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Ashok Kumar Lahiri, an Economist in the European Department, is a graduate of Calcutta University, and the Delhi School of Economics, University of Delhi. The author thanks Devjyoti Ghosh, Daniel Hardy, Leif Hansen, Mohsin Khan, Hahn Shik Lee, John Odling-Smee, Hans Schmitt, Jan van Houten, and Harilaos Vittas for comments and suggestions, and Mirko Novaković for valuable research assistance.
Growing policy slippages led to a renewed buildup of inflationary pressure in Yugoslavia since midsummer of 1990.
The possible inflationary bias of Yugoslav socialism under workers' self-management has been the subject of a lively discussion along structuralist lines. See, for example, Mates (1987), Mencinger (1987), and Bradley and Smith (1988).
Chowdhury, Grubaugh, and Stollar (1990) found that money supply in Yugoslavia was endogenous between 1964 and 1986. There is similar evidence on how inflation itself caused money to grow in many other countries. For the European experience, see Sargent and Wallace (1973); for Brazil and Chile, see Hanson (1980); for Indonesia, Aghevli and Khan (1977); and for Israel, Brezis, Leiderman, and Melnick (1983).
As a possible reason for passivity of money supply in Yugoslavia, Tyson (1979) has argued that in the absence of severe sanctions for payment defaults, enterprises deliberately generated liquidity crises and payments defaults to obtain fixed interest short-term credit with a high subsidy element in an inflationary environment. Coupled with a policy commitment to avoid disruptions in economic activity, this led to money supply increasing with inflation.
Although base money grew faster than prices between 1965 and 1988 and resulted in an overall increase in real base money, there was a dramatic difference in the relative behavior of the two series before and after 1980 (see Figure 1D).
All the data used in this study were taken from the International Monetary Fund's International Financial Statistics (IFS), except for data on deposit rate of interest prior to December 1984 and foreign currency deposits, which came from the Yugoslav Bankers' Association. I am grateful to Mr. Petrović of the NBY for making these data available to me.
The external environment deteriorated sharply in 1979 following the oil price shock and the increase in interest rates in world financial markets.
The survey begins with 1965, because the method of collecting data on components of hase money was revised in that year. For the analyses of base money growth in Table 1, annual data were used, because monthly data would have added little apart from complicating the exercise.
Foreign currency deposits were first introduced in Yugoslavia in 1963 to attract emigrants' savings and residents' transfers from abroad into the domestic banking system and to ease the availability of foreign exchange.
Instead of offering the redeposit facility along with dinar credit, the NBY could have made an outright purchase of the foreign currency from the banks. In this case, however, insofar as the exchange risk associated with foreign currency deposits would have rested with the commercial banks, the banks would have had an incentive to increase the dinar lending rates appropriately and thereby restrain monetary expansion.
The NBY credits were called “interest-free credit,” since in the period until April 1, 1985, no interest was paid by commercial banks on their dinar liabilities. As a reciprocal arrangement, the NBY also did not pay any interest on foreign currency deposits. Although banks and the NBY started paying interest on their corresponding liabilities from April 1, 1985 and August 1, 1986. respectively, interest rate parity was never maintained in the ex post sense.
It is well known that in the long run the authorities can set either the nominal exchange rate or the money supply independently but not both. Furthermore, as shown by Adams and Gros (1986), the pursuit of a target real exchange rate by devaluation in line with inflation leads to unstable prices at worst and, in the long run, lack of monetary control over the inflationary process at best. In an economy integrated with world financial markets, the long-run result extends to the short run through capital flows in the balance of payments. In such an economy, any tightening of domestic credit only leads to an acceleration of such flows. Given the restrictions on external capital transactions in Yugoslavia, however, it appears that there was considerable scope for pursuing an independent anti-inflationary monetary policy in the short run simultaneously with a real exchange rate rule. In this paper it is argued that the existence of foreign currency deposits and the NBYs policies toward these deposits circumscribed the scope for pursuing such an independent monetary policy.
