It is widely feared that, once prices are decontrolled in the formerly centrally planned economies, the release of financial assets accumulated by households will touch off hyperinflation. This paper finds, instead, that the money stock typically has little influence over whether or not a country’s fiscal, monetary, and labor market policies are destabilizing. High inflation is fundamentally a flow problem, not a problem of an initial money stock. Admittedly, an initial inflation can elicit more inflation, but the responses tend to be damped rather than explosive.
However, the money stock does bear directly on the dimensions of the initial price surge and on the consequent shock to real wages. The real wage compression must allow consumer markets to absorb over time not only the initial overhang but also the subsequent rounds of monetary emissions it induces. To permit recovery of future real wages, as required by labor market pressures, present real wages must bear most of the shock. The larger the initial holdings of cash and bonds or the weaker the stabilization policies pursued, the greater the shock.
Measures to soften the initial wage shock demand careful scrutiny. Social expenditure measures should be limited to the neediest or be phased out over time. If this is not politically feasible, a monetary overhang may indeed become “too big to work off” unless other stabilization policies are made more stringent. By spreading the adjustment burden over time, temporary wage controls (or reductions in guaranteed indexation) may be particularly helpful in easing the immediate shock. Another possible remedy is monetary reform, whose merits should be weighed against the likely further diminution of households’ confidence in domestic money.
These theoretical findings appear to be borne out by the recent Eastern European experience with price liberalization. The initial price surge quickly gave way to manageable rates of inflation, albeit at the cost of substantial labor unrest. In the former Soviet republics, stabilization appears to be endangered less by the existing monetary stock than by the attempts to peg minimum wages and social benefits at unsustainably high levels.