How does a new currency stop inflation?

Question

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?

In: 712

Answer 1

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.