Misspecification versus bubbles in hyperinflation data: Monte Carlo and interwar European evidence

This paper analyzes tests of the Cagan hyperinflation-money demand model that have several advantages relative to those in the literature. They do not confound specification error with rational bubbles, are implementable with a linear procedure, and are frequently able to detect periodically collapsing bubbles that have challenged existing tests. After a Monte Carlo analysis, the tests are applied to data from hyperinflations in Austria, Germany, Hungary, and Poland. Strong evidence of model misspecification is found for Austria, while the model with a rational, explosive component well characterizes the Polish data. Inferences for Germany and Hungary are mixed.