Generally, monetary freedom represents ability of people to use money, freely, as a mean of exchange. This use of money can be distorted in many ways by government intervention. On one hand, with excess supply of money controlled by central bank, state authority is able to influence overall price level in the country. Excess money, once it reaches citizens pockets, bids up the prices of goods and services. Inflation can also be pumped with excess, deficit, government spending on current consumption. On the other hand, distortion of market prices occurs when public authorities control and limit prices of particular goods and services.

Inflation redistributes income from net savers (people who in total save more than they take as a loan) to net spenders (people who build up debt). Inflation disincentives savings and melts down real purchasing power of people’s income. Earned income can buy less goods and services when overall price level rises. This way, buy printing money, monetary authority can decrease value of people’s income the same way taxation does so. On the other hand, controls distort prices of particular goods making them artificially cheaper or more expensive than needed. Distorted prices send wrong signals to the market, about people’s preferences and scarcity of goods and services. This creates unneeded inefficiency in the market, glut or shortages of particular goods and services, because businesses and people are not able to recognize the true nature of scarcity of particular good and service. It is hard to differ what change in prices is the result of economic circumstances and what change is the result of inflation of money supply.

Monetary Freedom in the Region

Valuable insight about monetary freedom can be found in Heritage Foundation’s Index of Economic Freedom., High level of monetary freedom means that all previously mentioned monetary distortions are at very low level. Graph 1 illustrates the state of monetary freedom measured by this index in Freedom Barometer West Balkan (WB) countries.

Heritage Foundation measures monetary freedom combining both, price controls and inflation. Overall score is measured as weighted average of inflation (measured with consumer prices index) in the most recent 3 years in the country from which at most 20% can be subtracted as a penalty for high level of price control. Inflations are weighted in such a way that the latest rate has the greatest importance. Measuring monetary freedom this way this index gives very insightful picture of ability of people to use money freely without distortions. Low inflation and prices controls in one country, over longer period of time, give people ability to trade without worry for the value of money, their income or possible shortages of particular goods.

From the Graph 1 we can see that Serbia is by far the worst case in monetary freedom between WB countries. Actually this is also the case if we compare Serbia to the most of European countries. Croatia has the best score in the region, closely followed with Montenegro and Bosnia and Herzegovina and Albania. All the countries have relatively small level of price control, except from Albania, B&H and Serbia in some particular industries (agriculture mostly). Therefore, the main reason for discrepancy in the level of monetary freedom between WB countries is different levels of inflation.

Very conservative monetary policy in Montenegro, Bosnia & Herzegovina and Croatia provides control of money supply. Montenegro uses Euro as formal currency, even though it is not a member of EMU or EU. This means that central bank of Montenegro cannot at all print money and can only play secondary role in regulation of country’s financial system. Bosnia & Herzegovina applies monetary board exchange rate system which constrains central bank of any excessive money supply. Exchange rate of national currency is fixed at the level of former Deutsch mark, at the level of 1.95 KM for 1 Euro. Little bit less monetary constrains lies in hands of Croatian central bank though its policy rightfully approved Croatia’s monetary independence. Albania has even less constrains in money printing, however its currency is quasi pegged to the EUR. On the other hand, Serbia applies flexible exchange rate with selective interventions of central bank in foreign currency market. The Serbian Central Bank was not able to put inflation under control in past two decades. The inflation rate in Serbia never fell below 5% which is regarded as rather high inflation rate in European countries.

To provide higher level on monetary freedom to their citizens, Serbian central bank and Government have to choose between two options. One possibility is to introduce some version of fixed currency exchange rate to peg Serbian prices to the fluctuations of prices in the region and EMU. This was the decision in almost all other transitional economies to combat monetary instability in past two decades. On the other hand, if Serbian central bank decides to keep flexible exchange rate policy, Government must constrain itself from running budget deficits ad building up incomes and consumption.