How does a new currency stop inflation?

I’m from Brazil, and we’re a success story in beating hyperinflation. No, just replacing the currency is not enough. We replaced the currency and adopted a number of economic policies, including cutting government spending and raising interest rates, which are the most common tools for countering inflation.

But (in my opinion) the most ingenious part of the plan was the realization that hyperinflation is psychological. Businesses start preemptively raising prices because they know prices are going up anyway, as well as raising wages every month to keep up. This creates a snowball effect

What the government did was create a symbolic currency called URV (real value unit). All prices were shown in URV and you converted that to Cruzeiro Real when you paid. I was 9 years old, I remember going to the ice cream shop and seeing the prices in URV. So, for example, if 1 URV = CR$ 2000, then if the ice cream cost 5 URV, I’d pay CR$ 10,000 for it.

But I knew that an ice cream cost 5 URV.

That was the intended effect. People had months to get used to what things actually cost, regardless of their value in the old currency. After the transition period, the government introduced the new currency and called it real. One real = one URV. It was a Sunday. Everybody who woke up and went to buy bread at the bakery knew what kind of prices to expect.

Short answer is a lot of the effects are related to confidence, or lack thereof, in a currency. changing the currency in question and using a new one (especially one thats backed by outside agency or currency) can break the cycle somewhat by restoring confidence in the currency.

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however, your right in that this doesn’t solve any underlying issues that were driving inflation in the first place, so ON ITS OWN, its just a band aid or a convenience of taking all the zeros off the notes. However, just like a band aid, it can give you some breathing space to actually enact those extra reforms.

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normally, you will find this new currencies are part of a wider package, rather than the sole element being changed.

If the value of a currency is bound to the previous currency then what you are describing is “redenomination”, not really a “new currency”. In that case the inflation of the old currency does affect the value of the new notes as you would think.

To address your broader question, yes introducing a new currency isn’t going to solve inflation. You would also need to address the underlying problems with the economic system that lead to the inflation in the first place. Zimbabwe for example had several massive redenominations between 2006 and 2009 that didn’t stop their financial disaster.

It doesn’t.

But once you have hyperinflation you can’t possibly use the old money anymore because it’s all junked up. So whatever else you do has to include making new money to start over.

Hyper inflation often happens when monetary policy lets the government issue a lot more currency without any underlying backing for the value of the money being issued, devaluing the money in circulation, ending up in a feedback loop.

The triggers for the government issuing more currency can vary, such as trying to alleviate some other major economic crisis, but that’s the general idea.

When the government eventually throws in the towel on the old currency there is often a period where the country will adopt some third country currency (Eg US dollar) for transactions while they try to reset their systems. As they can’t print more US dollars/ Euros/Whatever everyone is stuck with a currency that’s not hyper inflating, which often brings its own pain, but a better type of pain than hyper inflation.

When the country has sorted out whatever shitshow led to the hyperinflation to start with they’ll start issuing their own banknotes again, but often backed by another currency to force stability. They do this by buying currency reserves in the backing currency (Eg massive quantities of U.S. dollars/ Euros / etc) and then issuing their own notes against those at a fixed rate – called pegging the currency. This forces stability on the newly issued currency as it forces limits on how much currency can be issued, provided monetary policy isn’t changed.

This idea of currency backed by another is quite common – eg a lot of the Middle East and some of Asia has their currency set up pegged to the US dollar, sometimes with a mix of Euros in the overall valuation.

It makes it tougher for some monetary policy things – eg interest rate adjustments, but the trade off gives better currency stability.