In addition to owing war reparations, Hungary inherited an economy facing shortages and uprooted from traditional trading relationships. The erection of new national barriers restricted trade between regions of the former Austro-Hungarian Empire. To complicate the economic turmoil, A Bolshevik revolution threw Hungary into monetary confusion; the revolutionaries seized the plates for one- and two-crown Austro-Hungarian bank notes and ran the printing presses liberally in support of their cause. A right-wing regime supplanted the Bolsheviks, but through 1924 the government continued to finance between 20 and 50 percent of government expenditures with issues of paper money.
The Hungarian section of the Austro-Hungarian bank was spun off as the State Note Institute, a note-issuing bank under the authority of the minister of finance. The State Note Institute exchanged its notes, the Hungarian krone, for the notes of the Austro-Hungarian bank, and even the notes issued by the Bolshevik government.
Total notes and deposit liabilities of the State Note Institute grew by a factor of 85 from January 1922 until April 1924, the time frame over which prices increased by a factor of 263. The percentage growth in prices exceeded the percentage growth in the money supply, reflecting the effects of the flight from the krone. As prices escalated, Hungarian residents sought to spend krones before they lost value, raising the velocity of circulation, adding further fuel to the inflationary spiral. To restrict Hungarians from using krones to buy assets denominated in more stable foreign currencies, the Hungarian government established the Hungarian Devisenzentral as part of the State Note Institute. This agency was responsible for making it difficult or illegal for Hungarians to own foreign currency.
The end of the inflationary episode in Hungary came when the League of Nations arranged an international loan for Hungary conditioned upon government policies committed to balanced budgets and a central bank independent of government authorities. The reparation committee also gave up its claim on Hungary’s resources. The broad outlines of the reconstruction of Hungary’s finances mirror closely the Austrian experience. The new central bank, the Hungarian National Bank, was able to continue increasing the supply of paper krones, but these krones were now backed by gold, other foreign assets, and commercial paper.
Inflation stabilized in December 1924 and the krone ended its slide on the New York foreign exchange market.
The Hungarian inflation experience underlines the importance of expectations in monetary affairs. The assurance of a return to responsible government policies was sufficient to bring a quick halt to inflationary momentum.
