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Course: Macroeconomics > Unit 4
Lesson 3: Definition, measurement, and functions of money- Money supply: M0, M1, and M2
- Functions of money
- Standard of deferred payment and legal tender
- Commodity money vs. Fiat money
- When the functions of money break down: Hyperinflation
- Hyperinflation
- Lesson summary: definition, measurement, and functions of money
- Definition, measurement, and functions of money
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When the functions of money break down: Hyperinflation
To illustrate what the functions of money are, it can help to look at circumstances where those functions break down. Hyperinflation, in which prices of things increase really really fast, is one such example. Created by Grant Sanderson.
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- Neat video! On a lighter vein, was it intentional that the font colours used are only the colours on the Brazilian flag?(19 votes)
- At8:45, the URV was a temporary currency and its transformation by the " cruzeiro " was through the real exchange rate that was anchored in dollars. The great success of the URV was having removed the inflationary memory of the people and also the establishment of the real exchange rate with the dollar helped to slow inflation , since about 20 % of the products consumed in Brazil were foreigners.(10 votes)
- Good point, I liked this video because he talked about the psychological aspect of money. Just like you said, it erased the memory and gave people confidence again in their money. It shows how much the monetary system is based on confidence in the system. I thought money was just all about numbers and that it was boring but it is actually complex and can be studied from many different points of view.(10 votes)
- Why wouldn't the prices in URV also increase the same way the cruziero did?(3 votes)
- Think of it like if you were one of the 4 people in the initial simplified economy example. If the URV value of whatever you buy from the other person doesn't change, why would you sell your services/goods for a higher URV? There is just no incentive for doing so. In other words, people participating in the economy gained nothing by selling goods at a higher URV so there was no pressure on it increasing.(6 votes)
- So the URV evolved into what we know today as R (The "Real"), am I right?(3 votes)
- Yeah. On July 1, 1994, Real was introduced at parity with URV (R$ 1 = 1 URV)(7 votes)
- Hello, I,m Syaed from Malaysia. Ihave question regarding the money topic. Can you explain when is it money really be used in the world? and Store of value is really effective during rapid inflation right, so is it unit of account will no longer be exist. From here I want to know why the unit of account no longer be used?(3 votes)
- I imagine the psychology of hyperinflation is a relevant issue for behavior economists, isn't it?(2 votes)
- Of course it is, in fact many expectation theories have been present before the school of behavioral economy. Check the "hipothesis of adaptive expectations" or a younger "rational expectations hipothesis".
What is more, the expectation theories have been tested and are in different ways implemented by central banks to get rid of inflation problem by managing inflationary expectations.(2 votes)
- Hello from Turkiye! We have 60% inflation, not doing very well so far. My question: I have been watching the level of prices and the currency rate, and I was wondering about inflation. So we've been saving that inflation is the general increase in prices. Which also means that the currency of the country is getting weaker compared to other currencies. Does this mean that even if we have inflation, the prices in the currency of another country should remain constant? This is not the case for my country. The prices even when converted to dollars have increased dramatically. Does this mean that our inflation rate or currency rate is calculated with an error?(2 votes)
- Hi people sorry for asking this basic question but iam curious about how they introduce the URV into the market?(2 votes)
- So in a country like Zimbabwe, would you say the cruziero is similar to the Bond note(1 vote)
Video transcript
- [Voiceover] So in the last video, I was talking about
various functions of money. The first was that it's
a medium of exchange. If you want to trade for things, typically you give someone money and they give you the thing,
rather than trying to barter. Trading apples for oranges
or horses for legal services or things like this. The second is that it's a store of value. If you hold onto your money, it's value isn't just going to evaporate. Whereas if you hold
onto a bunch of apples, as they rot and degrade away
they're no longer valuable. And the third is that
it's a unit of value, it's a way that we
assign a number to items to say how valuable is this? That something that's 100 dollars is about twice as valuable as
something that's 50 dollars and having this sort of
number system for value, makes it a lot easier to
compare different goods. What I want to do in this video
is talk about a circumstance where these functions of money breakdown, and what I'm thinking of is
the case of hyperinflation. Hyperinflation. Now inflation means that
prices are increasing. So if you look at the
price of a carton of milk and let's say it's one dollar one day, it would be if it increases later on. So maybe it's $1.20, and
if the prices of all goods as a whole in the economy
tend to be increasing, it's not just milk is getting
rarer or something like that, it's called inflation, and
hyperinflation is basically a case where this is just
happening really, really quickly. So Sal has some videos
