Opening Address

Carlo Cottarelli, and Gyorgy Szapary
Published Date:
July 1998
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Peter Medgyessy

I am pleased that a seminar on disinflation policies in countries with moderate inflation, sponsored by the International Monetary Fund, the Ministry of Finance of the Republic of Hungary, and the National Bank of Hungary, was held on June 3, 1997 in Budapest. Speakers with broad international experience and outstanding knowledge on the subject—first among them Stanley Fischer, First Deputy Managing Director of the IMF, who has already published several studies based on international comparisons that are still regarded as authoritative on this subject—expressed their opinions, offered their recommendations, and formulated their own questions for others to think about. This short but substantive and concentrated event focused mainly on issues facing the transition economies of Central and Eastern Europe. However, it also took into consideration the experiences of countries in other regions with different circumstances and different cultural heritages that are also trying to stabilize their economies and regard the reduction of inflation as one of the central (perhaps determining) components of their economic programs.

For me, someone who looks at disinflation not as an outside observer but as a policymaker, the conclusions of the seminar offer food for thought. I am convinced that the readers of this volume, both policymakers and researchers, will be stimulated to give further thought and devote further research to the issues discussed. The country experiences presented have confirmed my impression that, quoting from the paper by Burton and Fischer, there is no “magic” formula or sure recipe for the successful taming of moderate inflation, which the authors define as a 15–30 percent annual increase in consumer prices. At the same time, I agree with another of the conclusions of this paper, namely, that a tight fiscal policy designed to reduce government indebtedness to sustainable levels is a crucial element of successful stabilization programs.

I believe that inflation will remain on the universal policy agenda for some time to come. We in Hungary are just beginning to recognize its importance, somewhat later than those countries that have experienced prolonged high inflation. The announced aim of our economic policy has always been to reduce inflation, but we have to recognize that very radical disinflation can have negative consequences. The issues involved are complex and must be examined from all perspectives.

The question of radically reducing inflation has now come to the forefront in the transforming countries of Central and Eastern Europe and, hence, in Hungary. In these countries, however, the issues are very different from the ones present, for example, in those European Union countries that are trying to reduce their already low rates of inflation in order to qualify for participation in Economic and Monetary Union. Our situation is equally different from the countries of Latin America that had experienced persistent high inflation—sometimes even hyperinflation—and had undertaken stabilization programs. The main difference between those countries and ours is that, in shedding the old structures of a planned economy, transition economies have, in a short time, undergone sea changes in institutional settings, ownership, trade, and production structures that are unprecedented in recent history. These changes may necessitate a somewhat different approach to inflation reduction or, at least, would warrant examination of whether a different approach is needed and feasible.

The requirements for a successful onslaught against inflation were formulated almost simultaneously with the advent of creeping (and later accelerating) inflation following the Second World War. Friedrich A. Hayek argued emotionally that the social costs of sustained inflation were, at least, not smaller than the social sacrifices entailed in a policy designed to stop inflation. Other well-known economists also hold this view. The essence of this classical train of thought is that policies that artificially stimulate the economy induce inflation that distorts market allocation mechanisms. By prolonging the survival of noncompetitive activities and easing the pressure for undertaking the necessary structural adjustments, these policies eventually weaken the economy, causing grave losses to its long-term potential. In other words, this type of economic policy does not increase, but on the contrary reduces, the growth potential of the economy. Milton Friedman expressed the same view in saying that, in the long run, monetary policy has no real effect on output and employment; at best, it can ease cyclical fluctuations.

These views are right in many respects, and yet economic policies that focus on reducing inflation are accompanied by sacrifices of growth that are felt directly, and their impact is immediately reflected in the decrease (or smaller growth) of the resources available for distribution. In contrast, the benefits of bringing down moderate inflation are longer term and may not be immediately perceptible. Thus, social factors do not facilitate the acceptability of such an economic policy.

As the papers presented at this seminar also point out, the situation is different when inflation reaches very high levels (hyperinflation). Under those circumstances, it is not possible to live with the destructive processes and uncertainties caused by inflation, and the social costs are clear. But when, as in Hungary, inflation is moderate—15-20 percent a year—the costs are less apparent. People get used to inflation and learn to live with it; within a short time, indexation mechanisms, explicit or implicit, emerge that ensure, however badly, that the relative positions of the different market participants and income earners remain predictable and tolerable. Mobilizing support for policies to reduce moderate inflation to single-digit levels demands significantly greater political efforts than suppressing hyperinflation. Therefore, economic policy must reckon with the social resistance to the costs of reducing moderate inflation.

Hungary, like Croatia, the Czech Republic, and Poland, is fortunate in that a broad and innovative debate on managing inflation is taking place. It is to a large extent thanks to the research activity pursued during recent years within the National Bank of Hungary that we in Hungary have come to a closer understanding of the history of inflation in a transition economy. I am pleased that, in its analytical work and in its fight against inflation, the government can rely on the active participation of the National Bank, recently reinforced in its independence. Its analyses have given policymakers a sounder base on which to make decisions on, for instance, how the trade-offs develop that determine the possibilities and the limits of disinflation policies, or on the extent to which one should rely on sterilized intervention by the central bank, even if it is expensive to the budget.

There are no clear answers to these questions, and, I am afraid, there will not be any. Perhaps the right views are those that have come to the fore lately, emphasizing that the answer to disinflation lies in the credibility and predictability of policies, particularly monetary and fiscal policies. Achieving such credibility is time consuming, especially in transition economies where governments have often underestimated the costs of economic transformation and where people have a tendency to blame government policies for these costs.

It is my opinion that the Hungarian economy has now passed the most difficult stage of stabilization and reform. Thus, there is a chance that we can put to good use the advice and recommendations we have heard at the seminar. Even if all the causes of inflation have not ceased to exist in Hungary, they are undoubtedly weakening and fading. We have a reasonable chance of achieving single-digit inflation by the turn of the millennium. It is increasingly evident to me that, as many have emphasized, successful disinflation can be achieved only through coordinated monetary and fiscal policy and a diminution of the redistributive role of the state. The countries represented at the seminar have made great progress in macroeconomic stabilization and reform, and the discussions have provided powerful arguments and suggested useful techniques that can help us in overcoming inflation.

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