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Economic Transition and the Exchange-Rate Regime Author(S): Jeffrey D American Economic Association Economic Transition and the Exchange-Rate Regime Author(s): Jeffrey D. Sachs Reviewed work(s): Source: The American Economic Review, Vol. 86, No. 2, Papers and Proceedings of the Hundredth and Eighth Annual Meeting of the American Economic Association San Francisco, CA, January 5-7, 1996 (May, 1996), pp. 147-152 Published by: American Economic Association Stable URL: http://www.jstor.org/stable/2118113 . Accessed: 27/01/2012 16:54 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact [email protected]. American Economic Association is collaborating with JSTOR to digitize, preserve and extend access to The American Economic Review. http://www.jstor.org EXCHANGE-RATEREGIMES AND MACROECONOMICSTABILITYt Economic Transitionand the Exchange-Rate Regime By JEFFREYD. SACHS* Exchange-ratemanagement poses special initialpolicy, even if the countriesshould then challengesin thetransition economies of Eastern move to flexible-ratesystems after one or two Europeand the formerSoviet Union. These yearsof stabilizationand liberalization. countriesare adapting to open,market-based in- Most of the transitioneconomies began the temationaltrade without prior experience with shift to marketswith a commonset of struc- currencyconvertibility. Most are undertaking turalimbalances: repressed inflation, marked stabilizationprograms to end high inflation. by extreme shortagesin consumerand pro- Therefore,monetary and exchange-ratepolicy ducermarkets; large fiscal deficits,including mustbe designedwith an eye towardcurrency an overhang of foreign debt; extreme cur- stabilization.They are undergoingenormous rencyinconvertibility, including a largeblack- structuralchange, with very large movements in marketpremium on the exchange rate; low relativeprices and productivity,so thatindica- levels of domesticcompetitiveness; and weak torsof a country'sinternational competitiveness tradeand financial linkages with marketecon- (e.g., relativeunit labor costs, relativeproducer omies, includingWestern Europe. In Central prices)provide a very impreciseguide for pol- Europe,Czechoslovakia stood out as the sole icy. Likemany other countries in thedeveloping case of a countrythat began the reformperiod world,these countries are experiencing large in- withoutextreme prior macroeconomicinsta- flows and outflowsof capitaland are therefore bility. The financialproblems of the former increasinglysubject to shocksemanating from Soviet Union andthe formerYugoslavia were worldcapital markets. greatlycompounded by the suddenemergence In this maelstrom,are there guidelinesfor of new nationstates withoutseparate curren- the appropriatemanagement of the exchange- cies and, thereby,with multiplecentral banks rateregime? What kinds of numericalindica- ostensiblysharing a commoncurrency, with- torsshould be uppermostin the policymaker's out overallcoordination or control. attention?What advice and assistanceshould The first stage of the marketreforms in al- be given by the internationalfinancial com- most all transitioncountries was the liberal- munity,and most importantly,the IMF? izationof prices,the unificationof the official exchangerate and the marketexchange rate, I. EarlyExchange-Rate Management and the opening of the economy to interna- tionaltrade. In Poland,this was combinedwith Exchange-ratemanagement is one of the strongfiscal and monetarymeasures, so that areasof reformwhere optimal transitional pol- inflationvery quickly subsided,falling from icies may well differfrom long-rangeoperat- 586 percentin 1990 to 70 percentin 1991 and ing policies. For example, there are good 43 percentin 1992. In some othercountries in reasonsfor countriesat the startof stabiliza- EasternEurope, notably Bulgaria and Roma- tion and liberalizationprograms to adopt a nia, monetaryand fiscal policies remained lax, pegged exchange-rate regime as part of the and triple-digitinflation persisted for several years. In Hungary,moderate inflation rates (20-40 percentper year) persisted throughout the early 1990's. In the successorstates of the t Discussants: Michael Bruno, World Bank; Stanley Fischer, InternationalMonetary Fund. Soviet Union, high inflationwas pandemic, * HarvardInstitute for InternationalDevelopment, One reaching triple- or quadruple-digitrates in Eliot Street, Cambridge, MA 02138. 1992 in every one of the 15 new nations. 