talking about inflation itself and the root causes and I'm
not going to go into that here. In this case, all you
need to know is the idea that prices increase
really, really quickly. And just to give an example, there's been lots throughout history and this isn't necessarily
the starkest example, but it'll be interesting to us in terms of what the ultimate solution was. Brazil in the 1980's and early 1990's, so 1980's and a little
bit into the 1990's, was undergoing very fast inflation, and to give a feel for the kind
of rates we're talking about at it's peak it was around 80% per month. And what this means is that every month the prices of general goods, a carton of milk, or a chair, or the price of land, things like that, would generally get
multiplied by a factor of 1.8. Now if you compound this over a full year and every month it's increasing by 1.8. So you multiply it in 12 different times. This is actually an increase by more than a factor of 1,000. So that would mean if you
have something that costs 100 dollars one day, it's
gonna cost after a year, if inflation increases at
this rate, 100,000 dollars. So the annual inflation
rate, the percentage per year would actually be 100,000% per year. Now there have been
inflation rates in history faster than this but this
is still really insane. And just to get our minds around what it might feel like to
be in en economy like this let's just imagine a
super simplified economy where you have only four different people. So we'll have four different people here, and let's say let's name these guys, person A, person B,
person C, and person D. I guess I should give person D some eyes. And let's say it's the case that the way that this economy works is that A buys all of his things from B. So A will give B maybe let's
say it was 50 dollars a month for all of his things. And B in response gives A things. And then B, she buys all
of her things from C, and she pays that same amount. She takes the full 50
dollars that she earned and she gets various things
that she needs in life from C, and then similarly C buys
all of his things from D. And let's say just for simplicity
that it's the same amount and then D buys all of her things from A. And this is obviously way
over simplified as an economy, but I do think it gives a good feel for the cyclic nature of things. That one person's income is
another person's expenses. Now let's say that you're in a hyperinflationary circumstance where you have this 80% increase per month. Something that costs 100 dollars one day, a month later is gonna cost 180 dollars. If you were person A and you knew that prices of things are gonna increase, you might in anticipation
raise your prices as you're selling things to
D you might raise your prices and say well actually today
I think I'm gonna charge you 51 dollars because things
are getting more expensive so I want to earn more. And then D in response says
geez now I have to pay more so I'm gonna have to charge my customer C a little bit more as well. I'm gonna charge him 51. And then C says I'm gonna
have to charge my customer more as well in order to make ends meet. And everybody has to increase
their prices to keep up. And when the next day rolls around, no one wants to be the last
one to increase their prices so maybe this time B says oh yesterday I had prices increase on me, and I was earning less but
then I had to spend more, so today I'm gonna make sure
that I'm not the last one so I'm gonna increase my prices. I'm gonna increase them maybe
she says 53 just to be sure. And then A, noticing the
prices have increased has to keep up as well
so he needs to do this. And of course the cycle continues. Everyone in order to make ends meet has to increase their prices. So this circumstance where
you're changing your prices in anticipation of future change is what distinguishes hyperinflation in a qualitative sense
from regular inflation. I think there's a quote
that I really like. I think it's by Napoleon. It's "Quantity sometimes has
a quality all of it's own." And that's definitely the
case with hyperinflation because ordinary inflation, ordinary inflation like
let's say that which the United States dollar is
undergoing around these days typically ends up being around 1% to 3%, it depends, but 1% to 3% per year. So obviously this is dramatically less than 100,000% per year. But the idea is that
hyperinflation isn't just that it's a much bigger number. It's that there's a psychological
difference in the society where people are starting
to anticipate changes and change their prices accordingly. And this is how things
spiral out of control. This is how you get insane
numbers like 80% per month. Now why am I talking about this? This is about functions of money. Why am I talking about hyperinflation? Well let's take a look at
these functions of money and analyze whether or
not they still apply in a hyperinflationary economy. Now medium of exchange, money is still being used
as a medium of exchange. People are still buying things
using the national currency. So that one stays intact. Store value however, this
one clearly breaks down, because if you're holding on, let's say you have 100
dollars in savings today and then you know that
things are increasing by 100,000% per year it's gonna be 1,000 times less valuable after a year. So most certainly it is no
longer a store of value. And you could argue by the way that even in an ordinary
inflation circumstance money doesn't quite serve this
function as a store of value because even if prices are increasing only very slowly every year, it's still the case that a
dollar that you hold on to, you're not investing it or
collecting interest rate, slowly degrades over time. So you could argue that even
in an ordinary circumstance, store of value doesn't quite
