liquidity. Accordingly, it could be said that monetary restraint has not been strong enough to control domestic demand.

Second is the effect of exchange rate devaluation to correct relative price distortion. This might be sometimes underestimated in affecting domestic inflation. Third is the monopolistic behavior of state enterprises. Confronting liberalized higher input prices, they might have set their selling prices at higher than market-determined levels.

There seems to be a consensus view that, to cope with this kind of hyper-inflation, the larger the once-and-for-all price shocks, the shorter the duration of its impact. But we must note also that industrial adjustment would take time so that price liberalization could not necessarily guarantee quick improvement in resource allocation but may even hamper it through increasing risks. Then, sectoral imbalances and the resulting inflation could be prolonged for a while.

## 2 -2-2 Output Decline

Output response to the new incentive system or liberalized prices has sometimes been greater than expected. Among other things, a decline of output has been sharp and its duration has been unduly long in Eastern Europe and the former Soviet Union. Especially, the reaction of the 'ancient' structure of production, namely state enterprises, has been generally slow and their output decline has also been pervasive. On the contrary, output decline in Vietnam was relatively short-lived with only transitory stagnation, and there was nonnegative output growth in China.

This ‘output collapse’ during the reform, which has generated explicit and implicit unemployment and helped reduce real wage rates, can be attributed to a variety of factors.

First, one can point out demand-side factors such as prevailed hoarding of goods and materials based on inflationary expectation and, then, reduced demand afterwards, real reduction of money, credit and wages due to unexpected inflation and monetary tightening, and the ‘terms-of-trade effect’ due to the collapse of the CMEA regime.

Second, more important, however, there are supply-side factors which include a decline of real credits, a rise in nominal interest rates due to price shocks, high real interest rates maintained thereafter, and risk averseness intensified by management shocks due to regime changes. Moreover, while price liberalization resulted in increased input goods prices, the collapse of the CMEA regime itself has brought about a sharp cut of imports of materials and intermediate goods.

## 2 -2-3 Transmission Mechanism

This output response resulted directly from stabilization measures in the reform and the close relationship among the fiscal budget, financial market, and enterprise organization as described below.

First, fiscal reform consists of an overall cut in subsidies, which means an overall cut in profit and investment finance of state-owned enterprises (SOEs). In view of a significant role played by these SOEs in raising revenue to the government budget under the 'soft-budget constraint,' this kind of expenditure cut could, after all, expand the budget deficit rather than vice versa. On the other hand, it may need time and resources to enlarge the tax base and to