Great Depression vs Hyperinflation

The same loan contract ruins the borrower in one case and the lender in the other

Run the Fisher equation once and the asymmetry is unmistakable. The real interest rate is roughly the nominal rate minus the inflation rate, so take a fixed loan written at a nominal 5 percent. If prices fall 10 percent a year, the real rate is 5 minus negative 10, which comes to 15 percent, and the borrower repays in money that buys far more than the money he received. Farmers and firms who had borrowed before the slump were crushed by contracts they signed in good faith, and every default pushed another bank closer to failing. Now write that same 5 percent loan during a hyperinflation running at 50 percent a month. Prices climb by a factor of roughly 130 over a year, so the real rate is enormously negative and the lender is the one wiped out. Identical contract, opposite victim, and that flip is the whole comparison. Deflation carries a second sting that fast inflation does not. Nominal rates cannot fall far below zero, since anyone offered a negative return can hold currency instead, so a falling price level puts a floor under the real rate exactly when an economy needs it lowest. A central bank can cut its policy rate to zero and still leave borrowing at 10 percent in real terms, which is the liquidity trap. Practice the arithmetic at /calculate/real-interest-rate and see /glossary/liquidity-trap.

Both are monetary disasters, and the money supply moves in opposite directions

In a depression the quantity of money contracts without anyone choosing to contract it. Failing banks destroy the deposits on their books, nervous households hold currency rather than accounts, and surviving banks sit on reserves rather than lend, so broad money shrinks even when the monetary base holds steady. Put a number on that last channel. With a 10 percent reserve requirement the simple money multiplier is 10, but if banks voluntarily hold another 10 percent as excess reserves, the effective ratio becomes 20 percent and the multiplier halves to 5, so the same base now supports half as much money. Hyperinflation is the mirror image with a budget behind it. A government unable to tax or borrow enough has its central bank buy the debt, the base explodes, and because people spend money the moment they receive it, velocity climbs too, so prices outrun even the growth in money. Written as the quantity theory, MV equals PY, a depression has M and V both falling while a hyperinflation has both rising. The cure follows from that: runaway inflation is a fiscal problem wearing monetary clothes, and it ends when the deficit stops being financed with newly printed money. See /glossary/quantity-theory-of-money and /glossary/excess-reserves.

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