The Relevance of the "Bottom-up" Methodology for the Understanding of the High Inflationary Process in the Formally Centrally Planned Economies

This paper starts from the observation that the standard theory of high inflation, derived from Cagan's works in the Fifties, is not able to explain the main characteristics of the high inflationary process in the transition countries of Eastern Europe (Part I.). This literature, which is rooted in the quantity theory, focuses on the direct link from issue of money to price changes. This paper asserts that the understanding of high inflationary pressures in Eastern Europe involves a reversal of methodology for the two following reasons. First, the main question is not to know how the money creation acts on the price level but why governments of centrally planned economies raise seigniorage revenues to satisfy their financing requirements. Second, the standard monetary and finance modelling - in the line of the famous paper of 1956 - deals with short periods of extremely high monetary instability. Such situations do not correspond with the economic reality of the transition countries suffering of both persistent and high inflation. In order to move away from the standard link issue of fresh money - inflation and thereby studying the sources of monetary phenomena occurring in the Eastern countries in transition, this paper suggests both to adopt and to evolve the "Bottom up" approach recently initiated by Axel Leijonhufvud (Part 2.).