Inflation in Czechoslovakia, 1985-91

The authors assess inflation in Czechoslovakia between 1985 and 1991 and identify the main causes of inflation through a literature survey and empirical studies. The official prices in centrally planned economies were never perceived by central planners to be fully market clearing. Only by coincidence would the overall price level correspond to the level associated with general equilibrium. What is missing in official price indices in centrally planned economies - including the consumer price index - is suppressed inflation, manifast in queuing for products, forced substitution of demand, and forced savings. Also missing is hidden inflation, associated with practices that disguise price increases behind cosmetic or other change in product quality. The authors argue that inflationary pressures in Czechoslovakia in 1985-89 originated mainly in the investment sector. Even though the investment sector was strictly controlled, making it difficult for open inflation to emerge, the scope for inflationary pressures was great in Czechoslovakia. Such pressures arose from a mixture of factors, including poor investment planning, accommodating government finance, and the high priority given to investments and social consumption. For Czechoslovakia, the official price indices show virtually no inflation between 1985 and 1989, when there were long waiting lists for such products as cars and state and cooperative flats. Trends in these price indices do not seem to depend on the method used for constructing them, according to the sensitivity tests conducted by Czechoslovakia's Federal Statistical Office. Obviously, the official price indices failed to capture the full extent of economic disequilibrium in that period. But the extent to which official price indices understated inflationary pressures was not serious in Czechoslovakia, compared with other centrally planned economies. Estimates of hidden inflation for 1985-89 range from 0.5 percent to 2 percent a year in consumer markets and about 3 percent in the industrial sector. Estimates for suppressed inflation were less than 5 percent. The relatively small inflationary gap is indirectly confirmed by the sharp inflation associated with the recent price liberalization that subsided in a relatively short period, and both suppressed and hidden inflations have virtually disappeared. Estimates of hidden inflation were based on benchmark price comparisons between Czechoslovakia and such market economies as Austria. Those for suppressed inflation were based on disequilibrium econometric models of asset holdings and on conjecture tests.