Can money perform its functions despite a high rate of inflation? 

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pohnpei397 eNotes educator| Certified Educator

Money can conceivably perform its functions even when the rate of inflation is high.  However, it is much harder for money to do so in these conditions.  In addition, it can be completely impossible for money to perform its functions if the rate of inflation is both high and unpredictable.

We typically say that money has three functions.  Money is a store of value, meaning that our money that has value today will still have value in a year.  We can therefore keep our wealth in the form of money.  Second, money is a unit of account.  This means that we can express how much things are worth in terms of money.  We can say that a car costs X number of dollars and that our labor is worth Y number of dollars.  Finally, money is a medium of exchange.  This means that I can give you money and you will give me valuable things in exchange.  All of these functions become more difficult to perform when inflation is high and impossible if inflation is high and unpredictable.

If inflation is high, money cannot act as a store of value.  Inflation causes money to be less valuable.  If inflation is high enough, money can lose most of its value in a matter of days and no one can keep their wealth in the form of money.  If inflation is high and unpredictable, money cannot be a good unit of account.  If I do not know how much money will be worth tomorrow, I cannot tell you how much my labor (or anything else) is worth.  When the value of currency fluctuates, we cannot use it to clearly state how much various things are worth.  Finally, when inflation is high and unpredictable, money cannot be used as a medium of exchange, largely because it cannot be used as a store of value.  If I own a store and you want to give me money in exchange for my goods, I want that money to have value.  Otherwise, I will not give you goods in exchange for it.  If inflation is high and unpredictable, I will not believe that the money you bring will be worth anything tomorrow or next week so I will not agree to exchange goods for it.

In these ways, it is much harder for money to perform its function if inflation is high.  If inflation rates are high enough and are unpredictable, money cannot perform its functions at all.  This is one reason why hyperinflation is so dangerous for a country’s economy.