Arrears as a Sign of Financial Repression in Transition Economies - The Case of Romania

This study looks at the signs of financial repression in a transition economy, by evaluating to what extent "perverse financial innovations" resulting from soft budget constraints interfere with monetary developments at the aggregate macroeconomic level. Specifically, the paper investigates to what extent inter-enterprise arrears could act as substitute for transaction money and interfere with the efficiency of restrictive monetary policies, as reflected in money velocity. The particular case of Romania is analysed in two settings: (i) in an ad-hoc econometric investigation on the determinants of M1 and M2 velocity and (ii) in a simple money demand-money supply model which is estimated with and without endogenous inter-enterprise arrears as determinant of money demand. The general conclusion of the research is that, even though it is theoretically possible for overdue trade debt and arrears to interfere with monetary policy effectiveness and reflect upon the evolution of monetary aggregates, this was NOT the case with inter-enterprise arrears in Romania between 1991-1995. The main conclusion for economic policy is that restricting the growth of liquidity and credit in the economy through monetary measures is not enough for hardening budget constraints.