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

No-name money 161was reinforced by the fact that creation of a new currency was the very process ofestablishing the credibility of a new state” (Bole 1996: 234).The temporal dimension of the process leading to the determination of the valueof a new fiat currency is also important. It contributes to the explanation of thepersistence of inflation even after its monetary causes have been removed. In thecase of Slovenia, the inflation rate declined rapidly and settled, within a few months,at levels that compared favorably with most Western European economies. Thishappened because the anti-inflation program was sufficiently credible to overturnexpectations and cause at least a sufficient number of individuals to revise theirexpectations accordingly. If prices, including the prices of labor, rise at a significantrate for a prolonged period of time, individuals learn how to predict those changesand adjust their expectations accordingly. A new restrictive policy has the potentialfor succeeding in stopping inflation only if individuals are willing to respond to it.And individuals react to the policy only if the strength of the signal is such to makethem fear that, by not adjusting their behavior, they will lose competitiveness.Evidently, in Slovenia, a sufficient number of individuals believed that otherswere to have similar perceptions and revised their expectations and behavioraccordingly. Thus, given the restrictive policy implemented, the new actual rate ofinflation emerged as the unintended consequence of adjustments in individualexpectations.Finally, the initial exchange ratio of one tolar for one dinar performed the role ofa “launching vehicle.” 26 But, in fact, the exchange ratio between goods and servicesand the tolar was not yet established. Although the policy switch had changed theequilibrium price level, this new equilibrium was still unknown and, as discussedpreviously, partly dependent on changes in people’s expectations. Since moneydoes not have a specific market, the determination of its “price” has to be reachedthrough adjustments and trials in all markets, and such a process may take a longtime. This is a process with multiple possible equilibria, including a non-monetaryone in which the currency fails to receive acceptance. Indeed, this was certainly apossibility in Slovenia, where people still remembered negative experiences withprevious conversions and where a large portion of the country’s wealth was alreadykept in foreign currency. Interestingly, in the case of Slovenia, the initial exchangerate with the dinar did represent a “launching vehicle,” but the new currencyworked exactly because the initial parity was immediately abandoned. In otherwords, the tolar was accepted and used on the basis of trust, while its real value wasstill unknown.ConclusionShortly after the declaration of its independence, in 1991, Slovenia succeeded inreducing inflation and in establishing a new political system. This success wasaccomplished through a gradual approach that included tight controls over themoney supply and some temporary controls on selected prices. In this paper, weargued that one of the crucial factors that allowed the success of the stabilizationprocess was the introduction of a new, independent and freely floating currency. In