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inflation have returned to growth within a year or so (Fischer et al., 1996). There is also a strong correlation between inflation and decline in output. In 1995, 13 of the countries still had inflation exceeding 40 percent per annum, although virtually all inflation rates were lower than in the preceding year (Åslund et al., 1996:236-237). In 1996, nearly all the countries got inflation down to below 40 percent per annum. The only exceptions were Bulgaria in Central Europe and Tajikistan and Turkmenistan in the New Independent States.

In Belarus, on the other hand, inflation may explode again. There have been several such cases in which inflation has fallen temporarily to a low level and then increased. Examples are Russia and Ukraine in the summer of 1994. In those two cases, the temporary stabilization was based entirely on monetary policy and not on a sufficient reduction of the budget deficit. Sustained monetary stabilization needs to be based on fiscal adjustment as well. Only when the budget deficit has been limited so that what remains can be financed by noninflationary means has inflation been brought under permanent control (Fischer et al., 1996).

The frightening case is Bulgaria. In 1993, its inflation had decreased to 64 percent, but it doubled the next year—to 122 percent. Inflation was again reduced to 33 percent in 1995, but as the budget deficit stayed at almost 7 percent of gross domestic product (GDP), the exchange rate collapsed in 1996. As a consequence, inflation surged again to 305 percent a year (Stockholm Institute of East European Economies, 1997:1), and the associated social cost is likely to be very high. The Bulgarian experience illustrates the danger of trying to do only what is absolutely necessary, effectively walking a tightrope on the verge of an abyss.

The countries most successful in controlling inflation have not calculated how large a deficit they can finance. Instead, they have aimed at a balanced budget or a small budget surplus. Croatia had a budget surplus of 0.7 of GDP and a deflation rate of 3 percent in 1994; the Czech Republic has a steady surplus of 0-1 percent of GDP and had an inflation rate of 8 percent in 1995; Slovenia balances its budgets almost perfectly, although its inflation rate was 9 percent in 1995; and Estonia maintains a budget surplus of 0.5-1 percent of GDP, while it recorded an inflation rate of 29 percent in 1995 (Stockholm Institute of East European Economies, 1997). Presumably, some of these countries harbor hidden semifiscal budget deficits, but that is an additional argument for eliminating the official budget deficit.

With the exception of Croatia, not a single post-communist country has managed to achieve what would be considered low inflation in the West. This illustrates both how difficult and how important it is to combat inflation. One reason for the lingering high inflation is the existence of hidden deficits, often bad debts taken over by the government. Another reason is that these countries started with extremely devalued currencies, and real revaluation often

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