Multiple Regime Shifts and Multiple Ends of the Taiwanese Hyperinflation, 1945-1953.

• Author: Burdekin, Richard C. K.

Richard C. K. Burdekin [*]

Hsin-Hui I. H. Whited [+]

We reexamine the behavior of money growth, inflation, and real money balances in post-World War II Taiwan. Our results suggest that the importance of the June 1949 reform package has been overstated. The empirical work reveals an extended period of instability that begins several months prior to the June 1949 announcements and continues until early 1950. This implies that stabilization was achieved only gradually. We also point to the importance of two high-interest deposit programs-introduced in May 1949 and March 1950--in helping account for the Taiwanese authorities' ability to end the inflationary spiral.

1. Introduction

   As with the famous post-World War I European hyperinflations studied by Sargent (1993, chap. 3), Taiwan's hyperinflation was fueled by large budget deficits and exceedingly high rates of monetary expansion. Interestingly, though, prior to 1950 the deficits were not those of Taiwan per se but rather those run by the Nationalist regime in mainland China that used the proceeds from "excess" loans to public enterprises in Taiwan to help finance its war effort. By excluding loans to public enterprises from the official budgetary accounts, Taiwan's provincial government had the dubious distinction of reporting a (highly misleading) budget surplus in the midst of hyperinflation (see Li and Wu 1997). Consolidated fiscal data are not available until 1950, in which year the deficit amounted to 5.2% of Taiwan's GDP (see Table 1). Given that Taiwan is generally considered to have implemented a successful stabilization package in June 1949, such large deficits in 1950 seem to depart from the earlier European hyperinflati on experiences where inflation was ended by a stabilization package that incorporated dramatic fiscal consolidation and movement away from deficit finance.

   Makinen and Woodward (1989, p. 103) conclude that effectiveness of the June 1949 reform package, in spite of continuing deficits and reliance on the printing press, implies that the Taiwanese public must have "believed in a nonexistent regime change." One explanation for such seemingly perverse behavior has been suggested by Li and Wu (1997), who argue that the June 1949 program could have balanced the budget had it not been for the subsequent retreat of the Nationalist central government to Taiwan in December 1949 that led to a dramatic increase in fiscal pressures. If these events were not foreseeable earlier in 1949, the June program's deficit reduction measures may have been credible ex ante even though later observation showed a widening, not a shrinking, budget deficit. A problem with this interpretation, however, is that by June 1949 the Nationalist regime had already been subjected to defeat after defeat on the mainland, culminating in the fall of Shanghai in May 1949. Prospects of Nationalist victory over the Communists were close to nonexistent; and, with the movement of Nationalist forces to Taiwan already accelerating in early 1949, the completion of this process later in the year was surely not a complete surprise. So, even allowing that the full budgetary consequences were subject to a lot of uncertainty, we still do not see how there could have been much justification for widespread optimism about the fiscal position in June 1949.

   Do these arguments lead us back to believing in a "nonexistent" regime change? No. The empirical work performed in this paper suggests that the inflation and money growth processes in Taiwan were, in fact, subject to a series of shocks from 1948 through 1950 and that these processes did not stabilize until well after the June 1949 policy announcements. This suggests that Makinen and Woodward's (1989) approach of dividing Taiwan's experience into a "hyperinflation period" pre-June 1949 and a "stabilization period" post-June 1949 is actually not supported by the available data. The evidence of structural breaks beginning in 1948 also raises concern with later work--such as Phylaktis and Taylor (1992)--that treats the pre-June 1949 period as a homogeneous sample. [1] While we do not pretend to resolve all the mysteries of the Taiwanese experience, we do believe that our allowance for multiple structural breaks highlights the fact that there was much more to the evolution of the inflation process than the June 1 949 reform announcements. Indeed, we argue that other measures, both before and after June 1949, may well have been more important than the June 1949 package.

2. Origins of the Taiwanese Hyperinfiation

   During World War II, Taiwan was ruled by Japan, and the Bank of Taiwan was forced to purchase a huge amount of national debt from Japan to help finance Japan's war effort. The money supply, which consisted mainly of notes issued by the Bank of Taiwan, increased by 807% between December 1940 and Japan's surrender in August 1945. Before Taiwan's provincial government took control in November 1945, the price index jumped from 242 in July to 1171.7 in August and 2585.8 in September. To make matters worse, the Taiwan provincial government inherited a budget deficit resulting from previously made (forced) bad loans to the Japanese government and diminishing real resources after the war. To contain inflationary pressures, the Bank of Taiwan set up a special deposit program on November 7, 1945, and prohibited the circulation of notes issued after the Japanese surrender. According to this program, the public needed to deposit all Japanese notes within one month; after that time these notes would be deemed worthless. Total money issue decreased 20% between October and early December 1945 following the implementation of this program.

   Unfortunately, just as the Japanese government had enacted forced loans from the Bank of Taiwan during World War II, so too did the Nationalist government demand loans to help fund its military conflict with Communist forces on the mainland. On May 22, 1946, the Bank of Taiwan was authorized by the Nationalist government to issue a new local currency called the "taipi" in the amount of 5.3 billion yuan. There were no reserves for the taipi, and the circulation of the taipi was limited to Taiwan. In addition, the issuance of taipi was dictated by the Nationalist government on the mainland. Left with the burden of financing the expenses of both the Taiwan provincial government and those of the mainland government, the Bank of Taiwan effectively lost control of the money creation process. For a time, however, the Bank of Taiwan was able to limit the increase in currency by requiring, as of September 1947, that all divisions of the provincial government deposit funds only in the Bank of Taiwan. This policy fuele d a year-over-year 258% increase in deposits by December 1947 and allowed the rate of money issue to be kept well below the overall growth of loans. Thus, as in November 1945, a special deposit policy again helped to temporarily limit the rate of money supply growth even in the face of large deficit spending pressures.

   The situation deteriorated quickly, however, following the monetary reform of August 19, 1948, in mainland China, where the old "fapi" currency was replaced by the "gold yuan." On August 18, 1948, 1 taipi could be exchanged for 1635 fapi. On August 19, 1948, the exchange rate between the gold yuan and the fapi was set at 1:3,000,000 (one gold yuan note was equal to three million fapi). This implied that the official exchange rate between the taipi and the gold yuan became 1835:1. However, in the face of Nationalist military defeats and blatant overissuing of the new currency, attempts to unload the gold yuan by exchanging it for the taipi at the new official 1835:1 exchange rate fueled a huge capital inflow into Taiwan. Taiwan's money supply consequently doubled between August and October 1948, and inflation accelerated to 109.6% in October and 96% in November. However, even this was better than the situation on the mainland, where...