its just a band aid or a convenience of taking all the zeros off the notes. However, just like a band aid, it can give you some breathing space to actually enact those extra reforms.

normally, you will find this new currencies are part of a wider package, rather than the sole element being changed.

Anonymous 0 Comments

Hyper inflation often happens when monetary policy lets the government issue a lot more currency without any underlying backing for the value of the money being issued, devaluing the money in circulation, ending up in a feedback loop.

The triggers for the government issuing more currency can vary, such as trying to alleviate some other major economic crisis, but that’s the general idea.

When the government eventually throws in the towel on the old currency there is often a period where the country will adopt some third country currency (Eg US dollar) for transactions while they try to reset their systems. As they can’t print more US dollars/ Euros/Whatever everyone is stuck with a currency that’s not hyper inflating, which often brings its own pain, but a better type of pain than hyper inflation.

When the country has sorted out whatever shitshow led to the hyperinflation to start with they’ll start issuing their own banknotes again, but often backed by another currency to force stability. They do this by buying currency reserves in the backing currency (Eg massive quantities of U.S. dollars/ Euros / etc) and then issuing their own notes against those at a fixed rate – called pegging the currency. This forces stability on the newly issued currency as it forces limits on how much currency can be issued, provided monetary policy isn’t changed.

This idea of currency backed by another is quite common – eg a lot of the Middle East and some of Asia has their currency set up pegged to the US dollar, sometimes with a mix of Euros in the overall valuation.

It makes it tougher for some monetary policy things – eg interest rate adjustments, but the trade off gives better currency stability.

Anonymous 0 Comments

If the value of a currency is bound to the previous currency then what you are describing is “redenomination”, not really a “new currency”. In that case the inflation of the old currency does affect the value of the new notes as you would think.

To address your broader question, yes introducing a new currency isn’t going to solve inflation. You would also need to address the underlying problems with the economic system that lead to the inflation in the first place. Zimbabwe for example had several massive redenominations between 2006 and 2009 that didn’t stop their financial disaster.

Anonymous 0 Comments

New currency is like throwing a bandaid on an open wound that’s infected. Yes, it stops the bleeding, and from the outside, it can seem like everything is fine. But the problem is still there destroying things under the surface and without policy changes (aka antibiotics in this metaphor) things will continue to fester and eventually you lose the limb if left untreated.

Anonymous 0 Comments

It doesn’t. It’s completely cosmetic, real effects if any come from stopping futile attempts to print yourself out of bankruptcy. Usually, these two things are attempted at the same time. Stopping the printers is the real policy change. New bills are the cosmetic display of that policy change.

Anonymous 0 Comments

It doesn’t.

But once you have hyperinflation you can’t possibly use the old money anymore because it’s all junked up. So whatever else you do has to include making new money to start over.

Anonymous 0 Comments

It doesn’t. Argentina did it 4 times since 1970 and continues with 100% inflation per year

Making new currency only helps writing less zeros, at least for a few years

Anonymous 0 Comments

If let’s say the us dollar lost 90% of it’s value every day, and you introduced a new currency, one of which is equal to 5 us dollars, wouldn’t that new currency

Well yes if the USA insists on the new currency being pegged to the old one. But that’s not normally what happens.

On the face of it, it’s supposed to be a new currency independent of the old one. But in actuality, the fact the new currency comes from the same suppliers means that trust in it is largely lost. Creating a new currency also doesn’t address the original reasons for hyperinflation.

Usually post hyper-inflation, the country may choose to adopt the currency of another country with a more stable currency. In effect, they not only lose control of the currency used in their economy, but the provision of the new currency normally comes with terms and conditions in favour of the supplier country.

Anonymous 0 Comments

It’s just psychological.

Inflation is stopped when people and businesses decide that their currency is a good investment and stop spending it all on the days they get their wages fearing it will lose value otherwise.

The easiest way for a government to do that is to raise interest rates. Now spending becomes more difficult (loans are more expensive) and holding currency becomes more profitable (savings accounts pay more).

This is pretty much exactly what’s happening all over the western world now. First people spent too much and now central banks are raising interest rates.

But it’s not always as simple as that. In countries that depend on import a lot, a trade balance can also have a big effect on currency rates and inflation. But that’s just economics nuances that to be honest have to looked at case by case.