The
aim of this paper is to clarify the failure of the Cagan
model with perfect foresight, and to draw new axes for the
investigation of monetary hyperinflation analysis. Firstly,
the paper evaluates the relevance of the Cagan d hoc model
with perfect foresight as a theoretical framework for investigating
hyperinflation processes. It is shown that deficits can
never generate monetary hyperinflations, confirming the
results of Buiter (1987). The only hyperinflationary processes that can occur are speculative
hyperinflations. Secondly, the paper assesses the consistency of
hyperinflationary paths with the optimizing behavior of representative
agents within two perfect foresight inflationary finance framework, modeling
the use of money as a medium of exchange. In the context of a money-inthe-
utility framework, the results obtained in the Cagan ad hoc model with
perfect foresight are founded and confirmed. This implies restricting the use
of the latter model only to speculative hyperinflations analysis. In the context
of a transaction costs based model, it has been shown that deficits can
generate monetary hyperinflations. Moreover, speculative hyperinflations
remain possible. This result is in sharp contrast to that of the money-in-theutility
framework and implies a demand for money, different from the Cagan
form.
The modeling of hyperinflation starts with the seminal work of Cagan (1956) within the
new quantity theory of money. In his original contribution, Cagan defines hyperinflation
as a speeding-up inflation process, where the inflation rates exceed 50% monthly.
He provides the explanation of hyperinflation as being the result of an excessive public budget
deficit, financed by money creation or seigniorage revenues. Within this framework which
relies on the specification of an ad hoc demand for money, hyperinflation is viewed as
a pure monetary phenomenon, where both inflation rates and money growth rates accelerate
and explode. This model deals with monetary hyperinflation. However, Cagan’s original modeling with adaptive inflation expectations does not succeed in producing monetary
hyperinflations, as monetary growth is not modeled yet. Evans and Yarrow (1981), and Bruno
and Fischer (1987) complete Cagan’s model by modeling the money supply process through
the government budget constraint. Nevertheless, Cagan’s model approach is seriously
challenged with the introduction of rational expectations, when Buiter (1987) shows that
the model with perfect foresight is unable to produce any hyperinflation. The failure of the
Cagan model to generate hyperinflations under rational expectations has created some trouble
in the literature. Evans (1995), for instance, states a strict association between the correct
running of the model and adaptive expectations. Blanchard and Fischer (1989), and Walsh
(2003) present the Cagan model only under the adaptive expectations assumption. |
