eli5: how do some countries get to the point of having crazy inflation?


Turkey and now Argentina have inflation around 70%

How does this happen? And how can they cope with similar interest rates by their central bank?

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Hyperinflation happens when people lose confidence in the currency which causes more hyperinflation.

Let’s say you buy and sell vegetables, this has slim margins. Normally you add 20% on to your sale price and make a 10% profit after costs.

However the last time you did that, over winter (when there was nothing to sell), elevated inflation over the winter caused your saved money to devaluate more than 10%, so this year you could only afford to buy less than last year when you get new stock.

Suddenly you, and all your fellow sellers think “I have to raise prices because I can’t have this happen again next year” – so you bump prices by 20% overnight.

This causes a feedback loop, the shop who buys your vegetables puts prices up 40%. Every goods/service provider starts to worry “I might end up losing money due to inflation, I have to increase my margins to maintain profitability.” Every consumer starts to think “I can afford potatoes this month, but I might not be able to next month”, so people start spending all their money the moment they earn it. The sudden surge in demand pushes the prices up further. Workers start to demand daily pay increases to keep up with basics like food and rent, companies have to raise prices to keep paying workers. The government has to start printing money to be able to pay public sector workers and everything else the government pays for since it can’t keep up with the rising prices via taxation. This adds fuel to the fire with extra money supply.

Foreign companies start to not want to trade in your currency, so start charing huge 2-3x cost premiums for imports because its going to be really difficult for them to exchange the currency back to their currency.

Inflation is now completely out of control.

Actual inflation is a measure of how much new currency is being introduced. Which has been insane, world wide, for a very long time now. Which is why we don’t care about it.

What we do care about is the CPI or consumer price index. Basically, “this is the stuff people need money to have, how much does the money get them?” So like rent, utilities, groceries, vehicles, etc. The stuff people spend money on.

We frequently use this as a measure of inflation, because it’s more accurate to how inflation is affecting the common person.

So when we say 8.5% inflation in the USA. That doesn’t mean there’s 8.5% more dollars in circulation. There’s probably 20% something more dollars. But the buying power of the dollar is 8.5% less. So if a loaf of bread cost $1. Now it costs $1.09.

How the prices that determine the CPI change is a complicated economics problem. Because there’s nothing stopping the baker from saying “that loaf now costs $2.” Well nothing other than the baker across the street selling the same bread for cheaper and stealing business.

But when all the baker’s agree that the price of flour and yeast is going up they gotta raise their prices.

Eventually you’ve got some folks somewhere in the supply chain saying “I don’t think inflation is stopping, we better charge more pre-emptively.” Or basically they’re losing confidence in their currency. They don’t think it will hold value so they’re going to get as much as they can for it.

This is what’s happening in Turkey. It’s what happened during the great depression. And generally it’s pretty bad. You need to have confidence in your medium of exchange or else it becomes worthless.