147 148 AEA PAPERS AND PROCEEDINGS MAY 1996 The practical issue facing governments and bank financing of the Russian budget deficit. central banks was the appropriate manage- Russia and the other successor states were able ment of the exchange rate after price liberal- to achieve stabilization only when they be- ization, both in the immediate aftermath and came masters of their own monetary fate (i.e., in the longer term. This choice, of course, was only when they adopted a separate national partof a larger set of choices involving the role currency not used by other countries). In Rus- of the central bank, the implementation of sia, full monetary independence from the other monetary reforms (in the new nations), the states effectively began in the fall of 1993, scale of fiscal deficits, and their mode of when Soviet currency notes were withdrawn financing. Four countries relied initially on from circulation in Russia, and republics that pegged exchange rates: Czechoslovakia, Es- still lacked their own currency finally moved tonia, Hungary, and Poland. Four others relied to establish new national currencies. on floating exchange rates: Kygyzstan, Latvia, Poland established a patternfor other reform Russia, and Ukraine. By 1994, all but Russia countries with its rapid introduction of con- and Ukraine had succeeded in ending high in- vertibility on January 1, 1990. Ten Western flation, and in carrying out other main aspects governments joined to provide a $1 billion of reform.' zloty stabilization fund to provide reserves to Even before reaching the decision over defend the newly convertible currency. The exchange-rate regime, the successor states to zloty was devalued sharply, unified with the the Soviet Union had to take decisions regard- black-market rate, and then pegged vis-a-vis ing a national currency. In this, the IMF made the dollar. Inflation spiked in the month of a serious mistake in early 1992, in pushing price liberalization, to 100 percent in January, hard for the continuation of a common cur- and then fell to 20 percent in February, and 5 rency for the successor states, despite the ex- percent in March. The nominal exchange-rate istence of 15 separate central banks and little peg held successfully, without resort to the sta- feasibility of monetary coordination among bilization fund, and was maintained until a de- the separate central banks (see Sachs [1995a] valuation in April 1991. Poland adopted a for further discussion). In the spring of 1992, crawling peg in October 1991 and then a the IMF advised all countries that introduction crawling band in July 1995. Czechoslovakia of separate national currencies should be de- followed the Polish example one year later, layed for months (until the fall of 1992 at the when it devalued the koruna, established lim- earliest, in the case of advice to Estonia) or ited convertibility, and pegged the exchange indefinitely. This naive advice set back stabi- rate in January 1991. Hungary eschewed a lization by at least one year in most of the for- one-time step to convertibility but achieved mer Soviet Union, since the common currency substantial convertibility on the trade account effectively gave a license to issue credits to in 1990 and, thereafter, pegged the exchange each of the central banks. The Russian gov- rate, with occasional devaluations. ernment continued to accept the ruble credits Under IMF advice, other Eastern European issued by the non-Russian central banks in economies established quick convertibility, payment for imports from Russia and, in the but the IMF urged the other countries to move end, effectively supplied up to 7 percent of directly to a floating rate. Bulgaria and Ro- Russian GDP to the other republics in net ship- mania floated their exchange rates beginning ments financed by credits in the period April- in 1990. A similar pattern played out in the December 1992. This 7 percent of GDP former Soviet Union, once the Soviet ruble showed up in the Russian money supply and was dropped in favor of a national currency. provided a financial impetus to inflation of One country, Estonia, adopted a pegged about the same magnitude as did the central- exchange rate, counter to the initial advice of the IMF (though the IMF agreed to support the Estonian position). All other countries of ' A table summarizing the decisions taken for a repre- the former Soviet Union, under IMF tutelage, sentative selection of eight countries throughoutthe region moved directly to floating-exchange-rate re- is available from the author upon request. gimes. In early 1994, two of the initial floaters, VOL 86 NO. 2 EXCHANGE-RATEREGIMES AND MACROECONOMICSTABILITY 149 Latvia and Lithuania, adopted a pegged rateis usefulin the earlyphase of stabilization exchange rate
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