In 1966, Milton Friedman wrote, as he often did, some memorable lines that have entered the lexicon of economic quotables. As Friedman correctly put it in a book chapter titled “What Price Guideposts?”: “Inflation is always and everywhere a monetary phenomenon, resulting from and accompanied by a rise in the quantity of money relative to output…. It follows that the only effective way to stop inflation is to restrain the rate of growth of the quantity of money.”

While true, Friedman’s classic statement doesn’t tell us anything about what drives the growth of the money supply that fuels inflation. The importance of this omission becomes particularly important in hyperinflations, when the monthly inflation rate exceeds 50% for thirty consecutive days. Hyperinflations are rather rare. There have only been 58 episodes of hyperinflation in recorded history. The first episode occurred in France, where the mandat collapsed. In August 1796, France’s monthly inflation rate peaked at 304%. Today, there is only one hyperinflation, Venezuela’s. I measure both Venezuela’s monthly and annual rate of inflation with high-frequency data each day. On August 27th, Venezuela’s monthly rate of inflation was 177% and its annual rate of inflation was 60,934%.

Many people ask, how can this be? What drives the money supply and inflation to astronomical heights? To answer these questions, we must go behind Friedman’s heavily quoted words.

In hyperinflations, the “printing presses” go into overdrive because governments spend, and all the sources for funding their largess either never existed or wither away, except one: central banks. To set the stage, in a pre-hyperinflation situation, when a full array of financing options are available, government expenditures can be financed by taxes, by the domestic and international bond markets, by revenue from state-owned enterprises, and by central banks. In addition, governments can defer payments by accumulating arrears. So, arrears are also a means of “funding.” Governments can also go hat-in-hand to obtain foreign aid, yet another source of funding.

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