Thursday, February 23, 2012

Macroeconomics Research Proposal

Research Proposal on Macroeconomics: Hyperinflation in Romania

Sometimes inflation rates get completely out of control, which in extreme cases can lead to hyperinflation. Hyperinflation is very rapid inflation reaching 50, 100, 200 or even more percent per year. Hyperinflation is usually described in monthly terms and starts at 50 percent monthly inflation, even though there is no common definition. During the hyperinflation the prices rise very fast at an ever-accelerating rate so that money cease to be useful as a medium of exchange and a store of value. Hyperinflation is many cases in history was extremely difficult to manage. When people receive money they rush to spend them as soon as they can. People who posses goods become more and more reluctant to accept the depreciating money until no one wants to accept money on any terms.

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Hyperinflations do not occur very often, however, there are some documented examples of hyperinflation throughout the history. Hyperinflation occurred with continental (currency of that time) during the American War of Independence and the rouble during the Russian Revolution. Severe hyperinflation occurred in Germany in 1923 reaching 332 percent monthly; in Greece, Hungary and China in the years after the Second World War. Most of the hyperinflations in history were accompanied by a very unstable political situation, often wars and revolutions. Hyperinflations were usually caused by great increases in the money supply – new money were printed to give the governments purchasing power that they could not obtain from the taxes. In Serbia, for example, during 1993-1994 the inflation rates were absolutely mind-blowing – 302 million percent monthly. In January 1994, prices were rising faster than 100 percent an hour.

During the 1990s hyperinflation occurred in Angola, Argentina, Belarus, Bosnia-Herzegovina, Brazil, Georgia, Mexico, Nicaragua, Peru, Poland, Turkey, Ukraine, Yugoslavia, Zaire and Zimbabwe. Romania is one of the post-Soviet countries where hyperinflation took place during the 1990s.

The regime of Nicolae Ceausescu fell in Romania in 1989 and since then the new government tried to coupe with the difficulties that arose on the way of democratization of the country and privatization of the sate property. Many lands were returned to the original owners, some state industries were privatized and government subsidies to industry were eliminated. However, the progress was not very fast, in addition to local difficulties, there was the World economic slowdown.

The private sector in Romania was continuously growing since 1989, but since 1996 government spending was consuming all the gains. During the 1990s, constant price increases and food shortages led to civil unrest. For many Post-Soviet countries the 1990s with the movement from planned economy to market economy were difficult times and Romania was not an exception.

The economic recession was marked by a dramatic 25 percent decrease in economic output from 1990 to 1992, deterioration of the labor market and high rates of unemployment. The hyperinflation in Romania has lead to deteriorating living standards and financial scandals. The level of corruption in the country was impressive. Romania enjoyed a temporary export-fueled recovery from 1993 to 1995, but then very restrictive economic approach returned it back to a deep economic and financial crisis. Macroeconomic indicators deteriorated dramatically.

The highest denomination before 1996 was 10,000 Lei. By 2003 it was 1,000,000 Lei. In the 2005 currency reform, 1 Leu was exchanged for 10,000 old Lei.

Only in the 2000 the Romanian economy was finally stabilized. Since then it has been constantly growing 5.3 percent over the past five years despite a slowdown in the global economy. In 2004 the national economy impressively reached 8.3 percent and GP finally grew above the level of 1989. Because of the fiscal discipline in the recent years, strong economic growth and the accompanying favorable developments in budget revenue, the government has been able to reduce the budget deficit to below the critical for European Union 3 percent mark.

In 2005 the government launched currency reform – redenomination of the currency at a ration 10,000 to 1. Flat tax of 16 percent was introduced as of 1 January 2005. Many big national enterprises were privatized. Romania has complied with key demands of the EU and the IMF and on 6 October 2004 Romania received the status of a functioning market economy. Romania joined the European Union in 2007, and its currency is now pegged to Euro.

The largest denomination issued was 1 Million lei before the currency revaluation on July 1, 2005 which made 10,000 “old” lei equal to 1 “new” lieu. As of January 1, 2008, the “old” lei notes can still be redeemed for reevaluated notes at some Romanian National Bank branches.

Hyperinflation usually happened in very difficult, unstable times – when the empires were falling apart, governments collapsed, during after-war times or social unrests. Most of the hyperinflations were accompanied by great increases in the money supply. If the government is in control of the money supply, it can print as much money as it needs to cover the expenses. It leads to fiscal chaos and social collapse, mistrust, despair and cynicism in society.

It is clear that high inflation rates over a period of time do not mean the inevitable or even the likely appearance of hyperinflation. Hyperinflation is extremely difficult to manage, however, it is possible, as Romania has proved. After the hyperinflation, the price system can be restored only by repudiation of the old monetary unit and its replacement by a new unit. This of course destroys the value of monetary savings and of all contracts specified in terms of the old monetary unit, but it is a necessary measure.
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