Hyperinflation in a small open economy with a fixed exchange rate: A post Keynesian view

ABSTRACT

This paper examines the emergence of hyperinflation in a small open economy with a fixed exchange rate from a post Keynesian perspective. Three variables play key roles: distributive conflict, external debt, and expectations about the exchange rate. First, we propose a short-run Kaleckian macro model. Then, we study the long-run behavior of the model by endogenizing the price level and foreign indebtedness. We conclude that the existence of expectations about the nominal exchange rate is crucial to explaining the emergence of hyperinflation.

KEYWORDS:

• Distributive conflict
• expectations
• foreign debt
• hyperinflation
• Kaleckian model

JEL CLASSIFICATIONS:

• E12
• E31
• F41

Notes

¹The paper was initially published in the Economic Journal in 1938, in a shorter version. It was written as a comment on The Economics of Inflation by Bresciani-Turroni (1931).

²This does not mean that hyperinflation can occur in an open economy only. As posited by Kalecki (1962), in a closed economy, agents convert the domestic currency into goods.

³We observe such a phenomenon in various hyperinflationary episodes. Broadberry and Ritschl (1995) estimated that the unemployment rate in Germany was 1.5 percent in 1922, the year before the hyperinflationary peak. According to the International Monetary Fund (2011), the unemployment rate was 4.6 percent in 1983 (the year before hyperinflation) in Israel.

⁴An example might be the CGT (General Confederation of Labor) in Argentina, where the union played a very important role historically.

⁵Our assumption does not mean that we ignore the effects of high-inflation on income distribution. We are exploring the emergence of hyperinflation and not its consequences.

⁶Here, government intervention is not explicitly modeled so as not to make our model unnecessarily complex and because it is beyond the scope of this study. However, incorporating stabilization policies would not qualitatively modify our main conclusions. Indeed, a simple formalization could be proposed: $${\dot{g}}^G=\lambda (g-g^d)$$ with λ > 0 and g^G = G/K the ratio of public spending to capital stock. When g*>g^d, government increases its expenditure, otherwise when g* <g^d, it diminishes public spending to avoid inflation in the short run, also ensuring the stability of Expression (11).

⁷See Heymann (1991) for a specific description of the Austral plan established in Argentina in 1985, Pastor (1991) for the Bolivian case, and Bruno et al. (1988) for Israel, Brazil and Mexico.

⁸Our short-run equilibrium requires equilibrium on the goods market. But that does not mean we want to emphasize excess demand in the dynamic. Post Keynesian open economy models of conflicting-claims inflation developed by Vernengo (2003) or Vera (2010) insist on cost-push elements. We see in the next section that those elements can be very important to our analysis.

⁹We performed several simulations assuring that $$\hat{p}=0$$ is always above d_X = 0 when $$d_X\to -\mathrm{\infty }$$, which rules out the possibility of obtaining three equilibria.

Additional information

Notes on contributors

Sébastien Charles

Sébastien Charles is an associate professor in the Department of Economics, Université Paris 8.

Jonathan Marie

Jonathan Marie is an associate professor at the Center of Economics of Paris Nord (CEPN), Université Paris 13.