Financial Arrangements, Soft Budget Constraints and Inflation: Lessons from the Yugoslav Experience

Abstract

This paper explores primarily how financial arrangements may be responsible for creating or exacerbating inflationary pressures in Yugoslavia. The ways in which financial arrangements can contribute to inflation are discussed under three different headings: misallocation of savings and credit, failure to enforce financial discipline and accommodation by the monetary authorities. Ultimately, however, these are to a significant extent manifestations of the same phenomenon. They describe a situation where resources can be obtained without adequate screening and monitoring, where their apparent cost does not reflect their scarcity value, where agents are capable of shifting the costs of economic failure on to the government, where, therefore, there do not exist proper mechanisms for discriminating between productive and unproductive economic behaviour. Under these conditions, not only can inflation be generated or perpetuated, but traditional measures of government transfers and related monetary financing lose much of their significance.