Welfare Implications of Strategic Economic Policy in Eastern Europe

By Haber, Gottfried | International Advances in Economic Research, May 2000 | Go to article overview

Welfare Implications of Strategic Economic Policy in Eastern Europe


Haber, Gottfried, International Advances in Economic Research


GOTTFRIED HABER [*]

This paper evaluates the welfare effects in a block of selected eastern European countries (Bulgaria, Romania, former Czechoslovakia, Hungary, Poland, and former Yugoslavia) emerging from the possibility to participate in the European integration process and to act as strategic players in dynamic games. The results of the cooperative and noncooperative dynamic game scenarios are compared with fixed policy solutions. The McKibbin-Sachs global model (MSG2 model), which incorporates rational expectations, is used as a framework. A global supply-side shock and a fixed exchange rate regime are considered under the alternative policy layouts. It is shown that international economic cooperation may be advantageous over noncooperation. For the anchor currency of the European Monetary Union (EMU), fixing the eastern European block currencies to the EMU may lead to significant destabilization. (JEL E61, E63, C73)

Introduction

The transition process of the eastern European countries is one of the main economic issues of this decade, besides the European Monetary Union. This transformation process is not only limited to the change of the political systems toward market economies in these countries, but includes participation in the integration process of the western European countries as well. The main focus of this discussion rests on the effects concerning the involved eastern European countries. However, in a period of high and still increasing global interdependence and integration, there are a variety of quantitatively important international spillovers and feedbacks. Therefore, it is not straightforward to evaluate the domestic effects in the eastern European countries on one hand and the consequences for the rest of the world on the other hand.

To show the long-run effects of the integration of the eastern European countries, these countries are regarded as a single block in the following simulations. The second section gives an overview of the theoretical framework used in this paper, the McKibbin-Sachs global model (MSG model) of the world economy. Then the simulation layout is described in the third section. The results of the calculations are presented in the fourth and fifth sections.

The MSG Model

The MSG model is a dynamic general equilibrium model of a multiregion world economy. It is based on microeconomic foundations by assuming that economic agents maximize intertemporal objective functions. In contrast to computable general equilibrium models, individual countries' economies are not disaggregated into several sectors. However, dynamic relations are explicitly taken into account. The model exhibits a mixture of classical and Keynesian properties. Expectations are assumed to be formed in a rational way, but various rigidities are taken into account by allowing for deviations from fully optimizing behavior. In particular, nominal wages are assumed to adjust slowly in the major industrial economies (except Japan). Due to this wage stickiness, extended periods of unemployment can be present in these economies. Nevertheless, the model solves for a full intertemporal equilibrium in which agents have rational expectations of future variables. As a model with theoretically constrained long-run properties , it can display how the short-run adjustment of the world economy to exogenous shocks depends upon the long-run adjustment.

The theoretical structure of the model as well as a listing of its equations are given in McKibbin and Sachs [1991] and McKibbin [1991, 1994]. This paper points out only some of its theoretical features which make it particularly well suited for analyzing adjustments to exogenous shocks. First, the long-run of the world economy is well determined, being driven by a neoclassical growth model, with exogenous technical progress and population growth. In the short-run, the dynamics of the global economy toward this growth path are determined both by Keynesian rigidities in the goods and labor markets and by optimal decisions, conditional on expected future paths of the world economy. …

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