Abstract
Since the publication of Cagan's seminal contribution in 1956 and its further development by Sargent (1982) there has been a growing literature that seeks to explain German hyperinflation in terms of the monetary hypothesis. However, this article shows that the origins of this hyperinflation can be traced back to a sudden stop that occurred in the summer of 1922 at a time when expectations that the German economy would stabilise began to subside. The reversal of capital flows that took place in those months led in the short term to a dramatic depreciation of the mark, a significant increase in prices and a decline in output. This decline sparked bitter social conflict that fuelled a wage and price spiral. This spiral was accommodated by monetary authorities, leading in turn to explosive inflation.
Highlights
Analysis of hyperinflation during the Weimar Republic occupies a prominent place in studies on the origin and development of episodes of hyperinflation
As shown by Dornbusch et al ( ), one problem with the monetary view is that basically it refers to a closed economy, meaning that it disregards the role of the exchange rate, which plays a crucial role in the traditional balance of payments view with its focus on current account imbalances and in relation to the financial part of balance of payments
As a result of this, in the early part of, a large share of the country’s debt, both public and private, was held by non-residents. In this context the country was exposed to a sudden stop, that is to say, a sudden reversal of capital inflows. This reversal occurred after certain events in June that wiped out any hope among foreign investors that a solution could be found to the reparations problem and that the German economy could be stabilised
Summary
Since the publication of Cagan’s seminal contribution in and its further development by Sargent ( ) there has been a growing literature that seeks to explain German hyperinflation in terms of the monetary hypothesis. The reversal of capital flows that took place in those months led in the short term to a dramatic depreciation of the mark, a significant increase in prices and a decline in output. This decline sparked bitter social conflict that fuelled a wage and price spiral. Two stand out: the monetary view and the balance of payments view.[1] The former sees hyperinflation during the Weimar Republic as mainly due to an excess in the money supply. To put it more precisely, in the years immediately following the end of the war, the Weimar Republic significantly expanded public spending.
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