Structural uncertainty and subsidy removal for economies in transition

Abstract

Economies in transition are faced with a high degree of ‘structural uncertainty’ i.e., uncertainty about which it is possible to learn through experience. We study structural uncertainty's effects on a subsidy removal program. Subsidy removal causes unemployment, but yields fiscal benefits and facilitates private sector growth. When the policymaker does not know the speed with which the private sector absorbs the unemployed, he will be driven toward a more decisive, and therefore more informative, policy. The model also rationalizes policy reversals and implies that irreversibility constraints and political instability dampen the learning effect making policy more gradualist.