Eastern Europe
Macroeconomic equilibrium

During their transition, Eastern Europe and the former Soviet Union face a combination of problems without historical precedent, which require new economic models. In Discussion Paper No. 758, John Bennett and Research Fellow Huw David Dixon construct a general equilibrium model consistent with the following five stylized `facts' concerning their current situation: inherited industries are highly concentrated; many privatized and state firms are independent of state control; there is an excess supply of labour; many goods prices are still subject to official control and kept below market-clearing levels; and there is a privately-owned small-scale production sector. The oligopolistic sector consists of profit-maximizing firms, while the state-controlled sector produces a fixed output at a fixed price. Markets clear in the state sector by queuing and not on price, while the labour market is competitive and supply is perfectly elastic at the market wage.

Bennett and Dixon use this framework to show that a monetary expansion leads to `overinflation' and leaves net output and employment unchanged, although more real resources are used up in queuing and there is a general equilibrium complementarity between state-sector and oligopolistic output. The liberalization of prices is deflationary in terms of full economic prices, but it may raise average money prices. The authors advocate indexing social security and pensions to free market prices instead, since some money prices are distorted by controls. Finally, if post-privatization output is higher (lower), output in the oligopolistic and small-scale sector will also be higher (lower).

Macroeconomic Equilibrium and Reform in a Transitional Economy
John Bennett and Huw David Dixon

Discussion Paper No. 758, January 1993 (IM)