Inflated Serbian bill, 1993, photo: Predrag Trokicic
Inflated Serbian bill, 1993, photo: Predrag Trokicic

The Yugoslav case

I need to write a paper on the 1980s and the crisis of socialism with an emphasis on the stagflation in Yugoslavia. I wrote a paper on the crisis and on the Yugoslav macroeconomic policies already in 1982. The centre of the crisis was the workout of the foreign debt. The main instrument through the decade was rising inflation as the consequence of continuous devaluation with the aim to improve the trade balance and thus achieve solvency.

It is not important here, but it helps to remove possible misunderstandings to point out that the foreign debt to GDP ratio was not really all that high – below 40 percent in all probability. After the introduction of reforms in December of 1989, it took just a year or so with fixed exchange rate regime and liberalisation of foreign investment to buy almost the entire debt back ahead of time.

So, it is not really the level of the debt that matters.

But then the country collapsed. It did not disintegrate for economic or financial reasons as I argued in my book on Why Do Countries Break Up? The Case of Yugoslavia. There was, however, at the end of 1990, an episode of money printing which provided for a scandal and influenced the politics of the break-up. The role of scandals in politics is an interesting topic by itself, but that is for another time (crisis is a scandal).

In any case, this episode was important because the run on the foreign currency reserves through money printing was perpetrated by the state, Serbia, not the federal government or the central bank. Then the foreign currency savings of the population were frozen and effectively confiscated.

Comparison with the Asian crisis

The early 1980s Yugoslav foreign debt crisis has some similarities with the Asian Crisis of the late 1990s. In both cases, the countries favoured foreign debt over direct investment. That increased the sensitivity of the corporate balance-sheets to rising interest rates. Not because there is some inherent advantage of foreign direct investments over foreign debt, as their ratio does not matter due to the Miller-Modigliani Theorem, but because the distribution was skewed towards debt due to legal restrictions on direct investments from abroad. Thus, debt accumulation was encouraged, which is to say that it was overpriced or that the interest rate was low.

Once the actual, in the Yugoslav case, or the expected, as in the Asian case, interest rates increased due to actual or respectively announced FED’s policy, with the intended monetary regime change, the rebalancing of debt versus direct investments exposure was needed. Which led to the stop of foreign debt financing and thus to the exchange rate crisis in both cases and then to the financial crisis and finally to the crisis of the real economy.

The Yugoslav crisis was more difficult to deal with because of the quite unbalanced foreign trade with the trade deficit being much higher than in the Asian countries going through the crisis. And the institutional and the policy adjustment was much more difficult to engineer given the nature of the political regime.

Even just the introduction of the domestic capital market might have been sufficient to work out the foreign debt with IMF support. But that meant some kind of privatisation, e.g. through the distribution of shares, which required political change.

Politically, democratisation would have been the right political change, but that was unappealing to the ruling party or rather to the ruling parties of the federal states and provinces. If Yugoslavia had just been a Communist dictatorship, rather than a federalised Communist dictatorship, it might have been able to democratise like the countries in the Soviet Block.

Federalism in this respect meant that the states were liable for their respective shares of the foreign debt, not the federal government. And every proposal for pulling together their fiscal responsibility for the public debts met with the rejection for fear of the formation of a transfer union.

Near the end, in 1988, the debt was mutualised to secure yet another IMF programme and financial support, but the political unity was already lost.

Sims’ paper money

In any case, how helpful can money printing be in a public debt crisis?

In Paper Money 2015, Sims argues for the distinction between nominal and real money. E.g. between money the government can print and the money like gold or foreign money that it cannot. It need not default on debt in nominal money, but it might have to when debt is in real money.

The distinction is not altogether as clear cut as he makes it, because he is in fact arguing that nominal money, the money printed at will, needs fiscal backing even in the absence of real money in order for the price level to be determined.

In the Yugoslav case, the fiscal backing was either lacking or was removed by secessionist member states. That is a useful example because Sims discusses the EU or rather the European Monetary Union as such a case – where fiscal backing can be denied making the euro real money rather than nominal for the member states.

His discussion of the EU, I think, is marred by the common mistake of treating the monetary union as a fixed exchange rate regime, though Sims does that inconsistently as he indeed acknowledges that the European monetary union does supply or certainly could supply its members with nominal money.

It is the fiscal backing that is uncertain.

But, apart from that, the argument that nominal money needs at least the minimal fiscal backing is useful to the understanding of debt defaults; both of defaults on debts in nominal as well as real money (most often in foreign currency).

