The Monetary Dynamics of Sustained High Inflation: Taiwan, 1945-1949

Abstract

Taiwan experienced a sustained period of very high price inflation in the period 1945-1949 which led to an eventual rise in prices even greater than that experienced during some of the classic European hyperinflations analyzed by Cagan [3] and others. Makinen and Woodward [22, 90] note that On the list of recognized hyperinflations one will not find Taiwan, but nevertheless argue that this episode should be classed as such. Although the average rate of Taiwanese inflation during this period was not as high as in the episodes examined by Cagan, the very length of the period during which inflation remained high singles the Taiwanese experience out as an extremely interesting period for analysis by monetary economists. In this paper, a primary aim is to examine whether the salient features of the demand for money during this period can be adequately characterized by an application of Cagan's model of money demand under conditions of hyperinflation. In particular, we apply a test of Cagan's model which is not contingent on any particular assumption concerning expectations formation except that agents' errors in forecasting inflation are stationary. Using these first-stage estimates, we then examine, subject only to the same weak assumption of stationary forecasting errors, the hypothesis that the monetary authorities expanded the money supply in such a way as to maximize the inflation tax revenue ensuing from money creation. Finally, we test the rational expectations version of the hyperinflation model of money demand. The remainder of the paper is set out as follows. In section II we discuss the background to the Taiwanese hyperinflation of 1945-1949.