Money and Markets: Essays in Honor of Leland B. Yeager

152 Maria Minniti and Lidija Polutnikmonetary authorities were able to leverage popular expectations in favor ofstabilization.Inflation, of course, is a monetary phenomenon, and the successful trend couldnot have been sustained over time without an appropriate policy of the centralbank capable of modifying the money supply appropriately. Nevertheless, thereforms could not have started if political credibility had been lacking and ifSlovenes had not been willing to accept the new currency even before knowing itsreal purchasing power. 2 In other words, reforms would not have achieved theirobjectives if the demand for the new currency had not adjusted suitably to thechange in monetary conditions.The Slovenian case illustrates the crucial role that people’s expectations play indetermining the successful interruption of the inflationary momentum and in containingthe costs associated with the adjustment process. Also, the credibility of theanti-inflation policy is shown to be of primary importance in influencing suchexpectations since the political element in anti-inflationary policies has the potentialto condition expectations and to turn them around, thereby breaking themomentum of inflation. Finally, the Slovenian experience suggests that, even for avery small country, the benefits of having one’s own currency may outweigh costsbecause of the ability to conduct an independent monetary policy. 3The contribution of our paper is twofold. First, we provide a review of the currencyconversion process in Slovenia and identify the economic circumstances thatmade the Slovenian reform successful. Second, we show how the asymmetricnature of expectations among different groups of dinar holders played a crucialrole in determining the success of the currency conversion, and how the Bankof Slovenia successfully leveraged these expectations to break the inflationarymomentum.Yugoslavian monetary conditions and the inflationarymomentumThe Yugoslav economy of the 1980s was characterized by stagnation and rapidlyincreasing prices. Large companies, banks, and the government all lacked budgetarydiscipline. The National Bank of Yugoslavia allowed systematic and sustainedincreases of the money supply which, eventually, led the federation into hyperinflation.Average output growth declined from 6.4 percent in the late 1970s to lessthan 1 percent in the late 1980s, while inflation began increasing in the early 1980s,and rose to 1,253 percent in 1989. 4 In 1987, in order to stop the hyperinflation,improve financial discipline, and provide new economic incentives, the Yugoslaviangovernment introduced a package of economic reforms. 5 These reformswere intended to eliminate social ownership of non-financial enterprises, restructurelarge enterprises, reform taxation, and create a new credit distribution role forthe National Bank of Yugoslavia.Although the program was initially successful, its overall results were veryuneven. Stabilization reforms were implemented amidst a series of free electionstaking place in different republics. Pressed by the need to receive public support,