As an aside, it is to be noted that the so-called Modern Monetary Theory or Post-Keynesian Monetary Theory also relies on the support of taxation to determine the price level.

The Russian case

The episode to start with is Russia in 1998. They decided to default on their rouble denominated government debt. Why?

They could have printed as many roubles as needed. Russia’s central bank was losing foreign currency reserves. In order to stop the haemorrhaging, the central bank kept hiking the interest rate, which however proved self-defeating.

The point of the ever-higher interest rate on treasury bills was to reinforce the assurance that there was no lack of supply of roubles at the fixed exchange rate. Except that, the supply of roubles being unlimited, there was money to be made by demanding ever higher interest rate to hold on to roubles.

One notes, as an aside, that Russia had been running a trade surplus for some time up to the crisis of 1998. So, there was no reason to devalue to correct the trade balance.

So, one might want to argue that Russia could have printed as many roubles as it wanted had it had a floating exchange rate regime. And thus, would not have needed foreign currency reserves, i.e. real money. Which would be wrong.

During the crisis, as public revenues continued to decline, and with the central government looking ever weaker and more conflicted, with public revenues shrinking as the printing of money sped up, it increasingly looked as if there was not going to be any fiscal support for the monetary policy which was pursued.

And indeed, it was in the end denied with the government defaulting on the debt in its own paper money. This was unexpected precisely because the debts were in nominal money, which could be supplied in unlimited quantities. So why default?

The Swedish case

Compare this case with Sweden in 1992. The central bank was defending the fixed exchange rate of the krona by hiking the overnight interest rate on government debt ever higher. The overnight rate reached 500 percent at one point, if memory serves. The central bank was in effect promising to print as many kronor as needed to keep the demand for krona up to stop the loss of foreign currency reserves. The central bank was issuing a threat to speculators – you will lose heavily once the tide turns and interest rates drop dramatically.

Until the central bank gave up and stopped standing in the way of devaluation. As a consequence, the banking system collapsed. And later, there was a change in the monetary regime to that of inflation targeting, which is clearly not one in which the central bank can supply money in unlimited quantity.

It is important to mention here that it was not the case that the foreign currency reserves were not plentiful enough. In the exchange rate crisis, the level of foreign currency reserves is not the ultimate insurance of the stability of the fixed exchange rate. Once interest rate needs to be hiked ever higher, the costs to economic activity start to increase and even without the loss of reserves, it does not make sense to hang on to the fixed exchange rate.

The alternative to higher interest rates is indeed the fiscal backing, i.e. the adjustment in the budget to achieve primary surplus, perhaps over a few years, which is precisely the required cost to economic activity.

Sims argues that fiscal backing is needed also with the inflation targeting, floating exchange rate regime, otherwise the Taylor rule or rather the Taylor Principle, which support inflation targeting, also fail to determine the price level.

The difference

The difference between Russia and Sweden was that the former country’s government decided to default on government debt in its own currency. Sweden judged that defaulting would be worse than honouring its debts, in its own and in foreign currency, though they ballooned with the devaluation. Russia calculated differently. Without going into the details of both stories, the point here is that printing money is not always better than defaulting.

One reason is that discussed by Sargent and Wallace 1984. Without foreign currency reserves in the central bank, the public will switch from domestic to foreign currency. This is clearly seen in the hyperinflations, which Sargent and Wallace studied. The money balances corrected for inflation basically go to zero as money is being printed ever faster to make the public want to hold it. In the process, foreign money becomes the money. Giving up on the fixed exchange rate does not help, as long as there is not some limit to money printing.

Put simply, devaluation or the change in the exchange rate regime may prove to be as costly as the defence of the fixed exchange rate – while defaulting on foreign debt may be the least costly way out of an exchange rate crisis. Though, afterwards, fiscal backing will still be needed to determine the price level.

To see this, a simple idea of currency crisis will be useful. Any generation of the theory will do, so take Krugman’s original argument. So, why did ever higher interest rate succeed, until it did not, to sustain the refinancing of the public debt? Because of expected devaluation after which there is money to be made by buying back cheaper, in foreign currency, government debt. Which makes defaulting on the debt in own currency attractive.

One deficiency of Sims’s distinction between nominal and real money can also be seen in the Russian debt crisis. Debts in local currencies are substitutes in the international capital market. So, the effects of devaluation as well as of default spill over. Sims likens the nominal money to equity, which indeed is what makes the difference between debt and equity financing in the Miller-Modigliani set up because there is no fixed nominal value to the equity unlike in the case of debt. So, bankruptcy makes a difference.

