In Yemen as in other less developed countries, the circle of inflation has expanded and the level of prices has gone up considerably during the 1990s. However, special circumstances and conditions pertaining to Yemen and the operation of inflation mechanisms caused a severe influence on both the structure of the economy and the standards of living.

In its attempt to rectify the economic situation following the end of the war aimed at enhancing unity in 1994, the Government prepared an economic reform program targeting in its entirety the resolving of the structural imbalances in the national economy through increasing production. In this respect, some monetary and credit measures were applied focusing mainly on controlling the money supply in parallel to decreasing the demand for foreign exchange. Such measures aimed at stabilizing the exchange rate and reducing the severity of inflation via administering aggregate demand.

Needless to mention here that Yemen, even before unification, suffered from many imbalances. The severity of these imbalances increased as a result of the circumstances that prevailed during the transitional period and the splitting of powers which culminated in the secessionist war.

These imbalances were at the same time causes and results of a rigid production system which created many negative phenomena, of which the most apparent are stagflation and slow economic development during the first part of the 1990s. Such situation forced the Government to follow the Economic, Financial, and Administrative Reform Program which concentrated at this stage on the monetary and fiscal aspects of the economy, which is the theme of this paper.

The first part of the paper discusses inflation mechanisms in the Yemeni economy in both its demand and the supply sides, with some mention of inflation indicators. The influence of the Economic Reform Program on these mechanisms is shown in part two, while part three presents a critical view of the viability of the reforms in both short and long terms.

The paper reaches several important conclusions. First, the Yemeni economy witnessed rising inflation during the period prior to the Economic Reform Program in 1995, which then declined during its implementation. Second, it has been associated with increasing unemployment and recession much worse than prior to the implementation. Third, the program measures concentrated on monetary issues through the usage of the interest rate, policies to limit credits, and fiscal policies aimed at reducing public spending and increasing revenues to minimize the budget deficit. In addition, the Government stopped resorting to issuing new money to finance its deficit and diverted towards issuing treasury bills. These last policies succeeded in controlling liquidity and reducing domestic money supply, hence squeezing the great urge towards dollar speculation and achieved exchange rate stability.

On the other hand, the following of a policy of managed floating to administer the foreign exchange needs and to absorb any surplus, and then floating the Yemeni Rial has enhanced efforts towards stabilizing the exchange rate. Also, reducing foreign debt as a result of negotiations with the Paris Club members, and liberalizing prices by lifting subsidies to goods and services except to those more basic ones like wheat and flour, diesel and electricity convinced international institutions to adopt favorable assistance policies to support Government efforts in this respect.

These efforts reaped fruit only in the short term, since the reform measures concentrated on the demand side while leaving supply side mechanisms untouched because of their links to the main causes of economic backwardness and the rigidity of the production system. These conditions failed to provide adequate incentives in areas that would ignite growth and development. Needless to mention here, the absence of any economic development management which would ensure the optimum utilization of available material and human resources through applying several measures and policies in the short, medium and long terms.

However, program measures have overlooked many issues that represent the necessary environment for the success of the Economic Reform Program. The most important issues are administrative reforms, reforming the judiciary and the security, implementing execution measures of the laws and by-laws to preserve public money, and facilitating activities in the investment sector encompassing the production of goods and services by the private or public sectors.

The paper concludes by expressing the need to incorporate in the Economic Reform Program a long term strategy to focus on broader and more comprehensive goals. Also, priority should be given to reforming and expanding the social safety net, to include other aspects of the monetary and fiscal and administrative reforms, and to address issues relating to the creation of a favorable environment for the reforms.