Weimar Republic Hyperinflation through a Modern Monetary Theory Lens
Phil Armstrong and Warren Mosler
The hyperinflation in Weimar Germany in 1922-23 has become the poster child of mainstream economists - and especially the monetarists- when presenting the benefits of constraining governments by the rules of ‘sound finance’. Their narrative presumes that governments are naturally inclined to spend beyond their means and that, if left to their profligate ways, inflation ‘gets out of hand’ and leads to hyperinflation in a continuous, accelerating, unstoppable catastrophic collapse of the value of the money.
In contrast to this ubiquitous mainstream analysis we recognize a fundamentally different origin of inflation, and argue that inflation requires sustained, proactive policy support. And, in the absence of such policies, inflation will rapidly subside. We replace the erroneous mainstream theory with the knowledge of Modern Monetary Theory (MMT) identifying both the source of the price level and what makes it change. We are not Weimar scholars, and our aim is not to present a comprehensive historical analysis. We examine the traditionally reported causal forces behind the Weimar hyperinflation, along with the factors that contributed to the hyperinflation and to its abrupt end.
The purpose of this paper is to present our view of the reported information from an MMT perspective. In that regard we identify the cause of the inflation as the German government paying continuously higher prices for its purchases, particularly those of the foreign currencies the Allies demanded for the payment of reparations, and we identify the rise in the quantity of money and the printing of increasing quantities of banknotes as a consequence of the hyperinflation, rather than its cause.
In this article, we dispute the mainstream view that the inflation of the Weimar Republic was caused by a proactive expansion of the stock of money by the German government acting in concert with the Reichsbank.
In part 1, we examine the source of the price level and causes of inflation, first from a neoclassical and then from an MMT perspective.
In part 2, we analyse the Weimar hyperinflation.
In part 3, we apply the insights of MMT to Weimar hyperinflation and present our alternative narrative.
In part 4, we conclude.
1. The Price Level and Inflation
The Neoclassical Approach
Neoclassical economists define the price level as the current level of nominal (money) prices in the economy. And while there have been theories which attempt to explain what causes the price level to change, there is no neoclassical theory which explains how it came to be. By default, it is assumed to be historic- the consequence of an infinite regression. Neoclassical models therefore simply assume an initial price level when presenting the quantity theory of money (QTM), the tautology MV=PT, where the money supply (M) multiplied by the velocity of circulation (V) = the average price of each transaction (P) multiplied by the volume of transactions (T). With M assumed to be exogenous (under the control of the authorities) and V assumed to be stable, it is then asserted that causality runs from M to P, giving rise to Friedman’s famous explanation of the cause of inflation: ‘Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. …’ (Friedman 1956, emphasis added).
The presumption of a money supply fixed by the government, however, applies to a convertible, fixed exchange rate currency, such as existed under the gold standard. This relegates the applicability of the quantity theory of money to fixed exchange rate regimes and makes it entirely inapplicable to today’s floating exchange rate regimes (as well as in the Weimar Republic) where the government does not offer convertibility at a fixed rate.
After a decades-long search for an ‘M’- a monetary aggregate that correlates to and leads to inflation- mainstream economics today has moved on to its current position of inflation expectations being the cause of inflation. They continue to begin their analysis with an assumption of a given price level and assert that inflation expectations are the source of changes to that price level. Central banks have, in fact, developed intricate methodologies to measure inflation expectations to guide policy, while their researchers have struggled to find evidence of the validity of the theory.
Of further note is the fact that mainstream economists accept the classical dichotomy of real vs nominal (monetary) factors and contend that in a competitive marketplace the introduction of money is merely the introduction of a numeraire into a barter economy. Money is a ‘veil’ that improves transaction efficiency while leaving quantities produced and relative prices unchanged (Armstrong 2015; Armstrong and Siddiqui 2019). This assumption is known as the neutrality of money. However, the assumption of neutrality is obviated by the introduction of coercive taxation.
Modern Monetary Theory
Modern Monetary Theory (MMT) recognizes that the funds to pay taxes and net save come only from the government or its agents (Bell 1998); the currency itself is a public monopoly and therefore the price level, as a point of logic, is necessarily a function of prices paid by the government (Mosler 1993). Said another way, the value of the currency is a function of what economic agents must do in order to obtain it from the government and its designated agents, directly or indirectly. With the currency a public monopoly (imperfect competition) mainstream quantity theory, inflation expectations theory and the neutrality of money are not applicable.
With the currency a public monopoly, in the context of a market economy the government need only set one price as market forces adjust all other prices to express indifference levels, or what is also referred to as relative value (Tcherneva 2002).
The value of the currency is defined by what a given amount of it can buy. So, for example, if the government increases purchases at current prices, regardless of the quantity of money spent, that additional (price constrained) spending has not driven up prices, and the value of the currency has not been altered. However, if the government instead pays more for the same items purchased, the value of the currency, by definition, has become lower, as it takes more of it to buy the same quantity than was previously the case.
As a practical matter, governments utilize buffer stock policies. With a buffer stock policy, the government sets the price of the buffer stock item, while market forces result in all other prices expressing indifference levels to the price of the buffer stock item (we further recognize that there are additional institutional structures that influence the determination of a vast array of prices). This logic underpins both fixed and floating exchange rate regimes. For example, with a gold standard the government sets the price of gold and conducts fiscal and monetary policy so as to retain a credible buffer stock of gold, while offering to buy or sell gold at a fixed price and allowing other prices to continuously adjust and reflect relative value. With today’s floating exchange rate regimes, governments use monetary and fiscal policy to maintain a credible buffer stock of unemployed workers to stabilize wages, while allowing other prices to adjust to reflect relative value. Inflation is therefore, in the context of buffer stock policies, a continuous increase in the price set by the government or its agents, directly or indirectly, for the buffer stock item (Mosler and Silipo 2017).
With the German mark a non-convertible state currency in the Weimar Republic, interest rates were set by policy. And, ironically, the radically higher policy rates intended to support the mark instead worked to exacerbate the inflation through two channels. The first is the interest income channel, where interest payments by the state are additional income for the economy that add to deficit spending and aggregate demand. The second is through forward pricing, where prices of goods and services purchased for future delivery increase in line with interest rates.
2. The Weimar Republic Hyperinflation
Reparations and Inflation
Two avenues of discussion arose out of the war reparations demanded from Germany following the 1919 Armistice. The first is ‘the budgetary problem’, questioning whether Germany was fundamentally capable of paying the monetary sums demanded for reparations (Keynes 1919; Rueff 1926; Mantoux 1946). The second is ‘the transfer problem,’ which reflects a concern over the conversion of the German money to foreign currency for payment to the Allies. (Keynes 1929; Ohlin 1929). ‘The Dawes Committee divided the payment of German reparations into two parts - into the Budgetary Problem of extracting the necessary sums of money out of the pockets of the German people and paying them into the account of the Agent-General, and the Transfer Problem of converting the German money so received into foreign currency’ (Keynes 1949 : 161, emphasis in the original).
Keynes stresses the significance of the transfer problem and argues that even if the German authorities had been able to reduce German domestic consumption sufficiently by taxation, the resources thus freed would not necessarily have produced the increase in exports required to fulfil the Allies’ reparations demands. Keynes argues that something in addition is required, German wage rates must be lowered sufficiently to make their potential expor