The transition to the market economy entails a change in the role and effectiveness of monetary policy. The development of capitalism in Hungary and elsewhere in Central and Eastern Europe has led to the emergence of many large firms with risky prospects and affected the banking sector's own expectations of success. Many of the resulting difficulties have been compounded by the reforming governments' current monetary policy stance. In Discussion Paper No. 841, Research Associate István bel and Pierre Siklos demonstrate that the restrictive policy of high ex post real interest rates imposed on the banking sector by the National Bank of Hungary, ostensibly to stem credit growth, is likely to reduce the chances of a successful transition to a market economy.

bel and Siklos note that the most pressing issue at the start of transition is how to deal with the dubious quality of enterprise debt, including inter-enterprise credit, and how to treat it in a reformed banking system. They note that the well-known implications of the relationship between trade credit and inflation appear to have been largely neglected by policy-makers, who have adopted a monetary policy consonant with those of Western industrialized countries. Enterprises simply do not possess the means necessary to adjust their portfolios in a world which operates a conventional monetary policy framework after years of central planning.

bel and Siklos then illustrate that the drawbacks of Hungary's monetary policy currently outweigh its advantages. This arises because the authorities have assumed that the types of efficiency improvements in and rationalizations of enterprises made possible by a well-functioning market economy have already been achieved, which is not the case. For example, while the introduction of a new bankruptcy law in January 1992 led to an acceleration of firms' failure rate, many inefficient firms remain. Also, internal finance remains the principal source of credit, since the continued underdevelopment of capital markets ensures that bank finance accounts for only a small proportion of firms' sources of funds.

Constraints on Enterprise Liquidity and their Impact on the Monetary Sector in Formerly Centrally Planned Economies
István bel and Pierre L Siklos

Discussion Paper No. 841, November 1993 (AM)