But of course, the stock market can crash. Which is what happened in the emerging international capital market or was prevented in the US by massive intervention by the FED after Russia defaulted on its debt.

It is important to see why. While it is true that nominal money is like equity rather than like debt, which is to say is default free as its value can be changed through printing, each country’s debt is a close substitute to other countries’ debts so it is subject to arbitrage in international financial markets. Which is the basis for the investment strategy of the Long-Term Capital Management hedge fund which almost crashed the US financial markets when Russia defaulted on its debt.

So, for nominal money to be as different from real money as Sims makes it out to be, it would have to be inconvertible. Otherwise, it is not like equity as it can be defaulted on. Alternatively, the international currency market would have to in effect transform nominal money into real and allow for defaults. As in Friedman 1948, I think.


The first case I looked at a long time ago was that of Soviet Russia in 1922, when the government introduced the chervonets – the hard or real money, with the explicit aim to go back to the gold standard. Obviously, gold is not something that the central bank can print. So, the need for real money besides the nominal one was recognised. The need was that of determining the price level, i.e. stopping hyperinflation.

The story of chervonets is not simple, and it is not important here. The point of the chervonets being that even if domestic currency is not substituted with the foreign one, it will be substituted with commodity money, e.g. by gold.

One anecdote to note is Lenin’s belief that there is nothing as destructive of the system they indeed wanted to destroy as the debasement of the currency. He, if I remember correctly, celebrated the moment when Russia’s inflation outpaced the one during the Paris Commune as the indicator of the radicalism of the revolution.

It is interesting to note that Russian economists were quick to point out the need for real money. Kondratiev published a paper, I believe in 1921, on the limits of seigniorage, Novozhilov on shortages in 1924, and there is the very good history of early monetary policy by Yurovsky (if I remember correctly the first edition was in 1924).

So, the idea that a country with its own money cannot or should not default is wrong both theoretically and as a matter of history.

Another anecdote to note is that of Mr. Avramovic saying that he fashioned the stabilisation policy in Serbia in 1994 after the example of the chervonets. The hyperinflation was indeed so fast that redenomination of the dinar and the introduction of fixed exchange rate 1 for 1 with the real money, which was the German mark, stopped inflation cold overnight. However, the success was short lived because there was no credible fiscal backing, as became clear already at the end of the same year.

Fiscal backing

What is fiscal backing? It is just the intertemporal budget constraint of the government. Current budget deficits will be financed by future budget surpluses (net of interest payments, i.e. these are primary surpluses). These future surpluses, Sims argues, need not be large enough to either eliminate or reverse the growth of public debt, certainly not in a very short period of time. They can be as small as possible. They will, however, limit the growth of money printing and thus determine the price level or the rate of inflation. The public debt, however, can be as high or as low as needed.

So, the fiscal backing substitutes for real money. If a government cannot commit to fiscal surpluses to cover the public debt, foreign money is the alternative source of real money with the exchange rate setting the price level.

Sims writes that nominal debt is like equity: “Real sovereign debt promises future payments of something the government may not have available — gold, under the gold standard, Euros for individual country members of the EMU, dollars for developing countries that borrow mainly in foreign currency. Nominal sovereign debt promises only future payments of government paper, which is always available. Both types of debt must satisfy the equilibrium condition that the real value of the country’s debt is the discounted present value of future primary surpluses — revenues in excess of expenditures other than interest payments. But if an adverse fiscal development increases debt, the increased real debt will require increased future primary surpluses, whereas with nominal debt there are two other ways to restore balance — inflation, which directly reduces the real value of future commitments, and changes in the nominal interest rate, which will change the current market value of long term debt.

Obviously outright default on nominal debt is much less likely than default on real debt. So long as the country is capable of generating any positive stream of primary surpluses, its debt will have non-zero real value. But if debt is real and the country finds itself unable to maintain primary surpluses above its predetermined real debt service commitment, it must default, even if in absolute terms it is running substantial primary surpluses.”

He goes through three monetary models to highlight the point of fiscal backing.

(i) Samuelson’s overlapping generations with storage, where storage is the real, commodity money which substitutes for worthless nominal money in the absence of fiscal backing of government bonds (Samuelson suggests the constitutional solution which I discuss in my Fiscal Rules and Councils).

