Discuss the importance of each of these factors, and any other factors that you think are important, in explaining both long-run and short-run variation in the inflation rate.

The main cause of ongoing inflation is ongoing money supply growth (in excess of the growth rate of money demand, which is determined primarily by the growth rate of real output). The weak labor market, reduced export demand, and moderation of medical costs all seem to be one-time events. Thus, they can have no effect on the long-run inflation rate, although they may have some temporary effect on inflation. In addition, these temporary factors can have no long-run effect on the price level, meaning that any temporary effect on the inflation rate for 1992 will be reversed in the future. Thus, these factors at most have a minor effect on the timing of price level changes without any cumulative, long-run effect.

An increase in productivity is somewhat different. It raises real output and thus increases the demand for money, which tends to lower the price level. If the increase in productivity is a permanent, one-time event, then it leads to a permanent, one-time reduction in the price level. A permanent increase in the growth rate of productivity would lead to a permanent reduction in the rate of inflation.

The direct cause of the Yugoslavian inflation was excessive money growth caused by the government. The underlying reason for the excessive money growth was the government’s use of money creation as a source of revenue. High rates of inflation would cause people to reduce their holdings of dinars, whether in cash or in deposits unless the deposits paid interest rates high enough to compensate for the inflation. The reason people reduce their money holdings is that inflation increases the cost of holding money (with the exception noted in the previous sentence). People could reduce their money holdings by devoting more time to transactions activity, so that they never have too many dinars on hand at any time. They could also use something other than dinars as a medium of exchange. This could be either a foreign currency or a commodity. Because of Purchasing Power Parity, inflation in dinar prices would cause the dinar to depreciate relative to other currencies. The Yugoslavian government could stop the inflation by drastically reducing the rate of money growth. It would not have to reduce the rate of money growth to zero instantly, because people would want to increase their dinar holdings as the inflation rate dropped. An important feature in stopping the inflation is convincing people that the inflation will actually end. The government can do several things to restore confidence in stable prices. For example, it can fix the exchange rate between the dinar and some stable currency like the U.S. dollar or the German mark. This alone might not be fully credible. So it would probably be important for the government to institute reforms that would make it difficult to use money growth as a source of revenue. For example, it could require the government to balance its budget, or it could make the central bank more independent.