Disinflation in Transition Economies

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280 pages

The authors of this outstanding scholarly work analyze the dynamics of disinflation in transition economies in Central and Eastern Europe. The volume covers all the key factors of this process: changes in money supply and money demand; exchange rate policy; currency crisis; fiscal policy; legal status of central banks; monetary policy strategy; changes in relative prices and changes in nominal and real wages. The book contains 13 chapters related to various aspects of disinflation and covering different sets of transition countries depending on their relevance to the analyzed topic and data availability.

In 1989, the editor was invited to help prepare the economic program of the first democratic government of Poland. From 1989 to 1990 he was First Deputy Minister of Finance. In 1991 he helped found and later became Vice Chairman of the CASE-Center for Social and Economic Research, a private international research and policy-advising institution in many transition-supporting projects. From 1994 to 1995, he was a visiting consultant in the Policy Research Department of the World Bank. Since 1998 he has been a member of the Monetary Policy Council of the National Bank of Poland.

The publication brought fresh arguments to the ongoing policy discussion on the importance of low inflation in transition countries and the role of a proper monetary policy mix and exchange rate policy in achieving sustainable disinflation.

List of Figures
List of Tables and Appendices
About the Authors
Foreword (Simon Johnson)
Introduction (Marek Dabrowski)

1. Disinflation Strategies and Their Effectiveness in Transition Economies (Marek Dabrowski)
1.1. The Economic Rationale for Disinflation
1.1.1. The Damaging Effects of High and Very High Inflation
1.1.2. Moderate and Low Inflation: The Danger of Inflation Inertia
1.1.3. Results of the Empirical Research
1.2. The Varying Speeds of Inflation
1.2.1. The Size of the Initial Destabilization
1.2.2. The Timing of Disinflation Programs
1.2.3. The Speed of Disinflation (until 1997)
1.2.4. Inflation Developments, 1998–1999
1.2.5. Reversal of the Disinflation Trend
1.3. Looking for an Effective Disinflation Strategy
1.3.1. Stabilization Strategies in the First Stage of Transition
1.3.2. Controversies Surrounding Exchange-Rate Targeting in Moderate- and Low-Inflation Environments
1.3.3. Exchange Rate Arrangements That stimulate Inflation Inertia
1.4. The Role of Fiscal Policy in Supporting the Disinflation Process
1.4.1. Monetary Financing of Fiscal Deficits
1.4.2. Nonmonetary Financing of Fiscal Deficits
1.4.3. Debt-Trap Episodes and Financial Crises
1.4.4. The Role of Fiscal Policy and Central-Bank Independence
1.5. Conclusions

2. Monetary Expansion and Its Influence on Inflation Performance in Transition Economies (Rafal Antczak)
2.1. Stabilization and Inflation
2.2. Simple Monetary Accounting
2.3. Inflation and the Rate of Growth of Broad Money
2.4. Final Remarks

3. Money Demand and Monetization in Transition Economies (Marek Jarocinski)
3.1. “Unfreeezing” the Monetary Overhang
3.2. Monetization in the Transition Economies Compared
3.2.1. Broad-Money Monetization and Per Capita GDP
3.2.2. Inflation and Monetization
3.3.3. The Banking Sector and Broad-Money Monetization
3.3. Factors Determining Monetization in the Transition Economies
3.3.1. Real GDP and Inflation Dynamics
3.3.2. The Shadow Economy
3.3.3. The Banking Sector’s Circumstances
3.3.4. Currency-Board Arrangements
3.4. High-Monetization Transition Economies
3.5. Medium-Monetization Transition Economies
3.6. Low-Monetization Countries
3.6.1. General Characteristics
3.6.2. Additional Factors in Low-Monetization Countries
3.6.3. How Demonetized Economies Function?
3.6.4. Money-Demand Dynamics during Stabilization, Following Hyperinflation
3.7. Conclusions
Data Sources

4. The Influence of Exchange-Rate Stability on Inflation (Malgorzata Antczak and Urban Gorski)
4.1. The Transmission Channels of a Currency Depreciation on Prices
4.2. Inflation and Currency-Depreciation Rates in a Simple Analytical Framework
4.2.1. Exchange-Rate Stability
4.2.2. The Partial-Adjustment Model
4.2.3. Hypothesis
4. 2.4. Data
4.2.5. Results of Estimates
4.2.6. Some Additional Comments
4.3. When is an Exchange-Rate Anchor Sustainable?

5. The Inflationary Consequences of the Devaluation Crieses in Russia and Ukraine: First Observations (Marek Dabrowski, Urban Gorski, and Marek Jarocinski)
5.1. The Crises: Similarities and Differences
5.2. The Crisis Spiral Develops
5.2.1. Dynamics of the Russian Crisis
5.2.2. Ukrainian-Follow-up
5.3. Explaining the Initial Inflation Surge
5.3.1. The Influence of the Exchange Rate-Rate Depreciation on Prices in Russia
5.3.2. Expectations and Speculative Demand during the Initial Price Spike
5.3.3. The Influence of the Exchange-Rate Depreciation on Prices in Ukraine
5.3.4. The Role of Administrative Price Controls
5.4. Channels of Money Supply and Money Velocity
5.4.1. Money Supply in Russia
5.4.2. Monetary Aggregates in Ukraine
5.5. Comparing the Inflationary Consequences of the Financial Crises
5.6. Final Remarks
Appendix. Data Sources