In these models (see, for example, Sargent and Wallace (1973)), financing of the deficit by seigniorage—that is, printing money—leads to inflation, which in turn generates an inflation tax on the public's holding of base money at a rate equal to the rate of inflation. En the absence of foreign inflows or direct credit to the private sector by the central bank, seigniorage equals the monetized public sector deficit. With the public sector deficit constant in real terms, the economy converges to the steady state, with inflation tax equal to seigniorage, leaving the real stock of base money unchanged.
The Yugoslav public sector consists of two types of communities: the sociopolitical communities at the federal, republican, provincial, municipal, and communal levels catering to traditional governmental duties; and the self-managing communities of interest looking after health care, education, child care, pensions, and so on.
For Israel during the 1970s, similar evidence has been found by Litvin, Meridor, and Spivak (1988).
During the hyperinflation in the early 1920s in Austria, Hungary, and Germany, the central banks in these countries made loans and discounts to private agents at very low nominal interest rates. These loans amounted virtually to government transfer payments to the recipients of the loans; see Sargent (1982).
Also note that credit repayments depend on the subsidy element of loans, and as the subsidy element increases, larger monetary injections are necessary to keep the flow of new credit unchanged.
The conventional measure of inflation tax, as reported in Table 2, has obvious limitations in the Yugoslav context. The conventional measure is appropriate only when there is no inflation-induced change in the real rate of interest that applies on the central bank's assets and liabilities apart from base money. Given the NBY's interest rate policy and, hence, the large reduction brought about by inflation in the real rate of interest that it earned on credits to banks and the private sector, only an increase in real fiscal tax revenue could have kept the consolidated public sector revenue constant in real terms with accelerating inflation, In that sense, it could be argued that the NBY did not get an inflation tax from explosive prices, but, rather, it paid an inflation subsidy.
Before launching the stabilization program in December 1989, the Federal Government of Yugoslavia took over the accumulated valuation losses of the NBY as its own public debt. See Mates (1991) for a discussion of the parafiscal operations of the NBY.
Apart from introducing greater transparency, this approach also clarifies the policy choices involved in reducing subsidies and identifying alternative fiscal sources of financing the subsidies. Whether such a consolidation would have led to a change in policies is difficult to speculate in the absence of a comprehensive analysis of the constraints facing the policymaker.
No data exist on foreign notes and coins held by the public in Yugoslavia during the reference period. Such “money under mattresses” is not captured in the measure of foreign currency-denominated liquid claims used in this paper.
Dinars and foreign currency assets may be complements as well, for instance, as a result of a cash-in-advance constraint in a setup with illegal goods markets, where both currencies are used in transactions. In Yugoslavia, however, the substitution effect appears to have dominated the complementary effect.
It may be argued that Yugoslav inflation is in terms of dinars and, hence, the focus of attention should he dinar money. Such reasoning is not correct when close substitutes exist for dinar liquidity. The existence of such substitutes can lead to a highly unstable relationship between dinar liquidity and inflation.
Note that E · FCLB is different from other components of base money insofar as the former cannot be used to support a multiple expansion of credit and deposits: that is, the multiplier is unity. With the growing importance of foreign currency deposits in M2, the money multiplier, defined as M2/BM, does display a tendency to converge to unity during the sample period.
For example. Kremers and Lane (1990) have found that the aggregate monetary demand equation for the countries participating in the exchange rate mechanism of the European Monetary System compares favorably with individual country equations.
Tyson's (1979) period of observation was 1961:4 to 1971:4; Payne's (1990) was 1952–85. Although neither study included the period when inflation accelerated the most, both authors estimated a significant negative impact of inflation on money demand.
Because nominal interest rates were controlled and relatively stable during the sample period, the variable R is not a good indicator of the relative tightness of the money market, which led Tyson (1979) to use the rate of growth of base money as a proxy for the rate of return variable in the demand for money by enterprises. However, since R is the only choice for return on interest-earning money substitutes in Yugoslavia, and it is not desirable to introduce money supply as an explanatory variable in money demand, R is returned here as an explanatory variable.
Bole and Gaspari (1991) used a synthetic single measure of the opportunity cost of holding money constructed from the rates of inflation and currency depreciation. They estimated the structural parameter of a “coefficient of dollarization,” which measured the relative importance of currency substitution. No attempt is made in this paper to retrieve this coefficient.
