Major Inflations in History.

Otrok, Christopher M.

The economist does not have a laboratory in which to test theories about cause and effect. Instead, he must isolate causal relations in the real world, an extremely difficult task which usually leads to ambiguous conclusions. Extreme examples of phenomena provide the best opportunity to isolate causal relationships and test theories. To the monetary economist, rapid inflation can provide such an opportunity to study the effects of monetary variables. As Phillip Cagan noted in his seminal study on hyperinflation, "Astronomical increases in prices and money |in a hyperinflation~ dwarf the changes in real income and other real factors. Relations between monetary factors can be studied, therefore, in what almost amounts to isolation from the real sector of the economy."

The study of past rapid inflations is also of interest to the economist interested in policy decisions. What causes rapid inflation? And perhaps more importantly, how can rapid inflation be avoided? These questions are especially relevant given the threat of hyperinflation attending the economic and political revolutions in the former Soviet empire.

Forest Capie has collected papers analyzing rapid inflations in Major Inflations in History. The first of these papers is a brief historical overview of each major inflation in history. The second two articles, which focus on post WWI inflations, provide the theoretical framework upon which the majority of the remaining papers in the volume are based.

The first of these two papers is Phillip Cagan's "The Monetary Dynamics of Inflation." Cagan argues that the rapid inflation many countries experienced following WWI can be attributed to the equally rapid rise in the quantity of money. The price level is determined by the ratio of the money supply to desired real cash balances. According to Cagan, desired real cash balances in a hyperinflation are dominated by inflation expectations, or the expected cost of holding money, since movements in real income are small in comparison to the changes in inflation. As money is created, inflationary expectations increase, the cost of holding money increases, and desired real cash balances decrease. In order to reduce real cash balances, individuals attempt to purchase assets or goods and thereby bid up prices. The rise in the price level is the result of a fall in desired real cash balances coupled with a rise in the amount of money supplied. The money supply increases because the government attempts to finance its expenditures through money creation. The original excess money creation is to blame for the increased cost of holding money and can be considered the root cause of inflation. Further, inflation can be stopped at any time, and eventually has been in each hyperinflation episode, by cutting off the growth of the money stock.

In "The Ends of Four Big Inflations," Thomas Sargent criticizes the quantity theory approach that Cagan advances. Sargent argues that the money stock is not the main factor in explaining inflation. He points to the stabilization periods of the inflations when the quantity of money increased rapidly, but prices did not rise commensurately. His explanation for the abrupt halt in inflation is that simultaneous monetary and fiscal regime transformations took place. Agents stopped bidding up prices and increased their real cash balances as soon as a credible regime change occurred. Credible reform included both an independent central bank and a fiscal authority with an ability to end deficit spending and raise revenue. Further, the monetary and fiscal reforms were interrelated, of equal importance, and could not occur separately. Sargent argues that the quantity of money in circulation is not the determinant of the price level. Instead, the type of currency and its backing determine how a given quantity of money will affect the price level. This hypothesis contrasts with Cagan's hypothesis that only the quantity of money determines the price level.

Later authors attempt to find support for one of these two competing hypotheses in other examples of inflation. Francis Lui, in "Cagan's Hypothesis and the First Nationwide Inflation of Paper Money in World History," is able to find support for Cagan's arguments in the first documented hyperinflation, that of China in 1100 AD. Bruce Smith, however, finds support for Sargent's hypothesis in "Some Colonial Evidence on Two Theories of Money: Maryland and the Carolinas," a study of inflation in colonial America.

Editor Forrest Capie notes that relatively little attention was paid to the rapid inflations of the 1920s by economists writing at the time. The 1937 publication of Bresciani-Turroni's study of the post WWI German inflation, The Economics of Inflation, sparked new interest in the subject. An excerpt from this book, "The National Finances, the Inflation and the Depreciation of the Mark," is included in the Capie volume. Bresciani-Turroni downplays the significance of reparations and the balance of payments that had dominated accepted explanations for the inflation. He provides a convincing argument that these explanations, though popular with the German government, were not wholly accurate. Instead, the increase in the quantity of money is the cause of inflation.

This view, however, is not completely accepted now, nor was it then. In "Review of Bresciani-Turroni's The Economics of Inflation," Joan Robinson argues, in line with popular sentiment at the time, for a cost-push explanation of the German inflation. According to this argument, the collapse of the mark in 1921 is to be blamed for the hyperinflation. The increased quantity of money came later, and according to Robinson, only allowed the inflation to continue. Although the popularity of Robinson's cost-push explanation faded in the 1960s, its inclusion in this volume serves as an important example of the Keynesian doctrine that dominated post-depression economic analysis.

Capie has included many papers that analyze the politics surrounding inflation, which provide both fascinating reading and variety to the volume. The topics range from Andrew White's narrative description of the pre-revolution French inflation to Charles Maier's political coalition explanation of modern Latin American hyperinflation. The issues covered are too numerous to list, but to Capie's credit the coverage is both complete and informative.

On the whole, Major Inflations in History serves as a useful reference on the study of inflation. It examines the causes of major inflations and extracts lessons from the experiences. The strength of the volume lies in the variety of perspectives used to analyze inflation. Students of the current crisis in the former Soviet Union would do well to read this book. They will be struck by the similarities between past and current situations.