apply due to inflation. But let's consider this
third function of money. Unit of value. If you're living in this
hyperinflationary circumstance the numbers that you're seeing no longer really correspond to value. Right, if you had something that originally was 50 dollars of value, and then after a year it's 50,000 dollars, you're not thinking of
the value of that thing in terms of the national currency. And often throughout history, people started thinking of
the value of various items in terms of another nation's currency. So if your own currency, all
of the numbers are fluctuating very rapidly and they're
increasing very rapidly, you look for a more stable number. So if you want to know how much should a carton of milk cost? Rather than thinking in
your own nation's currency maybe so oh it's analogous
to 1.5 British pounds or something that seems
a little bit more stable. So this unit of value
property no longer applies in the case of hyperinflation. And notice that that's distinct. That is something different between hyperinflation and regular inflation. Because even in let's say
the United States these days, even though prices slowly increase, we still think about the value of things in terms of the U.S. dollar. This still serves as our unit of value. So that's one of the core distinctions. I think that's actually very important for what distinguishes
hyperinflation from inflation in a qualitative sense. Now why did I choose to think
about Brazil's hyperinflation as opposed to a lot of other ones, like post World War I Germany, or Zimbabwe or places where you've had even faster rates of hyperinflation. And basically because there
was a really interesting way that they went about solving it. Any solution has to address
the underlying causes of inflation and this video
isn't necessarily about those. So there's gonna be things
associated with making sure that the government is
still fiscally responsible and balancing budgets and things like that but a different component
that needs to be addresses is that money is no longer
serving as a unit of value. So one really interesting
thing that Brazil did in the early 1990's is they introduced a fake currency that they called the URV, for unit of real value,
or really it was in the, really it's the Portuguese
words for these, I think Unidade Real Valor, I don't really know Portuguese but the initials are the same, URV. And what they started doing is saying okay everybody continue paying
in the national currency which at the time was the crucero I'm probably pronouncing
that wrong but crucero. So they're still paying for everything in terms of their crucero. That's serving as the medium of exchange but what they did is they said every time that you're pricing something please list your prices not
only in terms of the crucero. In this case I've written
dollars, so let's pretend this says 53 crucero, 51
crucero, things like that. In addition to listing it
there, please also list the price in terms of units of real value, which in this case might
have been like, 50, because everything started off being 50. And they loosely pegged
this fake currency, this made up number, to the U.S. dollar. So over time even though the
price in terms of cruceros was increasing, it might be
53 cruceros, and then 55, and then everyone's paying more and more in terms of cruceros, the unit of real value
would stay the same, because it had no reason to increase. It's just a made up number
that you're pegging on things just to keep straight how
valuable things actually are. So what they're basically doing, is they said currency, our current money, is not serving this
function as a unit of value so let's just make up
a new thing that does. So at this time the
crucero was still serving the function as a medium of exchange. Nothing was really
serving the store of value except for hard goods like land. And then this made up number was serving the function as a unit of value. And over time, as people
started getting used to the idea that you go out to buy milk and you know that it's gonna be let's say one unit of real value, and then you just have to look up, okay how many cruceros corresponds to a unit of real value today? People start actually thinking
in terms of this number even though they're paying
in terms of another. And after this had kind of set into the psychology of the society, and of course while certain
fiscal responsibility on the side of the government
was being addressed, they made the switch to make units of real value an actual currency and printing money in terms of these URVs and abandoning the crucero, and telling people they
could trade in their crucero for these URVs and that was
gonna be the new currency. And because people were used
to the idea that this was a stable number and they
were thinking of prices in terms of this stable number, and because the underlying
causes of inflation had started to be addressed,
it actually worked! And the number would stay stable and instead of having
prices increase 80% a month it decreased drastically to something that's much closer to a healthy economy's level of inflation. And I think that's
really powerful actually that you can recognize that
one of the functions of money has broken down and then
address it specifically and invent something new that
addresses that same function. Sure it's a made up currency, it's just a number
you're assigning things, but it's serving this function. And then apply that in a very real setting on the scale of an entire nation and solve an economic problem. So hopefully this sheds
a little bit of light on why it might be useful to break down the functions of money in terms of these three different categories. And with that I will see you next video.