Abstract

To characterize the macroeconomic disequilibrium in a typical European transforming country we construct a simple one-sector open macroeconomic model with restrictions on capital account transactions. Using this model we analyse the medium-term effects of the transformation, with special reference to the implications of foreign direct investment on the real exchange rate and the possible incompatibility of trade liberalization and economic stabilization. In the model, we follow the absorption approach in characterizing external transactions and assume that inward foreign direct investment is the only allowable private capital account item. Two crucial aspects of the transformation from the Hungarian perspective, i.e. foreign direct investment and the legacy of foreign debt, are highlighted.

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