Reforming the Financial System

  • Timothy D. Lane


Reform of the financial system is at the heart of the transformation of formerly centrally-planned economies into market economies. In a market economy the financial system plays a coordinating role that is a necessary complement to the decentralization of economic decisions. In centrally-planned economies resources are allocated through a combination of fiat and bargaining, and enterprises’ access to resources does not depend on their solvency. State enterprises face “soft budget constraints” and can continue to operate regardless of continuing losses, as their operations continue to be financed through easy credit and subsidies (Kornai 1980). If the centralized allocation of resources is eliminated, but enterprises’ solvency constraints are not enforced, the result is a “no-man’s land” in which firms’ demand for credit is unlimited at any interest rate—because they never anticipate having to service their debts—and only quantitative credit controls can restrain their borrowing (Beksiak 1989; Dooley and Isard 1991). Unless these credit controls are so detailed as to be tantamount to central planning, they will result in an arbitrary allocation of resources across different activities which is antithetical to a transformation to a market economy. The transition to a market economy thus depends on establishing financial discipline by building a sound financial system.1


Financial System Socialist Economy Trade Credit Security Market Former Soviet Union 
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© Springer-Verlag Berlin · Heidelberg 1994

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  • Timothy D. Lane

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