The Republic of Moldova An Assessment of Macroeconomic

The Republic of Moldova An Assessment of Macroeconomic Policies 1998 -2001 and Recommendations Shannon Hill, Liana Mesropyan, and Chad West – December 7, 2005

History n The Republic of Moldova declared independence from the USSR in August 1991 n Transnistria declared independence from Moldova September 1991 – “frozen conflict exists to this day” n Massive outflow of labor force: 25% currently resides outside of the country

Economy in the 1990’s n High inflation and low GDP/capita n Weathered the 1998 Russian financial crisis n Based on agriculture and agro-processing, later largely on remittances

Gross Domestic Product Russian Financial Crisis in 1998 caused downturn in output from 17. 475 billion Lei to 16. 020 billion Lei in 2000. n Beginnings of recovery from 2000 to 2001 to 17. 321 billion Lei. n GDP per capita decreased from 4, 064 Lei in 1998 to 3, 763 Lei in 2000. n Beginnings of recovery from 2000 -2001 to 4, 065 Lei. n

Household Consumption n Household consumption declined substantially from 1998 -2001 from 13. 172 billion Lei to 11. 990 billion Lei. n Consumption is likely due to the sharp rise in unemployment after 1998. n Consumption then recovers to 15. 516 billion Lei from 2000 -2001.

Government Consumption Total government consumption decreased from 4. 458 billion Lei in 1998 to 2. 561 billion Lei in 2001. n Government share of GDP declined from 35% to 22. 8% over the same time period. n Inconsistent with the IS-LM model because GDP rises from 2000 -2001 while government consumption continues to fall. n

Investment n n n Most significant problem facing Moldovan economy. Investment continued to decline from 4. 523 billion Lei to 3. 475 billion Lei from 19982001. Investment continued to decline despite a substantial reduction in the interest rate from 30. 9% to 5. 1%.

Net Exports n Moldova has been dependent upon imports since its independence from the Soviet Union in 1991. n Net exports have improved from 1998 -2001 from -4. 676 billion to -4. 231 billion. n Improvement in NX caused by a depreciation of the Lei to major currencies. Exchange rate against the dollar fell from 8. 3 to 13. 1.

Inflation and Unemployment n Inflation remained high after Russian Financial crisis. n 46% in 1999 and 31. 2% in 2000. n Inflation rates have decreased but still remain in double-digits to the present day. n Low unemployment figures before 1998 contribute to very high annual inflation rates (in some years unemployment is below 2%). n Unemployment has fallen from 11. 2% in 1999 to 7. 4% in 2001.

Monetary Policy 1998 -2001 n Contractionary from 1998 -1999 n Expansionary from 1999 -2001 Year Money Supply (in lei) Interest Rate Inflation (% over previous year) GDP growth (% over previous year) 1998 2, 041, 111 30. 9 1999 1, 942, 047, 244 32. 6 45. 9 -3. 4 2000 2, 023, 220, 000 20. 8 31. 2 2. 1 2001 2, 276, 867, 031 11. 0 9. 8 6. 1 -6. 5

Fiscal Policy

Loan Market

Policy Option 1. Reduce Inflation r LM 1 LM 0 BP IS 0 Y

Policy Option 1. Reduce Inflation r LM 1 LM 0 BP IS 1 IS 0 Y 1 Y 0 Y

Vulnerability In the short run n counter-productive effects for GDP in total n Unemployment increases

Policy Option 2: Encourage Foreign Investment n Setting high interest rate n Capital inflow to the country n New job-places created n Increase in output

Policy Option 2: Encourage Foreign Investment n … and expansionary fiscal policy n Expenditures to social sector n This will hold the shift of IS to the right which might be caused by decrease of Nx

Policy Option 3: Improve the Investment Atmosphere n EU Border Assistance n Resolution of Transnistria problem n Institutional reforms n Adoption of anti-corruption strategy n Reduction of transaction costs for business n Promoting vocational education n Retrain labor force for market economy

Conclusions Moldova has suffered from a number of negative macroeconomic trends, most of which do not follow from basic macroeconomic models. Fiscal and monetary policies alone will not address these challenges. Instead, Moldova must continue to make commitments to the previously mentioned policies.

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