Joan Robinson on the Weimar Hyperinflation

Joan Robinson’s review of Costantino Bresciani-Turroni’s The Economics of Inflation (The Economic Journal 48.191 [1938]: 507–513) contains Robinson’s views on the causes of the Weimar hyperinflation.

In essence, there are three major explanations of Weimar hyperinflation, as follows:

(1) the standard “quantity theory of money” explanation, which was sometimes called the “English” or “Allied” view. An influential statement of this view was Bresciani-Turroni (1937), and it assumes that money supply is exogenous;

(2) the “balance of payments theory” or what was called the “German” view. This explanation was pursued by Williams (1922), and Graham (1930) is considered by some to hold to some form of it;

(3) a Post Keynesian “balance of payments” theory but emphasising endogenous money and wage and price versus foreign-exchange spirals.

Joan Robinson (1938) formulated this on the basis of the earlier “balance of payments” view.

First, it is necessary to stress what the argument is not about. The argument is not about whether money supply exploded in Weimar Germany or whether the Weimar government ran a huge budget deficit in 1923 that was funded by central bank money creation (or monetising of the deficit).

These things are true.

Nor, as far as I can see, do Post Keynesians dispute that a sustained general increase in prices or hyperinflation requires a growing money stock to sustain it.

But, while a money supply expansion is a necessary condition for this, what is being disputed is whether exogenous money creation was the primary causal factor. The alternative view is that money creation can be seen largely as endogenous and a type of intermediate, though necessary, cause driven by other factors.

The “balance of payments theory” argues that the severe depreciation of the German mark was the fundamental causal factor in the hyperinflation, and that in turn was driven by the burden of the reparations imposed on Germany.

We can see how the Post Keynesian view contradicts the “quantity theory” view by looking at how both sides understand the causality involved in the hyperinflation.

If one accepts the “quantity theory” view and assumes an exogenous money supply, then the chain of causality runs as follows:

exogenous money supply → price inflation → the exchange rate depreciation.

The Post Keynesian view rejects this, and the depreciation of the mark is seen as the fundamental causal mechanism.

So under the Post Keynesian “balance of payments” view, then, the chain of causality runs as follows:

the exchange rate depreciation → price and wage inflation → inflation of money supply.

How does Robinson’s review fit into this?

First, Robinson noted that the facts seem to support the “balance of payments view”: the severe inflation that hit Germany in the later half of 1921 was preceded by the severe depreciation in the exchange value of the mark from May 1921 to November 1921 when the German government began paying large cash reparations payments (Robinson 1938: 507–508).

Of course, one has to demonstrate the causal mechanisms involved in this and look for further empirical evidence in support of it, and Robinson points to this:

“If the impulse comes from the side of the exchange, we should expect the fall in exchange to run ahead of the rise in prices, and the prices of traded goods to run ahead of home prices. This is precisely what occurred, the magnitude and speed of change being in this order: exchange, import prices, export prices, home prices, cost-of-living, wages. Moreover, the geographical diffusion of prices supports the argument, the movement spreading from the great ports and commercial centres to the interior of the country.” (Robinson 1938: 508).

Next, Robinson notes that the proponents of the “quantity theory” explanation of the hyperinflation like Bresciani-Turroni argued that this cannot be the case, because the tendency to balance of payments equilibrium would have prevented this, and that it was the German budget deficit financed by Reichsbank money creation that was the primary cause of the hyperinflation (Robinson 1938: 509).

But Robinson notes that the actual German government budget deficit was falling in 1921 and 1922: in 1920 the deficit was 6 billion gold marks, in 1921 it was 3.7 billion gold marks, and in 1922 2.4 billion (Robinson 1938: 509). Although Robinson concedes it had a role, nevertheless both the “quantity theory” view and the former “balance of payments theory” view had neglected an important missing link in the cause of the hyperinflation:

