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Shoukang Lin is an Economist in the Central Asian Department. He was an economist in the Research Department when this work was completed. He received his doctorate from Brown University and taught at York University before joining the IMF. The author would like to thank Eduardo Borensztein. Timothy Lane, Kent Osband, Tian–Ye Wang, Peter Wickham, and an anonymous referee for helpful discussions and comments. He also thanks Catherine Fleck for editorial assistance.
For instance, during 1985–89, the budget of the government of the Soviet Union deteriorated rapidly and budget deficits rose from about 2 percent to 9–10 percent of GNP. These deficits eventually contributed to the economic crisis in 1990. In China, owing to a dramatic decrease in revenues from enterprises (from around 17.1 percent of GNP in 1979–81 to 5 percent of GNP in 1989), government revenues fell steadily throughout the 1980s. Although the Chinese government managed to reduce expenditures, and budget deficits widened only slightly, it experienced increasing difficulty in financing these deficits. Moreover, the trend of rising subsidies to poorly performing state–owned enterprises remains a potential source of macroeconomic instability. For further discussions, see Blejer and Szapary (1989), IMF and others (1991). Khor (1991), McKinnon (1991), and Bell and Kochhar (1992).
Both methods have been observed, with the first being more popular. However, to the extent that the first channel is essentially equivalent to an increase in the wage rate and that both channels coexist, the assumption would not affect the final conclusion.
There are various definitions of “monetary overhang” (see Cottarelli and Blejer (1991)). In this paper, a monetary overhang is defined as household money balances minus voluntary demand for money.
This sustainability is from a purely economic perspective. It does not imply political sustainability.
Hypothetically, one can imagine a case in which there is a large variety of the same consumer good. Each household can queue for only a few varieties of the good at official prices. Since households would rather have a more diversified consumption package, they will resell the goods in the black market to make a profit and use the money to purchase other varieties. Assume that consumers must have cash in advance to purchase goods in the black market; profits in the current period can be spent only in the next period. In that case, the household budget constraint becomes
For instance, in China, the government spent almost one–fifth of its 1991 budget on subsidies to loss–making firms.
In general, J should be a function of real variables only. In this model, the government fixes prices of consumer goods in official markets. A different initial nominal money balance implies a different degree of shortage and thus of black market activity, which has a real impact on household welfare.
If the demand for even one good at the official price exceeds the supply of that good, the economy faces a shortage and there are shortage rents to be sought. To model how the shortage rents are dissipated, this paper follows the approach in Osband (1991). Assuming that good x is in shortage, and that the shadow price of x, Px, is higher than its official price,
Owing to the rigid control of prices, if demand at official prices does not exceed supply, the market is considered “cleared.” As an illustration, assume that I = 2.5. X –= 1, Y =2, and the utility function
In this kind of hypothetical situation, disequilibrium could be characterized as an emerging monetary overhang or “forced” saving.
Here, it is implicitly assumed that as income rises, household demand for goods x and y eventually exceeds their supply. Otherwise, the analysis is identical to the case of
According to Proposition 2, if a T > 0 exists, such that NT = 0, then Nt = 0 for all t ≥ T.
The results hold for any initial cash balances, M-1.
It is clear that as long as the per–household wage level is not too low and the official prices are not market–clearing prices, at least one good will be in shortage.
This result contrasts with the considerable discussion about disequilibrium and “monetary overhang” (or “repressed inflation") in a centrally planned economy (Nuti (1986)). The findings here are consistent with Cottarelli and Blejer (1991), who find little evidence of monetary overhang in the former Soviet Union between 1964 and 1985.
If there are “excessive” money balances at the time of price liberalization, the qualitative nature of the analysis would change. The release of the excessive money balances may initially speed up inflation, but its effect on long–run inflation is minimal.