A Monetary Model of a Shortage Economy

During the transition from centrally planned economies to market economies, many countries have experienced macroeconomic instability. This paper develops a monetary model to show how macroeconomic stability and instability can materialize in a rigidly planned economy with inherent structural imbalances and an irrational price system. The study shows that, without hardening enterprise budget constraints, wage and price liberalization may destabilize an economy and lead to persistent budget deficits and inflation. The paper also analyzes household savings and money demand in a shortage economy, clarifying the somewhat confusing concept of "monetary overhang" in the literature.