For its part, this has led to some convergence of high interest rates in the country to low world rates.
The problem for ideas for a narrative him is that "production must go up rapidly, not pull the load down." His doubts about the generally accepted theory are largely motivated by this contradiction.
However, Stiglitz ignores the argument that the decline in production in the early stages of the transition period is mainly associated with extremely large inherited distortions (structural and price) and the institutional crisis that has intensified the pace of price liberalization. Despite the great differences in the reform policy, the cumulative decline in industrial production by 40-60% was not only significant but also the same in all countries.
He also ignores the fact that Aslund, Boone, and Johnson first pointed out that the rate of macroeconomic stabilization had a significant effect on the time period of the recession and a very small effect on the size of the overall decline in production. In countries where inflation was slowly brought to an average level of, say, below 40% per year, these declines were greater. To suggest that the higher the inflation, the greater the decline, this evidence is too weak.
It is more likely that countries (mostly within the former Soviet Union) that experienced a shock to supply and demand also experienced a sharp decline and, consequently, high inflation. This issue is discussed in more detail in Section 1.3 (5) In addition, despite rising inflation, the main impact of loose macroeconomic policies is in most cases on reducing the level of recession and, consequently, stretching its duration during the transition period.
However, as stated in the EBRD report "Reform Reports 1995-1999." there is evidence to support the claim that in countries that have been largely liberalized and stabilized, the decline in production has not only stopped more quickly, but has also begun to recover more quickly. (This issue is discussed in more detail in Section 1.3.)
The purpose of medium-term reforms is to restructure the economy for the development of activities that provide more added value per unit of initial contribution (labor and capital). If the needs of restructuring are small and real wages are extremely flexible and sources of labor and capital are easily mobile, then a large decline in production is simply necessary to influence the restructuring process. However, the need for restructuring was actually extremely high and resource mobility was limited.
In such circumstances, although unemployment takes into account short-term costs, it plays a positive role in signaling how to do: achieve higher productivity or agree to lower real income. That is why the cost of social assistance associated with the temporary rise in unemployment can be seen as a form of investment to increase the level of continuing well-being from better allocation of labor and other resources.
Money was the main nominal anchor
It was believed that in most Central and Eastern European countries, price stabilization and liberalization should be based on International Monetary Fund standards, which play an important role as a nominal anchor in addition to restructuring fiscal and monetary policy, income policy and, where appropriate, a fixed exchange rate. However, in the case of loans to the country and to enterprises, they become the dominant nominal anchor, while the exchange rate and income policy play only a supporting role.
Based on the experience of deflation in countries with economies in transition, two interdependent conclusions can be drawn. One is that the key to deflation is the fiscal framework, ie the government budget deficit and the way it is financed (Tables 2 and 3), and the other is that a fixed nominal exchange rate policy was necessary but insignificant, and that in any case, its preservation depended heavily on sound fiscal policy. In addition, "the Reform Report states that setting an innovative exchange rate can only provide a short interval during which tight fiscal discipline must take its rightful place to control inflation."
As for the exchange rate, the low level of international reserves and unsatisfactory macroeconomic policies that existed just before the transition period led to a significant devaluation in all countries except Hungary. As a result, initially world prices did not have much effect on domestic. Restrictive income policy was aimed at establishing a certain level of inflation and, consequently, a slightly smaller crisis. However, such major changes and uncertainties did not make it possible to coordinate revenue policy through the main (fiscal and monetary) macroeconomic policies.
In Poland in 1990 and in Czechoslovakia in 1991, these main policies were initially so restrictive that income policies were not mandatory at all for most enterprises. In the former Soviet Union, the leadership believed that the policy of limiting income should not be implemented for political reasons.
In the CIS countries, politically dependent central banks, pursuing a policy of lending to enterprises, primarily considered the level of their economic activity, and this is the main area of government, not banks. As noted earlier, in the first years of the transition period, the CIS countries had a large budget deficit covered by emissions, as shown in table. 3. As a result, wages and prices spiraling, and then hyperinflation.
In the early years, some central banks successfully used the credit limit instrument. The use of this instrument means that there is no need for high real interest rates, although they should not be as negative as they were in most cases during the Soviet era. These rates may be higher in the middle of the transition period, when credit limits are rising and there is still time to raise the exchange rate.
It is at this stage that high interest rates become a key tool in the policy of protecting bank savings and curbing wage inflation. However, in the next stage of the transition period, greater creditworthiness and liberalization of the capital account led to an increase in the movement of international capital. For its part, this has led to some convergence of high interest rates in the country to low world rates.
Exchange rate policy
The free setting of the exchange rate was initially severely limited by the low level of international reserves and the urgent need to gain confidence in the new policy of full convertibility of the current account at a single exchange rate. At that time, it was desirable to have a regime of a fixed nominal exchange rate, and this rate served as an anchor for domestic prices and restrained inflationary attempts and inflation itself. However, the countries that introduced such a regime were forced to severely devalue the so-called "upfront" to ensure a competitive exchange rate and thus increase reserves.
As we have already noted, such devaluations have opened large gaps between domestic and external prices, thus undermining the role of the exchange rate as an anchor. In Russia (and many other CIS countries), international reserves were too small and monetary and fiscal policies too sluggish to address the issue of a nominal exchange rate. That is why the floating course regime was introduced. However, the need to create reserves meant that Russia, like other countries with such a regime, could not accept free navigation. As soon as the reserves become large enough as a result of intervention in the foreign exchange market, the tendency to free navigation immediately intensifies.
In the initial stabilization phase of the transition period, there were fears that deflation would help fix the nominal exchange rate, while later, when inflation was already low, the need to limit the destabilizing effects of capital inflows helped to create a more flexible exchange rate regime. Between these two, both inflation and reserves remain at a medium level, and concerns about maintaining competitiveness contribute to the introduction of a regime that combines some flexibility in nominal terms and stability in real terms. The mode chosen for this intermediate link was a typical creep band with a predetermined creep level tied to projected inflation.
As deflation progressed and the band was initially narrow, but eventually increased to a maximum ERM of -2 (+, -) 15%, this rate fell. To limit the internal costs of covering any external shock, it was better to link it not to a particular currency, but to a basket of currencies, thus indicating the composition of trade flows.
The exchange rate in all countries with economies in transition, with the exception of Hungary, followed the same path at the initial stage of reforms, first depreciating sharply and then actually increasing. This is not surprising given the low level of international reserves, the high risk of restructuring, inexperienced policies, the non-convertibility of the currency, and the typically low probability of chosen policies.
Several countries have introduced a currency board, in which the nominal fixation was combined with the full return of base money from international reserves. The main asset of this event is a significant achievement of trust. This immediately lowered inflation forecasts, which in turn reduced nominal and real market interest rates. The experience of the Baltic countries in the 1990s and Bulgaria in 1997 shows that the decline in interest rates can be large and rapid.
Lower interest rates soon reduced the cost of servicing both private and public debt, which in turn reduced unused banking sector equity funds and the state budget deficit, thereby strengthening confidence. Monetary government also helps to establish trust between investors and thus supports the revival of enterprises.
However, the "shirt" of the currency board deprives the macroeconomic framework of any flexibility in exchange rates. This, like any other fixed exchange rate regime, can lead the private sector to believe that there is no exchange rate risk at all. The result is a tendency to reduce the large external debt, which took place not only in Southeast Asia, but also in the Czech Republic.