Monetary reform in Eastern Europe

Abstract

Over the past months, the case for currency convertibility in most current account transactions appears to have been won in all the smaller nations of Central and Eastern Europe.’ It has been accepted that convertibility will help to bring a distorted domestic relative price structure more in line with world prices. The substitution effects both in production and consumption that are activated by the move to convertibility of the currency will be helpful in the transition to a market economy. But, to impose domestic relative prices that are more in agreement with world market conditions will initially impose heavy adjustment costs on consumers and producers. The benefits of more realistic prices do not appear immediately; the costs of reduced subsidies to consumers and producers hurt directly. For that reason alone, removal of distortions in relative prices will stimulate strong political opposition from consumers, workers and managers. A very important advantage of currency convertibility is that the speed with which domestic relative prices adjust to conditions in the world market depends less on domestic political conditions, but is to an extent imposed from abroad. The other argument from political economy in favor of immediate convertibility on current account is that the absence of an ‘economic’ market for foreign exchange implies the continued existence of a political market in which foreign currency receipts are collected from companies and allocated to companies (and individuals). Some (small, newly established) companies may have attractive investment projects but fail to obtain foreign exchange for vital imports of machinery, as other (large) businesses enjoy the political