Hyperinflation is often viewed as a phenomenon where a currency is repudiated by its holders who refuse to hold the currency in any nominal form i.e. a collapse in demand for the currency. This is a reasonable but nevertheless incomplete explanation of how hyperinflation plays out in reality in modern capitalist economies.
In a world of interest-bearing money, high and monetised fiscal deficits by themselves are not reason enough for deposit-holders to repudiate a currency. If the central bank maintains a nominal interest rate at the short-end that compensates money-holders for the fiscally-created inflation, then there is no shortage of willing holders for the currency (in an interest-bearing form such as deposits). By the same token, the central bank must adjust lending rates at the short end (the equivalent of the ECB repo rate) to avoid an explosion in private credit growth fuelled by negative real rates. For each chosen fiscal regime, there is a monetary stance that can avert hyperinflation. However as fiscal deficits increase beyond a point, the equilibrating monetary stance consists of a nominal lending rate that must necessarily crowd out the private economy.
Understandably, most central banks are reluctant to raise rates in such a dramatic fashion. Instead they raise rates but only to the extent that real rates remain negative but not negative enough to motivate a wholesale repudiation of the currency. So long as real rates are maintained at a small negative rate, deposit-holders usually treat it as a “safe asset” premium that they are willing to pay. An environment that enables hyperinflation as a possibility is triggered when these real rates turn significantly negative. Significant negative real rates encourage holders of the currency even in its interest-bearing deposit form to shed their holdings of the currency when faced with constant and high real losses, losses that cannot be justified simply on account of the safety premium of the nominal asset.
But this repudiation of money is not the core driver of hyperinflation as we know it in the modern world. What almost always accompanies this repudiation is a sustained barrage of borrowing at the artificially low nominal and real rate enforced by the central bank or government (directly or indirectly via banks). Until late in the Weimar inflation, the Reichsbank kept discount rates as low as 5% (see table here) , a free lunch that was taken full advantage of by bankers and industrialists to lever up and invest in any real assets they could find. As Adam Fergusson notes, “new borrowings from the Reichsbank…from whom commercial enterprises could obtain credit at very low discount rates even at the height of the crisis in 1923, were automatically written off” due to the ludicrously negative levels of real interest rates that were enabled by the Reichsbank. The same was true in Zimbabwe where the central bank not only maintained one-year treasury bill rates at a level well below the inflation rate (enabling monetisation of deficits at a subsidised rate) but did the same with prime and bank lending rates which led to the predictable explosion in private sector credit expansion (see data here for a sample month).
Once real rates become sufficiently negative, credit growth explodes and the positive feedback loop of ever higher inflation fuelled not just by currency repudiation but by active exploitation of the banking and central bank discount window to access essentially free loans is set in motion. In other words, hyperinflation in modern capitalist economies is characterised not just by a collapse in the demand for deposits but an explosion in demand for loans at the “free lunch” level of nominal interest rates enforced by the central bank. Many commentators have recently asserted that Iran is in the midst of hyperinflation. Whether this is actually the case is still unclear – the current bout of higher inflation and prices may yet turn out to be temporary. But what makes hyperinflation possible is clear. Both lending rates and deposit rates have been set at levels well below the inflation rate for years now, a situation that threatens to descend into farce with inflation at above 50% per month and bank rates at only 21% per annum.