Achieving Low Inflation In Transition Economies

• Pages: 86-88

Page 86

A key issue for IMF-supported macroeconomic stabilization and reform programs in transition countries is whether the persistence of moderate inflation-levels of about 20-40 percent a year-results from the traditional causes of insufficiently tight financial policies and wage pressures or from conditions peculiar to transition economies: specifically, the sizable adjustment of relative prices necessary for transformation to a market-based economy. A new IMF paper on Policy Analysis and Assessment, entitled Designing Disinflation Programs in Transition Economies: The Implications of Relative Price Adjustment, by Sharmini Coorey, Mauro Mecagni, and Erik Offerdal, addresses this question through an examination of the inflation-fighting experiences of 21 transition economies (Eastern Europe, the Baltic states, and the other countries of the former Soviet Union) between 1990 and 1995. Based on the empirical evidence, the authors conclude that money growth, inertia, and wage pressures play a dominant role in explaining inflation in transition economies. Relative price variability appears to have a sizable impact during the initial liberalization period, but a small effect in the later stages of transition. The evidence also suggests, however, that significant relative price adjustments take place throughout the transition period, even well beyond comprehensive initial liberalization, and that money growth in the later stages of transition may reflect-depending on exchange rate policy-surges in capital inflows.

Money growth plays a dominant role in explaining inflation in transition economies.

Determinants of Inflation

Five key variables largely explain the stickiness of inflation in transition economies:

* monetary growth fueled by fiscal obligations, often reflecting delayed structural reforms;

* inflation inertia reflecting explicit or implicit wage indexation and the slow adjustment of inflation expectations;

* wage increases out of line with productivity gains;

* underlying pressures for an appreciation of the real exchange rate coupled with a policy of resisting nominal appreciation through official intervention in foreign exchange markets; and

* relative price adjustment combined with downward price rigidities.

Principal Findings

Key findings of the IMF study include the following: Money growth plays a dominant role in explaining inflation...