(ii) Taylor rule based monetary policy with the Taylor Principle (react more than one-to-one with the interest rate adjustments to change in inflation), which may blow up the economy (hyperinflation) or become irrelevant at zero interest rate. So, it will fail to set the price level if not backed by fiscal policy.

(iii) Barro’s argument for improved timing of taxation with public borrowing as an alternative way to finance the budget, which of course needs fiscal backing, though does not require a public debt target.

He concludes: “The kinds of models that have been the staple of undergraduate macroeconomics teaching, with price level determined by balance between “money supply” and “money demand”, and money supply described using the “money multiplier”, are obsolete and provide little insight into the policy issues facing fiscal and monetary authorities in the last few years. There are relatively simple models available, though, that could be taught in undergraduate and graduate courses and that would allow discussion of current policy issues using clearer analytic foundations.”


Sims discusses the lack of fiscal backing which can come from political indecisiveness. This is not a new argument for him as he relied on it in his discussion with Sargent (and earlier in Macroeconomics and Reality 1980). Sargent’s model at the time was one of the advisor to a benevolent dictator who chooses between the current inefficient policy set-up and the efficient one which is a Pareto improvement over the former. Sims’ model has been that of changing policies as the consequence of political competition. Within that, political indecisiveness is one possible state of affairs, as in the EU.

The argument he makes is really about a country like Greece which cannot run primary surpluses high enough to avoid defaulting on its debt in euro, which is its nominal money which it cannot print, thus being in fact its real money. Compare the situation in the US. There the FED has also failed to determine the price level because there is a stalemate in the Congress over fiscal policy, or rather there is indecisiveness when it comes to raising taxes. Thus, fiscal backing of monetary policy is not assured.

In the EU, the EU budget does not have the same role as the EU cannot raise taxes. So, it cannot provide fiscal backing to the European central bank, even though the EU budget is balanced at all times. Sims’ discussion of the EU is somewhat sketchy, though he goes into some detail about the monetary arrangement or the set-up of central banking. His real point is not so much that there is no fiscal backing or that there is no money printing, i.e. monetisation of public debts of member states. Though he treats member states as if they were countries with fixed exchange rates which use foreign money as their real money, this is not how he treats them when he discusses their fiscal support for the common currency.

His argument is that it is likely that fiscal backing is not necessarily forthcoming or will continue to be forthcoming from member states, which is the consequence – he does not say that but it is clearly the implication – of the fact that the EU budget relies on contributions rather than on taxation. So, member states may have to default in some fashion on their debts, as has been the case with Greece.

The interesting comparison is with Yugoslavia with the federal budget which also relied on contributions and not on taxation. The central bank printed money and indeed was basically bankrupt (had high negative worth), but could not be recapitalised, but more importantly the federal government could not promise fiscal backing by running primary surpluses as it could not tax and thus defaulted on its foreign currency debt.

So, Sims’s argument could be that the EU may choose to disintegrate rather than form some kind of a fiscal union. The US case is a different one – it may be stuck in secular stagnation. In both cases, the respective central banks’ monetary policies cannot determine the price level.

So, printing money without fiscal backing cannot determine the price level. Put differently, printing money by itself is neither a monetary nor a fiscal policy instrument.

Pešč, 05.12.2019.

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Vladimir Gligorov (Beograd, 24. septembar 1945 – Beč, 27. oktobar 2022), ekonomista i politikolog. Magistrirao je 1973. u Beogradu, doktorirao 1977. na Kolumbiji u Njujorku. Radio je na Fakultetu političkih nauka i u Institutu ekonomskih nauka u Beogradu, a od 1994. u Bečkom institutu za međunarodne ekonomske studije (wiiw). Ekspert za pitanja tranzicije balkanskih ekonomija. Jedan od 13 osnivača Demokratske stranke 1989. Autor ekonomskog programa Liberalno-demokratske partije (LDP). Njegov otac je bio prvi predsednik Republike Makedonije, Kiro Gligorov. Bio je stalni saradnik Oksford analitike, pisao za Vol strit žurnal i imao redovne kolumne u više medija u jugoistočnoj Evropi. U poslednje dve decenije Vladimir Gligorov je na Peščaniku objavio 1.086 postova, od čega dve knjige ( Talog za koju je dobio nagradu „Desimir Tošić“ za najbolju publicističku knjigu 2010. i Zašto se zemlje raspadaju) i preko 600 tekstova pisanih za nas. Blizu 50 puta je učestvovao u našim radio i video emisijama. Bibliografija