The Forward Exchange Rate, Expectations, and the Demand for Money-The German Hyperinflation: Comment
Abstract
As Phillip Cagan pointed out, hyperinflation provides the opportunity to study monetary phenomena in a situation where increases in nominal quantities dwarf changes in real quantities. The large changes in prices, moreover, surely create sizeable incentives to predict as well as possible the changes in these prices. Thus a central feature of a model of asset supply and demand in hyperinflation is the way in which agents are assumed to form their expectations. In a recent article in this Review, Jacob Frenkel proposed to infer from the data on spot and forward deutsche mark exchange the onemonth future rate of inflation expected in Germany during the post-World War I hyperinflation. The major virtue of such an approach, suggested Frenkel, was that it depended on observable market prices rather than mechanistic formulae to generate agents' guesses as to the opportunity cost of holding money. Frenkel based his conclusion that foreign exchange data could be used to measure inflation expectations on evidence that during the hyperinflation the market in deutsche mark exchange functioned efficiently. He based his conclusion that exchange markets were efficient on his estimates of two regressions:
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