Draft; not for quotation Financial Repression in Transition: Output Reduction and Hyperinflation in the Former Soviet Economies

The output contraction and hyperinflation observed in the transition economies formerly of the Soviet Union was more profound and prolonged than anticipated. I argue in this paper that these magnified effects of transition to the market can be attributed to the government manipulation of financial markets in these countries. Policies undertaken to assist in financing government expenditures caused financial repression and financial fragmentation, to use the terms introduced by McKinnon (1973). After an introductory section, I introduce a theoretical model of real and financial sectors in transition. The dynamic path to equilibrium from transition is derived. It is shown to have a tendency toward output contraction and hyperinflation when government policies promote financial repression. In the third section this hypothesis is examined with macroeconomic data from Ukraine for the period 1992- 1999. These data are consistent with the hypothesis, although other factors (e.g., recession in trading partners) are also shown to be important. Thanks to Lewis Davis, Mark DeBroeck, and participants at a seminar at UNC-Chapel Hill for comments and suggestions. Any and all errors, of course, remain mine