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Bridging “the Great Divide”: Countering Financial Repression in Transition

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  • Patrick Conway

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    Abstract

    The large and widening gap between economic performance in Eastern European transition economies and those of the former Soviet Union has been dubbed “the Great Divide” by Berglof and Bolton (2002). This paper provides a rationale for the gap based upon the concept of financial repression. The magnified effects of transition to the market can be attributed to the government manipulation of financial markets in these countries, with the divide defined by the length of time that governments relied upon financial-market manipulation to finance government fiscal policy. Policies undertaken to assist in financing government expenditures caused financial repression and financial fragmentation, to use the terms introduced by McKinnon (1973). After an introductory section, I introduce a theoretical model of real and financial sectors in transition. The dynamic path to equilibrium from transition is derived. It is shown to have a tendency toward output contraction and hyperinflation when government policies promote financial repression. In the third section this hypothesis is examined with macroeconomic data from Ukraine for the period 1992 - 2001. These data are consistent with the hypothesis, although other factors (e.g., recession in trading partners) are also shown to be important.

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    File URL: http://www.wdi.umich.edu/files/Publications/WorkingPapers/wp510.pdf
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    Bibliographic Info

    Paper provided by William Davidson Institute at the University of Michigan in its series William Davidson Institute Working Papers Series with number 510.

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    Length: 41 pages
    Date of creation: 02 May 2002
    Date of revision:
    Handle: RePEc:wdi:papers:2002-510

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    Keywords: Transition Economies; Financial Repression; Inflation; Real balances;

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    1. Jong-Il Kim & Lawrence J. Lau, 1996. "The sources of Asian Pacific economic growth," Canadian Journal of Economics, Canadian Economics Association, vol. 29(s1), pages 448-54, April.
    2. William H. Branson & Dale W. Henderson, 1984. "The Specification and Influence of Asset Markets," NBER Working Papers 1283, National Bureau of Economic Research, Inc.
    3. Oriana Bandiera & Gerard Caprio & Patrick Honohan & Fabio Schiantarelli, 2000. "Does Financial Reform Raise or Reduce Saving?," The Review of Economics and Statistics, MIT Press, vol. 82(2), pages 239-263, May.
    4. Guillermo A. Calvo & Manmohan S. Kumar, 1994. "Money Demand, Bank Credit, and Economic Performance in Former Socialist Economies," IMF Staff Papers, Palgrave Macmillan, vol. 41(2), pages 314-349, June.
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