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additional pressure on the exchange rate. Even if the central bank had striven to keep
the parity constant, the loss of competitiveness entailed reserve depletion and, in the
end, the currency has to be devalued. A new inflation cycle is at work.
Today, the economic landscape has changed much. Most governments have
banned direct subsidies to firms. However, in the less advanced countries along the
reform path like Russia, Ukraine, or Romania, there is still a massive problem of tax
arrears, where the government tolerates the accumulation of unpaid taxes of the firms
that seem to face financial difficulties. The resulting deficit is in general monetized,
either directly or through the commercial banks that would refinance themselves
against treasury bonds as collateral.2 In addition there is a “hunger” for inflation, as
the latter becomes a perverse way of stabilising arrears in real terms, for otherwise the
economy would suffocate itself by not being able to pay wages and critical inputs.
One may argue that the rationale for firm support has not changed: there
would be still a need to keep some firms in the production chains under perfusion,
given a risk of overall collapse. However, the old argument has lost much of its force
today. Firstly, increased international openness allowed foreign suppliers to become a
sensible alternative to domestic firms. More important, transition economies have
undertaken an important process of de-monopolisation: many private firms have
entered the market and are today serious competitors for former national champions.
Capital markets have also widened and deepened, thus providing firms that face
temporary payment difficulties the needed relief. In this context, an inefficient
supplier may be replaced at a relatively low social cost (i.e. there would be no
undesired spillover).
While at the origin of the inflationist cycle stood the will of the government to
protect the weak firms, today the initiative seems to sit with the firms themselves,
which, in a quest for tax exemptions, try to hide the true costs and claim the state
support. This non-cooperative strategy is dominant, insofar as the firm which does not
play defection in the arrears game will be penalised (Daianu and Vranceanu, 2000).
One could notice that this vicious circle that perpetuates inflation, tax arrears and a
weak currency could also be related to lack of progress with restructuring and slow
resource reallocation, factors that hamper long-term growth.
As an upshot, consistent and well designed monetary and exchange rate
policies and mechanisms, backed by additional structural and institutional reforms,
could help today terminating inflation and inflation expectations without putting
additional strain on the productive sector.
3. Monetary discipline, fiscal discipline and the exchange rate
mechanism
As mentioned in the introductory section, in the last few years, notably after
the 1997-1998 Asian and Russian financial crisis, an increasing number of economists
argued that the recourse to super-fixed exchange rate mechanisms, like currency
boards and, more extreme, dollarization (euroization) would allow the countries
victims of high inflation and excessive currency instability to import the discipline of
the reference currency.
In the past, currency boards were mainly to be found in the UK colonies.
Today, only a few countries use such schemes (to mention only Argentina, Hong
2 In Romania, by mid-2000 tax and inter-firm arrears were more than 35% of GDP. When firms use
actual liquidity for paying wages and some taxes, inter-firm arrears emerge as temporary quasi-inside
money, which also fuels inflationary expectations (Daianu, 1994). See also the study of Pinto et al.
(2000) on tax arrears in Russia.