After the close of World War I, Austria, one of the states that emerged from the division of the Austro-Hungarian Empire, experienced an episode of soaring hyperinflation, registering an annual inflation rate of 10,000 percent between January 1921 and August 1922. A legacy of food shortages and high unemployment after World War I helped send Austria on a monetary path of economic insanity. The creation of new states, coupled with the scarcities of war, disrupted traditional flows of trade, and Austria, a loser in the struggle, owed war reparations.
The government of Austria met the crisis by incurring large expenditures on food relief and unemployment relief. From 1919 until 1922 the Austrian government collected less than 50 percent of public expenditures in taxes, and financed the remainder selling treasury bills to the Austrian section of the Austro-Hungarian Bank, which paid for the treasury bills with fresh bank notes, denominated in Austrian crowns. From March 1919 until August 1922 the Austro-Hungarian Bank multiplied Austrian bank note circulation by a factor of 288, increasing the supply of bank notes in circulation from the equivalent of $4.7 million to over $1.3 billion. Aside from public borrowing, the bank continued to make private sector loans at favorable interest rates.
As inflation mounted, Austrians began a “flight from the crown.” They spent the bank notes sooner after receiving them and Austrian crowns held as a form of wealth were spent. Austrians put wealth in foreign exchange or real assets, minimizing holdings of Austrian currency. Contemporary economists might describe the flight from the crown as an increase in the velocity of money, meaning money is spent more frequently on goods and services. The government instituted exchange controls in a rather ineffective effort to stop Austrians from converting Austrian crowns to foreign exchange. The value of Austrian crowns in the New York foreign exchange market dropped sharply. In January 1919 one U.S. dollar bought 17.09 Austrian crowns, and in August 1922 one U.S. dollar bought 77,300 Austrian crowns.
The flight from the crown caused prices to rise faster than the money supply growth rate. Between January 1921 and August 1922 retail prices rose by a factor of 110, while bank note circulation rose by a factor of only 39.
The depreciation of the crown in foreign exchange markets stopped abruptly in August 1922, and the upward spiral in retail prices ended the following month. The League of Nations arranged for the Austrian government to receive a loan of 650 million crowns. In return the Austrian government had to end deficit spending and establish a central bank independent of the government. The mere spread of knowledge of the agreement was sufficient to stabilize retail prices and the crown in foreign exchange markets.
The central bank of Austria continued to rapidly infuse bank notes into the Austrian economy but inflation subsided, appearing to defy the laws of economics. These bank notes, however, were backed with gold, foreign assets, or commercial paper, rather than government securities. The change in the composition of the assets of the central bank accounted for the end of the monetary disorder.
At the end of 1924, long after the inflation subsided, Austria issued a new unit of currency, the shilling, worth 10,000 crowns.