Barring some seasonal fluctuations, employment grew at almost a constant rate during the sample period, and variations in the growth of the wage rate were the main source of variations in total wage income. Because of lack of availability of data, transfers, subsidies, and pensions could not be taken into account.
The existence of a unit root at zero frequency is perhaps a common feature of many economic variables, and was found by Beaulieu and Miron (1990) to be true for prices, nominal and real interest rates, and nominal and real wages in the United States.
The problem may be akin to trying to relate demand for only golden apples to income and price, when red apples are very close substitutes for golden apples.
Because of the omission of foreign prices, the definition of the real exchange rate is unconventional. The expression is used as shorthand for the term x − p, which appears in equation (18) below, as an econometric construct used to simplify equation (17).
I am indebted to Daniel Hardy for drawing my attention to this simple illustration.
The model of demand for money used in the next section is much more general than that used in this illustration. In that model, expected inflation is implicitly assumed to be dependent on past developments in inflation, money supply, and other relevant variables.
Despite the pronounced seasonality in the series, no deseasonalizing filters were applied to the data before the demand functions were estimated, lest important information hidden in the seasonal patterns be lost.
Note that since p is I(2). Δp is I(1).
Note that exchange rate changes, apart from bringing about shifts in the composition of money between dinar balances and foreign currency deposits, also induce shifts between these two categories and deposits held abroad and money under mattresses, which are not part of the monetary aggregates analyzed in this paper.
If the real rate of interest remains unchanged in the face of increasing inflation, the semi-elasticity of demand for real balance with respect to inflation is -0.8 and not -0.65 (= -0.8 + 0.151).
GMP is observed to have had an elasticity of 0.73 with respect to the index of industrial production. When this relationship between GMP and the index of industrial production is taken into account, liquid assets appear to have been unit elastic with respect to income.
Some simple experimentation with longer lags did not indicate the need to increase the lag length beyond two months.
The tests were conducted sequentially.
See Mencinger (1987) for a chronological overview of interventions in price formation in Yugoslavia during 1971–86. Extensive price liberalization was undertaken in multiple stages in the period after May 1988. It is reasonable to assume that interventions in price formation did not alter the long-term trend in inflation but imparted a stop-go pattern to inflation. The resulting volatility of the inflation rate would be reflected in oscillations in real money balances, particularly when price controls and decontrols were unanticipated, and due allowance should be made for this factor in analyzing the stability of demand for real balances.
It is important to note that the test is biased toward accepting the null hypothesis in models with lagged endogenous variables. Furthermore, although there is no evidence to suggest that the sample should be broken up into two or more subsamples to accommodate the possibility of discrete structural breaks at specific points of time, the stability properties of the model are not fully satisfactory. For example, the recursive point estimates of the coefficients do not tend to converge rapidly to their final values, and there are indications of increased instability after 1984. The stability properties of the demand for money function in Yugoslavia merit careful scrutiny, especially in view of the changes in the economic system introduced from time to time. According to Ben-ner and Neuberger (1990), Yugoslavia has had six economic systems in the postwar period, with at least three different systems prevailing during the sample period used here.
This representation of zt's, for j = 1,2,12 contained in Beaulieu and Miron (1990) explicitly demonstrates how these transformations are related to particular seasonal frequencies.
Note that the hypothesis of d and m2(-v) having a unit root at frequency 5π/6, which corresponds to 7 and 5 cycles a year, can be rejected only Dy the sequential t-test at the 10 percent level of significance. However, since the F-statistics are better behaved than the sequential t-tests, the balance of evidence is in favor of not rejecting the hypothesis.
See Fuller (1976, p. 373). In general, the value of q was chosen to minimize the SC over the range of q = 0,1,2 … 19. In the case of testing the hypothesis that m2, p, w, and x are I(3) against the alternative of I(2), a monotonic positive relationship was observed between larger values of q and the likelihood of not rejecting the null hypothesis. Furthermore, although the global minima of SC were attained for q = 12 or 13 in the case of m2,p, and w, the SC tended to have local minima at a much lower value of q < 4. For these cases, the values of q chosen correspond to these local minima. The detailed results are available on request from the author.
The t-statistics are reported only until the hypothesis Ho: z ~ I(¯j) is not rejected.