Destabilizing effects of a successful stabilization: a forward-looking explanation of the second Hungarian hyperinflation

The extreme severity of the second Hungarian hyperinflation is argued to be related to the unusual way in which the inflation was eventually stabilize d. The historical features of this episode are represented in a general equ ilibrium model, which incorporates a transition from one monetary regime to another. During the inflation the government finances a fixed deficit with seigniorage revenue, After the stabilization the government budget is bala nced and the central bank engages in a program of subsidized lending to the private sector. Stabilization is achieved by targeting a low inflation rat e path through adjustments in the quantity of central bank lending. I show that under this stabilization policy (1) the dynamic equilibrium path of th e economy is indeterminate and (2) arbitrarily high pre-stabilization infla tion rates are possible.