THE CLASSIC EUROPEAN HYPERINFLATIONS REVISITED - TESTING THE CAGAN MODEL USING A COINTEGRATED VAR APPROACH

The Cagan model of hyperinflation under rational expectations, no bubb les and stationary velocity shocks has the implication that real balan ces cointegrate with money growth. In a re-examination or the classic European hyperinflations, I find support for this cointegrating proper ty, which gives evidence against the assumption made in most previous studies that velocity shocks follow a random walk. Based on a cointegr ated VAR model, I reject statistically, for four of the six hyperinfla tions, the exact rational expectations Cagan model; but at the same ti me I find evidence of a substantial forward-looking element in agents' demand for real balances, in the sense that a large part of the predi ctable movement in money growth is incorporated in agents' demand for money.