Major Inflations in History.

• Author: 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...