The Baltic countries began their stabilization and reform process in earnest in mid-1992. During the first two years of reform, these countries have made significant progress in macroeconomic stabilization despite serious initial imbalances resulting from two major supply shocks. The systemic shock--the collapse of the centrally planned economy--caused major disruptions in trade, payments, and monetary arrangements with Russia and other states of the former Soviet Union, The terras-of-trade shock, resulting from Russia’s sudden move toward world market prices in oil and raw material exports to the Baltic countries, called for a sharp adjustment of real incomes. By 1994 the output decline had bottomed out and economic recovery was under way. Financial policies have been tight and inflation has been brought down. With their rapid success, the Baltic countries have become widely recognized as model cases of stabilization for post-Soviet states.
This paper highlights several factors, some general and some specific, contributing to the success of the Baltic countries’ transition process. During the first years of serious reform, inflation has fallen more than it did in Poland, for example, during a corresponding period after that country’s “big bang.” Also, the output cost of the disinflation process has remained very small in Estonia, and has been rather limited in Latvia and Lithuania.
Strong commitment to sound financial policies has been crucial for these achievements. Fiscal positions in the Baltic countries--unlike those in many Central European countries after their economic reforms--have been solid throughout 1992-94 and helped establish the credibility of strong monetary policies.
While the Baltic countries initially adopted different exchange rate regimes, it appears that the credibility of their policies has been more important than the choice between exchange rate and money-based stabilization per se. Inflation has declined to low levels in each country regardless of the exchange rate regime. To some extent, the choice of regime may be reflected in the timing of the output variations, although the evidence for such causality is weak, given the large number of exogenous factors affecting output developments during the transition. The real exchange rate appreciation in each country, which has continued since the outset of the reforms, appears sustainable so far.