A (not so brief) history of inflation in Austria Christian Beer, We analyze the eventful history of inflation in Austria over the past two centuries against Ernest Gnan, the background of institutional, economic and political developments. Ultra-high inflation Maria Teresa or hyperinflation resulted from repeated monetary financing of war expenses, war-related Valderrama1 destruction of productive capacity as well as fear of short-term political and social conse- quences of anti-inflationary measures. Like other countries, Austria experienced the highest inflation during peaceful times in the 20th century when efforts were made to cushion the negative output effects of oil price shocks. Inflation volatility was high in the 19th century up to the Gründerzeit boom and in the 20th century during the Great Inflation; it was low in the half-century up to World War I and during the Great Moderation. Our frequency domain analysis for the pre-World War I and post-World War II periods finds that, in line with the economic literature, the correlation between money growth and inflation is considerably higher for long and very long frequencies than for business cycle frequencies. The varying correlation between money and inflation reflects changing monetary regimes. We cannot establish a stable empirical Phillips curve relationship; in the post-World War II period, the relationship breaks down once supply shocks (oil prices) are included. Deflation was quite frequent in 19th-century Austria and was not necessarily associated with recessions. By contrast, Austria’s 20th century Great Depression fits the textbook notion of deflation, high unemployment and economic slack. Formal central bank independence did not prevent the erosion of monetary value in “emergency situations” of wars. Hyperinflations and currency reforms repeatedly inflicted substantial and long-lasting damage on citizens’ trust in state money and in the state more generally. JEL classification: E58, N13, N14 Keywords: inflation, Austria Maintaining price stability is the pri- ing economic circumstances (such as mary objective of monetary policy the conduct of devastating and expen- nowadays, and we have become used to sive wars) and the evolution of economic very low rates of consumer price infla- thought (e.g. the doctrine of metal tion in Austria over the past three standards that applied throughout most decades. However, inflation has not of the 19th century, the Keynesian con- always been low. The bicentennial of cept of exploiting an – actual or per- the Oesterreichische Nationalbank ceived – tradeoff between unemploy- (OeNB) offers the opportunity to ana- ment and price stability during the lyze the eventful – and at times dra- 1960s and 1970s, and the emphasis on matic – history of inflation in Austria time inconsistency and central bank over the past two centuries. independence since the 1980s). Looking back in history, we find Any analysis of price and inflation that the central bank’s role, mandate, developments should take this broader and institutional status in relation to perspective into account rather than the government, the intermediate goals imposing present-day economic and of monetary policy as well as the in- institutional concepts ex post. In this struments available to, and used by, the article, we therefore combine a historic central bank have evolved considerably narrative that recalls relevant political, over time. These changes reflect vary- institutional and economic develop- Refereed by: Geoffrey Wood, 1 Cass Business Oesterreichische Nationalbank, Economic Analysis Division, [email protected], [email protected], [email protected]. The views expressed in this paper are exclusively those of the authors and do not School and necessarily reflect those of the OeNB or the Eurosystem. The authors acknowledge helpful comments and sugges- University of tions by Walpurga Köhler-Töglhofer, Clemens Jobst, Lukas Reiss, Fabio Rumler, Alfred Stiglbauer, our referee and Buckingham participants in a workshop among the authors of this volume. 6 OESTERREICHISCHE NATIONALBANK A (not so brief) history of inflation in Austria ments when identifying various infla- sistent policies resulting from the quest tion regimes with empirical statistical to achieve credibility for the central and econometric analysis to shed light bank and paper money despite rulers on Austria’s inflation history from vari- seeking ways to have the central bank ous angles.2 We use the long time series finance their expenses, most notably that have now been made available by for wars. Various institutional changes the OeNB to discuss specific features of had been attempted (Jobst and Ker- the development of the inflation rate. nbauer, 2016) to enhance the prede- In particular, we investigate inflation cessor institutions’ credibility by bol- volatility, the long-run relationship stering these institutions’ perceived – between money growth and inflation, rather than actual – independence. But and the short-run correlation between despite this