6. Disinflation Policy, Capital Inflow, and the Current-Account Balance (Krzysztof Rybinski and Mateusz Szczurek)
6.1. The Determinants of Foreign Borrowing
6.2. Policymakers’ Responses to Capital Inflows: Theoretical Models
6.2.1. The Absorption Approach
6.2.2. Responding to Capital Inflows: The Proper Policy Mix
6.2.3. Meade’s Internal–External Balance Synthesis
6.2.4. Mundell’s Assignment Problem
6.2.5. Intertemporal Current-Account Models
6.3. What Determines the Current Account’s Improvement?
6.4. The Current Account–Inflation Trade-of: The Causality Issue
6.5. Capital Inflows, Exchange Rates, and Inflation: The Czech Republic, Hungary, and Poland
6.5.1. Panel Analysis
6.5.2. PPP Model Analysis
6.6. Summary and Conclusions

7. Modeling the Real Exchange Rate in Transition: The Cases of Poland and Romania (Maryla Maliszewska)
7.1. Theoretical Considerations
7.1.1. Modeling Real Exchange Rates in Developed Economies
7.1.2. Modeling Real Exchange Rates in the Transition Economies
7.2. Empirical Research: Characteristics of the Model
7.3. The Real Exchange Rate in Romania
7.3.1. General Characteristics
7.3.2. Data Description
7.3.3. Methodology and Results
7.4. The Real Exchange Rate in Poland
7.4.1. General Characteristics
7.4.2. Data Description
7.4.3. Methodology and Results
7.5. Conclusions

8. Fiscal Policy and Disinflation in Transition Economies (Malgorzata Markiewicz)
8.1. The Interrelationship between Fiscal Deficits and Inflation
8.2. Budget Deficits in the Early Stage of Transition
8.3. Quasi-Fiscal Arrangements
8.4. The Consequences of Nonmonetary Deficit Financing
8.4.1. The Hungarian Crisis: 1994
8.4.2. The Bulgarian Crisis: 1994 and 1996–1997
8.4.3. The Russian Crisis: 1997–1998
8.4.4. The Ukrainian Crisis: 1997–1998
8.4.5. The Crises in Kyrgyzstan: 1996 and 1998
8.5. Conclusions

9. Central-Bank Independence and Its Impact on Inflation in Transition Economies (Wojciech Maliszewski)
9.1. Central-Bank Independence: Economic Theory and Empirical Evidence
9.2. Economic Theory and Transition Realities
9.3. Indices of Legal Independence
9.4. Revisions in Central-Bank Laws
9.5. Central-Bank Independence and Inflation Performance
9.6. Conclusions
Appendix. Central-Bank Laws in the Transition Economies

10. Relative Price Adjustment in the Czech Republic, Hungary, and Poland: A Comparison of the Size and Impact of Inflation (Przemyslaw Wozniak)
10.1. Inflationary Pressures Derived from Relative Price Variability
10.1.1. Theoretical Framework
10.1.2. Relative Price Variability: Visual Inspection and the Model
10.1.3. Description of the Data
10.2. Sources of Relative Price Variability
10.2.1. Outlier Price Changes
10.2.2. Seasonality
10.2.3. Relative Prices of CPI Aggregates
10.2.4. The Evolution of Price Structures
10.3. Summary and Conclusions
Appendix. Data Sources

11. The Wage–Price Spiral in Transition Economies (Mateusz Walewski)
11.1. The Wage–Price-Relationship Theory
11.1.1. The Wage–Price Spiral
11.1.2. Wage–Price Equation Theory
11.2. Empirical Research on the Wage–Price Spiral
11.3. Graphical and Statistical Analysis of Wage–Price Relations
11.3.1. The Data Source
11.3.2. The Price–Wage-Relationship during High-Inflation Periods
11.3.3. Graphical Analysis of the Data from a Moderate-Inflation Period
11.3.4. Statistical Analysis of the Relationship between Wages and Unemployment and Productivity
11.4. Econometric Analysis of the Relationship between Prices and Wages
11.4.1. Econometric Results from High-Inflation Periods
11.4.2. Econometric Results form High-Inflation Periods without the Unemployment Variable
11.4.3. Results of Analysis of a Moderate-Inflation Period with the Unemployment Variable Included
11.4.4. Results of Estimated Equations for Moderate-Inflation Periods
11.5. Summary and Conclusions

12. Monetary-Policy Targeting in the Central European Transition Economies (Lucjan T. Orlowski)
12.1. The Review of Monetary-Targeting Practices before 1998
12.2. Forward-Looking versus Backward-Looking Monetary Policies
12.3. The Advantages of Direct Inflation Targeting (DIT)
12.4. A Model of Direct Inflation Targeting for Central Europe
12.5. Core-Inflation Targeting in the Czech Republic
12.6. A Synthesis

13. Prospects for a Future Disinflation Policy in Poland (Witold M. Orlowski)
13.1. Future Inflation: The Structural Factors
13.2. The Exchange Rate, Inflationary Expectations, and the Current-Account Deficit
13.3. The Experiences of EU Countries
13.4. Poland’s Macroeconomic Policy and Inflation


"This is the only truly comprehensive analysis of disinflation in the post-communist period. The book is comprehensive in the sense that all the countries of the former Soviet bloc are covered, all of the key issues relating to disinflation are assessed carefully and with insight and the problems of disinflation are addressed using the latest theoretical and empirical tools. . The volume is likely to become the definitive work on the subject of disinflation in post-communist economies."