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This chapter looks at monetary policy in twenty-six transition countries in Europe and Central Asia from 1989 to 1995. The purpose is to provide a broad characterization of the experience of these countries as they make the transition from a socialist economy, where money and credit were largely determined as a residual, to a market economy, where monetary policy plays an active role in economic management and where economic efficiency is believed to be enhanced by the variety and sophistication of financial instruments. In the process, we classify countries by the extent of market orientation in the use of monetary policy instruments, by indicators of policy stance, and by broad measures of effectiveness. The relationships between these three dimensions are evaluated by cross-country comparison over the transition period and at the time of stabilization.
To place the discussion in context, the first section reviews briefly the nature of money and finance under socialism and provides a snapshot of various financial development ratios at the beginning of transition. The second section discusses countries' policy response to transition and distinguishes two groups – one where a monetary policy framework was quickly developed as part of the economic transformation strategy and another where continued participation in the ruble zone and greater ambivalence toward reform resulted in delayed stabilization programs.
In the third section, we look at how monetary policy has been conducted. The focus is on the use of specific policy instruments, for which we identify “late socialism,’ “transitional,” and “market-oriented” forms. We then classify countries by the extent of market orientation in their use of both direct and indirect instruments.
The transition from a planned economy to a market economy involves a complex process of institutional, structural, and behavioral change. Formerly communist countries have moved along this transition to varying degrees. This essay places these countries into a comparative perspective. It emphasizes the cornerstone of the early reforms – economic liberalization, for which an index is developed – and its interaction with growth and inflation: How do these outcomes relate to progress with reform? It also considers the macroeconomic and sectoral patterns underlying these interactions.
The findings here help to explain two paradoxes of transition. One is that the attempt to maintain employment and output by fiscal and quasifiscal transfers to enterprises results in larger output declines than a policy of hard budget constraints introduced along with economic liberalization. The other paradox is that the liberalization of prices results in lower inflation than do continued price controls. In both cases, liberalization leads to stabilization in a way that is not selfevident to policy makers accustomed to socialist pricing and output conventions.
The core countries analyzed are 26 in Central and Eastern Europe (CEE) and the former Soviet Union (FSU), plus Mongolia. China and Vietnam are also included for comparative purposes, although these countries are distinctive in many respects. The period covered is 1989 through 1994. The starting point is the last year before the initial postcommunist transitions, although Poland, Hungary, the former Yugoslavia, and China had previously initiated significant reforms and other countries had also taken some reform steps.
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