Having stabilized inflation rapidly and credibly, a number of advanced transition countries appear to have got stuck with moderate inflation in the 10–30 percent range (see Table 1, Section II, and Figure 4). The Czech Republic and Slovenia have spent 3–4 years in the high single-digit range. The Baltic States have only recently come down to those levels from the 20–40 percent range in 1993–95. Hungary has hovered in the 20–30 percent range throughout transition, until 1998, when it began disinflating into the lower teens from there. And Poland, after its rapid disinflation in 1990–91, has taken six years to get to the low teens. This section considers the factors underlying the slow progress after the initial dramatic successes.
Advanced Transition Reformers, 1990–97
Sources: Country authorities; IMF, World Economic Outlook; various EBRD transition reports; and IMF staff estimates.1The group consists of Estonia, Latvia, Lithuania, the Czech Republic, Hungary, Poland, the Slovak Republic, and Slovenia.2The black line is the median. The shaded area represents the range containing all but the highest and lowest observations.The characteristics of the transition countries that have sustained five or more years of disinflation are highlighted in Figure 4. The key features are as follows: growth resumed in the second year after disinflation was initiated; these are generally “big bang” structural reformers; after five years, the group has institutional characteristics closely resembling those of mature market economies; the group has achieved increasingly strong fiscal positions; and although large current account deficits have appeared, the debt financed component of the external current account deficit has generally been relatively contained, though latterly, with increased variance. Finally, a glance at Table 11 confirms that the group has overwhelmingly pegged their exchange rates or has applied crawling pegs, though the Czech Republic switched to a managed float in 1997, joining Slovenia.
This summary indicates that progress toward price stability halted despite a propitious environment for disinflation: output, the debt-financed external balance, and fiscal policies have been strong, and structural reforms are far advanced. Furthermore, the experience of two countries outside this group—Croatia and the former Yugoslav Republic of Macedonia—confirms that sustained low inflation is clearly possible in the transition context, although further policy adjustments, on both the structural and macroeconomic sides, may be necessary to sustain this performance.
Rather than reflecting a difficult environment for disinflation or an “inflation floor” in transition, the persistent inflation of advanced reformers appears to reflect their choices of exchange rate regime and their policy preferences about inflation. Some advanced moderate inflaters, including the Czech Republic and the Baltic States, were reluctant to abandon successful nominal exchange rate anchors. This commitment persisted even if initial undervaluation, reductions in underlying country risk premiums, and large relative price and relative productivity changes required real appreciations of their currencies. Clearly, in these circumstances, nominal appreciations would have been necessary to effect real exchange rate corrections with lower inflation. Persistent moderate inflation in the Baltic States appears to derive most clearly from this source (Richards and Tersman, 1995), compounded by the real effective appreciation of the ruble between 1994 and 1997. Paradoxically, after the initial stabilizations of inflation, further reductions toward industrial country rates may have been delayed by the commitment of these countries to nominal anchors that were in-tended to signal adherence to prudent policies. Mutatis mutandis, the same argument applies to countries with a crawling peg where the rate of crawl may have been lowered too gradually to avoid the risk of a real appreciation.
But the persistence of moderate inflation also reflected perceived trade-offs. Having reduced inflation to well below its recent peaks and to levels that international investors and the authorities perceived as “low by transition standards,” some moderate inflaters saw no urgency to progress further. And some also feared that further progress would require output losses on top of those that had accompanied the initial stages of transition (Medgyessy, 1998). Thus, for example, Hungary prioritized structural reforms and reduced the external current account deficit and external debt after 1995 over further disinflation.
Finally, administered price adjustments often bulk large in relative price changes: typically, rents and utility prices have been held artificially low, and these sectors generally have limited scope for productivity gains to ease supply constraints. The consequent relative price adjustments have boosted headline CPI rates, with an impact that is particularly evident in moderate inflation contexts where relative price adjustments automatically loom larger. Accordingly, moderate inflaters that “backloaded” administrative price adjustments in their reform programs, including the Czech Republic, report higher headline CPI rates. Nevertheless, even underlying inflation rates have remained persistently above industrial country levels in these cases.
Persistent moderate inflation among advanced transition countries thus appears to reflect policy choices rather than structural features of transition. Those choices had various elements, including concerns about abandoning hitherto successful nominal anchors, the risks further disinflation might imply for output, and a perception that sufficient progress on inflation had already been made. These choices are changing, however. Many of the authorities in the group believe now that reducing inflation to industrial country levels is both feasible and desirable. These views are reflected in their accession programs to the European Union, and in recent reforms of exchange rate regimes, including the shift to formal inflation targeting in the Czech Republic and in Poland.
