Empirical testing for bubbles during the inter-war European hyperinflations

In this thesis, I undertake an empirical search for the existence of price and exchange rate bubbles during the inter-war European hyperinflations of Germany, Hungary and Poland. Since the choice of an appropriate policy to control inflation depends upon the true nature of the underlying process generating the inflation, the existence or non-existence of inflationary bubbles has important policy implications. If bubbles do exist, positive action will be required to counter the public's self-fulfilling expectation of a price surge. Hyperinflationary episodes have been chosen as my case study because of the dominant role that such expectations play in price determination. In the literature, there are frequently expressed concerns about empirical research into bubbles. The existence of model misspecification and the nonlinear dynamics in the fundamentals under conditions of regime switching may lead to spurious conclusions concerning the existence of bubbles. Furthermore, some stochastic bubbles may display different collapsing properties and consequently appear to be linearly stationary. Thus, the evidence against the existence of bubbles may not be reliable. In my thesis, I attempt to tackle the above empirical problems of testing for the existence of bubbles using advances in testing procedures and methodologies. Since the number of bubble solutions is infinite in the rational expectations framework, I adopt indirect tests, rather than direct tests, for the empirical study. From the findings of my empirical research, the evidence for stationary specification errors and the nonlinearity of the data series cannot be rejected, but the evidence for the existence of price and exchange rate bubbles is rejected for all the countries under study. It leads to the conclusion that the control of the inter-war European hyperinflations was attributable to control of the fundamental processes, since the dynamics of prices and exchange rates for these countries might not be driven by self-fulfilling expectations