Hyperinflation in Germany After World War I and in Hungary After World War II

Two of the most well-known and largest instances of hyperinflation occurred in Germany after World War I and in Hungary after World War II. Before these two instances are to be critiqued and analyzed, it is essential to understand what hyperinflation is and the root causes for its occurrence. These two situations in history have long been investigated in order to prevent and better understand the economic development of hyperinflation. Within the last decade new information and analysis has been conducted and developed upon in regards to these two hyperinflations which has helped us gain a better understanding of hyperinflations in general. With both instances of hyperinflation, monetary and fiscal policy reforms were brought about that were successful in stabilizing the economies, but only after much hardship. In all cases, hyperinflations hinder economic development, which is why understanding instances in which they have occurred is vital. This paper will explain the effects of the hyperinflations and stabilizations in both instances while also examining the essence of hyperinflation in itself.

Basics Of Hyperinflation

Hyperinflation is an extremely rapid rise in the general level of prices of goods and services. It is a condition in which prices raise ultra rapidly and simultaneously currency looses value. Many economists classify hyperinflation as an inflationary cycle without any tendency towards equilibrium. There are four characteristics that the International Accounting Standard follows to classify if an economy is experiencing hyperinflation. They are: "1) The general population prefers to keep its wealth in non-monetary assets or in a relatively stable foreign currency. 2) Amounts of local currency held are immediately invested to maintain purchasing power. 3) The general population regards monetary amounts not in terms of the local currency but in terms of a relatively stable foreign currency. Prices may be quoted in that currency. 4) Sales and purchases on credit take place at prices that compensate for the expected loss of purchasing power during the credit period, even if the period is short. 5) Interest rates, wages and prices are linked to a price index and the cumulative inflation rate over three years approaches, or exceeds, 100%."1

As essential to knowing what hyperinflation is defined as, is knowing the root causes for its occurrence. The cause and dynamics of hyperinflation are well known in a general sense. The main cause for hyperinflation is an extreme imbalance between the supply and the demand of a certain currency or type of money. As Makinen describes in the Journal of Political Economy, this is usually attributed to a complete loss of confidence in the currency due to a weak economy and often times a weak government.2 Often times a weak government is forced to rely on the issue of new money as the principal source of its revenue. Usually associated with paper money, hyperinflation involves excessive money printing which increases the money supply.3 Eventually this even becomes a net loss for the government because of how much the currency becomes devalued. Because of this, the holding of government debt results in less buying power. Since the new money being printed is the main source of the government's revenue, "the proceeds may be thought of as an "inflation tax" on real money balances. As an increase in the rate of money growth increases the "tax rate" and, to the extent that the resulting increase in the rate of inflation is perceived and expected to continue, induces money holders to avoid the tax by reducing their real money balances."4 This is why in many cases when analyzing hyperinflation, the relationship between seignorage and the general inflation tax is looked at. In the New Palgrave of Economics, seignorage is defined as the difference between the face value of a coin and the cost of producing, distributing, and eventually retiring it from circulation.5 Ideally these two things should be equal, but as hyperinflation occurs the face value drops way below these other factors, hence seignorage occurs. Dr. Makinen explains, that in doing so they reduce the "tax base" and force the government to increase the tax rate (increase the rate of new money issued) if the government is expected to finance the same level of real expenditures.6 Hyperinflation in many instances wipes out the purchasing power of private and public savings and distorts the economy to favor extreme consumption. While many economists agree that in many respects some inflation is a necessary in the economy, hyperinflation is always looked at as a negative.7 For example, sometimes a little bit of inflation can be good for exchange markets and can help balance trade deficits in a country. Hyperinflation is in essence inflation, but to an extreme and out of control. In almost all instances, hyperinflations occur in economies during distress due to reasons and conditions that are otherwise not present. It by and large takes some sort of drastic force on the economy usually produced by war or natural disaster to cause hyperinflation. Hence, hyperinflation usually arises very fast and sometimes is almost unpredictable in the long run.8

Leading Up To Germany's Hyperinflation

After World War I Germany experienced one of the worst and most well known hyperinflations in history. Leading up to the harshest year in 1923, World War I was over and Germany was in post war economic turmoil. When the War broke out in 1914, the German Central Bank suspended its ability to redeem their notes for gold and after this there was no legal limit as to how many notes the bank could print. Instead of enforcing taxes on its people, Germany borrowed huge amounts of money to finance the war. The money borrowed was intended to be paid back by the enemy after the war; hence Germany was expecting to win.9 Most of the money was discounted and monetized by the central bank and this lead to printing up and issuing large amounts of paper money. By the end of the war the money that was in circulation throughout Germany had increased tremendously. In this respect, however, there was still not a very high amount of inflation. It was high, but by no means out of control and was even less than neighboring France. What had increased beyond normality, however, was the floating debt of the central bank. It had increased from three billion to fifty five billion marks by the time the war was over.10 The reason that inflation stayed under control during the war was because people tended to work hard, had little time for leisure, and saved money. After the war very harsh reparation payments were imposed on Germany and the mark immediately began to depreciate against foreign