Shock Therapy in Transition Countries: A Behavioral Macroeconomic Approach

I use a behavioral model to analyze how reforms in transition countries (i.e., price liberalization and competition policy) may affect their business cycle. The novelty of such a model is that the business cycle is generated endogenously interacting with confidence factors. It is assumed that agents do not form rational expectations, and they use simple rules and evaluate the forecasting performances of these rules ex-post. This paper generates policy implications that shock therapy may not be the ideal option for these countries as it may generate macroeconomic instability. The result of this model is in line with the recent macroeconomic literature that the size and the sequencing of reforms matter.