Transition Economy Readjustment: A Trade-Shock Perspective

Abstract

To what extent is Hungary’s recession between 1991 and 1996 driven by the costs of institutional adjustment following the collapse of the planned economy? Using a dynamic general equilibrium model with trade policy, price subsidies, and labor frictions, I build on prior work by Gorodnichenko, Mendoza, and Tesar (2012) to argue that the collapse of Soviet trade in 1991 induces a costly restructuring of Hungary’s planned economy. I show that the estimated model closely matches the trajectory of consumption as seen in the data. Counterfactual experiments indicate that high wage rigidity, habit formation in consumption, and large oil price subsidies, together, go a long way in explaining the severity of Hungary’s recession. The model highlights alternative policies resulting in a shortened and lessened severity.