conflict of goals (monetary the output gap and inflation in Austria; stability versus war financing) currency we then discuss whether these relation- stability was not seriously endangered ships have changed over time. until the Napoleonic wars, as taxation For our purposes, it is useful to dis- and loans sufficed to finance most war tinguish five periods of inflation in expenditure. In the end, however, the Austria over the past two centuries: Napoleonic wars proved to be too long; first, the pre-World War I period of an the pressure for the monetary financ- overall relatively stable price level (sec- ing of war expenses prevailed, and the tion 1); second, World War I (WW I) resulting expansion of money in cir- and the following period of hyperinfla- culation eroded the purchasing power tion (section 2); third, the post-WW I of money. Paper money, originally ad- currency reform, the Creditanstalt cri- opted by the public voluntarily for its sis and the Great Depression (sec- ease of use, was eventually enforced by tion 3); fourth, World War II (WW II) law, by being granted the status of legal and the postwar inflation and currency tender. Repeated attempts at currency reform (section 4); fifth, the further stabilization were half-hearted and had postwar period, which includes the re- no lasting impact. The amount of paper sponse to the demise of the Bretton money in circulation increased 120- Woods system, the first and second oil fold between 1792 and 1816. In the price shocks as well as the hard cur- two decades before the Nationalbank’s rency policy and Austria’s membership foundation in 1816, the average price of in Economic and Monetary Union seven food items in Vienna increased (EMU) (section 5). Section 6 summa- 50-fold. The sovereign default and cur- rizes and concludes. rency reform of 1811, which had at its core the compulsory devaluation of pa- 1 The first century until World per florins to one-fifth of their value, War I was considered “a brutal and wrongful The foundation of the privilegirte oes- method of debt relief that shook finan- terreichische National-Bank in 1816 re- cial and legal relationships to the core” flected the attempt to establish mone- (Brandt, 1978, as quoted and translated tary stability after 100 years of incon- in Jobst and Kernbauer, 2016). At the 2 For a detailed account of the broader economic historical and institutional developments, please refer to Jobst and Kernbauer (2016) as well as to Antonowicz et al. (2016). The latter publication also includes an overview chart of inflation in Austria spanning the period from 1800 to 2015 and numerous overview tables with relevant historical events. MONETARY POLICY & THE ECONOMY Q3– Q4/16 7 A (not so brief) history of inflation in Austria Chart 1 The first century until World War I (1816 to 1913) Price index Inflation Index (1914=100, logarithmic scale) % Standard deviation in % 1,000 15 8 10 6 5 0 100 4 –5 –10 2 –15 10 –20 0 1816 1826 1836 1846 1856 1866 1876 1886 1896 1906 1816 1826 1836 1846 1856 1866 1876 1886 1896 1906 Price index Inflation rate (left-hand scale) Inflation volatility (right-hand scale) Nominal GDP and money supply Industrial production ATS billion (converted from original currency Million currency then in force Index (1913=100, logarithmic scale) % (logarithmic scale) (logarithmic scale) 1.0 100,000 1,000 30 20 10 0.1 10,000 100 0 –10 0.0 1,000 10 –20 1816 1826 1836 1846 1856 1866 1876 1886 1896 1906 1816 1826 1836 1846 1856 1866 1876 1886 1896 1906 Currency in circulation (left-hand scale) Index (left-hand scale) M1 (left-hand scale) Growth rate (right-hand scale) Nominal GDP 1 (right-hand scale) Nominal GDP 2 (right-hand scale) Source: OeNB, Komlos (1986), Mühlpeck et al. (1979), Kausel (1979), Bank of Greece et al. (eds.) (2014), authors’ calculations. For further information on the data, see annex. Note: Nominal GDP 1: Kausel (1979), Nominal GDP 2: Bank of Greece et al. (eds.) (2014). Before 1900 Gulden österreichischer Währung (Austrian florin), 1900 conversion to crown. same time, the currency reform of 1811 privately owned institution was shaped did not bring the promised end to inflation. to pursue this objective. It is against this background that the However, subsequent changes in foundation of the Nationalbank in 1816 the central bank statutes successively needs to be seen. The currency reform increased the state’s influence on the of 1816 was based on three pillars: first, Nationalbank’s policy, and a coalition the return to convertibility into metal of interests of the state, the National- currency; second, the credible consol- bank’s shareholders and management, idation of state finances; and, third, who all sought to maximize seignor- the foundation of a new institution in age from note issuance, implied that charge of monetary stability, whose in- the share of banknotes in cash in circu- centive structure as an independent, lation increased to much higher levels 8 OESTERREICHISCHE NATIONALBANK A (not so brief) history of inflation in Austria than e.g.