Return to the market: Subsidies in the process of transition

Subsidy reduction is an important element in the transition from traditional command economies to a market system. Due to the interrelation of subsidies with other elements of the economy, however, their elimination depends upon other reforms. The first chapter focuses on the experiences of Hungary, and concludes that reform of the banking and taxation systems is an essential prerequisite for effective subsidy reduction, in order to create a budget constraint for enterprises, and that only a comprehensive reform can substantially reduce the allocative role of the state budget. The second chapter examines money demand in an environment of shortage, inflation and currency substitution. A simple optimization model is developed in order to examine the consumer\u27s choice of an optimal portfolio of currencies. Demand for domestic money is shown to be determined by the difference between official and black-market prices, the exchange rate, and expectations about devaluation, inflation and availability in official (subsidized) shops. The third chapter describes an econometric model of Czechoslovakia which was developed for use in simulating policy trade-offs. The model is applied to scenarios of subsidy reduction, and it is demonstrated that subsidy reduction, when pursued in isolation, will cause a sharp contraction in aggregate demand. On the other hand, subsidy reduction, when accompanied by an expansionary incomes policy, can increase aggregate demand over the baseline scenario