THE DYNAMIC ADJUSTMENT OF A TRANSITION ECONOMY
IN THE EARLY STAGES OF TRANSFORMATION
Bank of Greece, Economic Research Department
Eric J. Pentecost
Department of Economics, Loughborough University
This paper develops a model of a representative transition economy to explain the stylised facts of output declines and real exchange rate appreciation in the early stages of transformation. These facts can be explained by supply-side shocks, interest rate liberalisation or a reduction in core inflation. The policy implication is that price liberalisation in advance of financial liberalization and structural reform, including widespread privatisation of the production process, necessarily results in some temporary loss of output.
Keywords: Transition dynamics, overshooting, competitiveness, output decline.
JEL classification: F41
The authors would like to thank George Tavlas and Sophocles Brissimis for helpful comments. The views expressed in this paper are those of the authors and should in no part be attributed to their respective institutions.
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