The Debt-Inflation Channel of the German Hyperinflation

Abstract

Unexpected inflation can redistribute wealth from creditors to debtors. In the presence of financing frictions, such redistribution can impact the allocation of real activity. We use the German inflation of 1919-1923 to study how a large inflationary shock is transmitted to the real economy via a debt-inflation channel. In line with inflation reducing real debt burdens and relaxing financial constraints, we document a tight negative and convex relation between firm bankruptcies and inflation in aggregate data. Using newly digitized firm-level data, we further document a significant decline in leverage and interest expenses during the inflation. We show that firms that have more nominal liabilities at the onset of the inflation become more valuable in the stock market, face lower interest payments, and increase their overall employment once the inflation starts. The results are consistent with substantial real effects of the inflation through a financial channel that operates even when prices and wages are fully flexible.

Keywords: Inflation, macro-finance, macroeconomics, financial frictions, hyperinflation, economic history

JEL Classification: E01, E40, E50, G00, G20, G30