How can we end hyper-inflation?

The causes of all episodes of hyperinflation – including Zimbabwe –
have been the same. An already large budget deficit in a country with a
long history of high inflation suddenly increased dramatically – as a
result of war, the collapse of the international price of an important
export or a sharp rise in the interest rates applicable to foreign
debt.  Lack of access to foreign funding meant that the increased
deficit was funded by the central bank which printed money to do so and
prices soared as a result.

The subsequent spiraling of inflation to ever higher levels is typical
of all hyperinflation episodes.  But the level that inflation has
reached in Zimbabwe — some 231 million per cent at the latest official
measure in July 2008 and almost certainly very much higher today — is
extreme by comparison to almost all modern examples of hyperinflation. 
The peak of year-on-year inflation was usually in the thousands; few
countries have experienced inflation in the millions.  Moreover,
hyperinflation in Zimbabwe has now persisted for an unusually long time
of almost 2 years, whereas in most other countries it lasted for a few
months or perhaps a year.

To end hyperinflation in Zimbabwe, the Budget deficit must be slashed
as it was in other hyperinflation countries.  As hyperinflation
inevitably brings about economic collapse (economic activity has fallen
more than 40 per cent in Zimbabwe) and the erosion of the real tax
base, cutting the deficit can occur only if government spending is
slashed.  This is extremely difficult at a time of economic collapse as
it usually involves making significant reductions in welfare payments
and reduced employment in the public sector.   Central bank funding of
the reduced deficit must also end.  In most instances of hyperinflation
this has required separating the activities of the central bank from
the control of government. 

Success in combating hyperinflation is seldom followed by a swift
improvement in domestic activity.  This is because the very large
reduction in the fiscal deficit necessary to end hyperinflation
initially causes domestic demand to contract.  Thus, many countries
have experienced false starts on the road to ending hyperinflation,
either as a result of too timid initial policy action or an inability
to stay the course.   But eventually the extreme hardships caused by
hyperinflation and its accompanying further economic collapse resulted
in widespread support for the necessary tough policy adjustments, and
the policies necessary to end hyperinflation were successfully
implemented.

Despite the current hesitant steps towards establishing a government of
national unity in Zimbabwe, it is doubtful that the political support
for the necessary policy adjustments — notably a slashing of the budget
deficit and the ending of central bank funding of the remaining deficit
— exists at this stage.  If such support could, however, be achieved, a
possible silver bullet' to ease the pain of the necessary adjustments
may be forthcoming in the form of foreign aid and renewed access to
foreign borrowing.  Foreign funds could help stabilise the exchange
rate and at the same time reduce the magnitude of the deficit reduction
required once central bank funding of the deficit has ended.  In such
circumstances, hyperinflation in Zimbabwe could end quite quickly,
providing a necessary platform for future economic recovery and growth.
– The Brenthurst Foundation