“The missing item is not far to seek. It is the rise in money wages. Neither exchange depreciation nor a budget deficit can account for inflation by itself. But if the rise in money wages is brought into the story, the part which each plays can be clearly seen. With the collapse of the mark in 1921, import prices rose abruptly, dragging home prices after them. The sudden rise in the cost of living led to urgent demands for higher wages. Unemployment was low …, profits were rising with prices, and the German workers were faced with starvation. Wage rises had to be granted. Rising wages, increasing both home costs and home money incomes, counteracted the effect of exchange depreciation in stimulating exports and restricting imports. Each rise in wages, therefore, precipitated a further fall in the exchange rate, and each fall in the exchange rate called forth a further rise in wages. This process became automatic when wages began to be paid on a cost-of-living basis … . Thus … [Bresciani-Turroni’s] contention that the collapse of the mark cannot have caused the inflation, because the exchange rate will always find an equilibrium level, is deprived of all force as soon as the rise of money wages is allotted its proper role. ….

Without rising money wages, inflation cannot occur, and whatever starts a violent rise in money wages starts inflation.” (Robinson 1938: 510).

To the extent that the Reichsbank met the demand for high-powered money and loans from the private sector as wages and prices soared and there were also both official and unofficial “supplementary currencies” improvised during the course of the hyperinflation to meet demand for money (Robinson 1938: 511), then the explosion in the money supply was endogenous to a great extent.

If one regards the Reichsbank’s money creation to finance the German budget deficits and especially the huge deficit of 1923 as “exogenous” money creation, then the continuance of hyperinflation was dependent on both endogenous and exogenous money creation: this is what “allowed it to continue” (Robinson 1938: 511). Robinson also conceded that the very large German budget deficit of 1923 also had a role in the hyperinflation (Robinson 1938: 510).*

But even these observations do not lessen the role of (1) the exchange rate depreciation as the fundamental and primary causal driver of the hyperinflation and (2) the significant role that endogenous money creation played in the explosion of the money supply.

Addendum
To gauge the role of the German government budget deficits in the period from 1919 to 1923, we can look at this graph below of German government spending and tax revenue (in billions of gold marks) (from Eichengreen 1995: 138, Table 5.1).

As we can see, the hyperinflation was accompanied by a disastrous collapse of tax revenues, especially in 1923 when the deficit widened considerably. Government spending actually fell in 1922 and only rose slightly in 1923. The major cause of the massive budget deficit in 1923, then, was tax revenue collapse, not massive increases in government spending.

Another point is that budget deficits in 1919 and 1920 were very large, but inflation did not spiral out of control in these years even though it did rise appreciably (as seen in the second graph below). If such large budget deficits were the primary cause of hyperinflation, then why did it not begin earlier in 1919 or 1920? Why did it spiral out of control only after the currency depreciation?

Note
* And we can note that Joan Robinson (1938: 510), far from being some unreasonable dogmatist, was perfectly prepared to concede that excessively large budget deficits in periods of very low unemployment can initiate inflations, and that it is “even possible that an increase in the quantity of money might start an inflation” (Robinson 1938: 511), though that was not the primary cause of German hyperinflation.

Further Reading
There is an excellent analysis of the hyperinflation here by Matias Vernengo:

Matias Vernengo, “Inflation, Hyperinflation and Monetarist Perceptions about the Functioning of the Economy,” Naked Keynesianism, Monday, March 24, 2014.

BIBLIOGRAPHY
Bresciani-Turroni, Costantino. 1937. The Economics of Inflation: A Study of Currency Depreciation in Post-War Germany (trans. Millicent E. Sayers), Allen & Unwin, London.

De Grauwe, P. and Polan, M. 2005. “Is Inflation Always and Everywhere a Monetary Phenomenon?,” Scandinavian Journal of Economics 107: 239–259.

Eichengreen, Barry J. 1995. “The Legacy of Hyperinflation,” in Barry J. Eichengreen, Golden Fetters: The Gold Standard and the Great Depression, 1919–1939. Oxford University Press, New York. 125–151.

Graham, Frank Dunstone. 1967 [1930]. Exchange, Prices, and Production in Hyperinflation: Germany, 1920–1923. Russell, New York.

Robinson, Joan. 1938. Review of The Economics of Inflation by C. Bresciani-Turroni, The Economic Journal 48.191: 507–513.

Williams, John H. 1922. “German Foreign Trade and Reparations Payments,” Quarterly Journal of Economics 36: 482–503.