1. CH. 14 The Macroeconomy : Institutions and Policies

2. FROM BUDGET FINANCE TO PRIVATE CAPITAL MARKETS Under the Soviet administrative command economy, almost all enterprises were owned by the state. They received their investment capital from the state budget. The breakdown of the Soviet administrative command economy meant that new methods of meeting the need for operating capital and investment capital had to be developed. There were sources of investment finance in addition to the state budget "surplus," virtually all investment funds were under the strict control of the planners, even if they had been generated within the enterprise(enterprise depreciation and profit reinvestment) accounts or household(primarily in the form of cash or deposits in the state savings bank system).

3. FISCAL AND MONETARY ISSUES IN RUSSIA Fiscal System and Fiscal Policy: The Russian transition economy must make the transition from a Soviet-style fiscal system to one compatible with a market economy. Taxes: In Russia the major sources of revenue continued to be profits taxes and sales taxes. The role of payroll taxes and personal income taxes – little. Why?  The main factor has been the state's inability to identify and measure personal taxable income. State tax collections have been severely damaged by the decline in economic output, by the fact that much economic output is underground and out of the reach of the taxing authority, by the ability of influential enterprises to bargain down their tax obligations, and by the general decline in tax discipline.

8. Government Expenditures the financing of most investment directly out of the state budget the state budget also had to pay for a massive military establishment and for a large scientific and educational establishment the state budget had to provide massive subsidies to keep loss-making enterprises and whole industries in business Because of all these special circumstances, the Russian budget entered the transition period with a declining tax base, deteriorating tax discipline, and heavy obligations to pay military, education, science, and business subsidies.

9. Budget Deficits The state deficit has been the subject of intense negotiation with international organizations such as IMF, which use deficit as a benchmark for granting international credits. Prior to 1995, budget deficits were financed either by the issuance of new currency or by the issue of credit by the Russian Central Bank. Rubles were printed in ever-larger denominations to allow the state to pay its bills. Later, the budget deficit was financed by having the Central Bank of Russia (CBR) purchase the major portion of the debt. In April of 1995, new procedures were passed that prohibited the CBR from financing the state deficit. Instead, the Ministry of Finance and Treasury would have to finance the debt by selling bonds to the public and foreigners. These treasury bills are called GKOs.

12. Monetary Policies and Institutions One of the most important features of an efficient market economy is its use of money exchange. Money exchange is used in place of barter transactions whenever there is reasonable trust in the nation's currency. Trust is lost if inflation is excessive or if there is hyperinflation, which destroys money's function as a store of value and which diverts economic activity from productive activity to hedging against inflation. Since most money in a market economy is bank money rather than currency, the Russian transition required a conversion from administrative control of the money supply to control exercised by the central bank. A two-tiered banking system consisting of a central bank and commercial banks. The 1995 CBR legislation represented a modernization of Russian banking legislation. The CBR's monetary instruments now included interest rate policy, reserve requirements, open market operations, refinancing of banks, foreign exchange control and regulation of money aggregates, and quantitative regulations. After 1995, the CBR began to control the money supply much like central banks in the industrialized market economies.

13. Macroeconomic Stability, Deficits, and Money Supply The inflation rates have been strongly positively correlated with the growth of the money supply, albeit with a lag. The correlation between the growth of the federal deficit and the money supply is complicated, but since 1995, they appear uncorrelated. In the early years various Russian administrators, including chairpersons of the Central Bank of Russia, had to be convinced of the positive correlation between monetary growth and inflation (preferring instead to blame monopoly and structural factors for inflation) Even the most skeptical critics became convinced that inflation was caused by excessive monetary growth. The Russian government has also been under pressure from the IMF to limit federal deficits, thereby attacking the inflation problem from both sides-by creating mechanisms to reduce monetary expansion and to reduce government deficits as a potential source of monetary and credit expansion.

14. CREATING RUSSIAN CAPITAL MARKET In market economies. investment finance and working capital are generated by private capital markets. The creation of a Russian capital market has not been an easy challenge. It has required the formation of appropriate institutions for channeling domestic and foreign saving into productive investment through financial intermediation and, more difficult, it has required an investment climate that promotes the demand for productive investment. Despite improvements, the Russian two-tiered banking system has a number of problems that hinder its ability to effectively intermediate between savers and industrial borrowers: First, many Russian banks were often formed from funds from specific industries, like automobiles, textiles, or communal housing. Second, Russian banks have yet to gain the confidence of depositors, who have seen their savings eaten away by inflation or failures of their own banks. Third, the Russian banking system is still not well integrated regionally. Fourth, since Russian banks are unsure of their depositor base (will deposits perhaps be withdrawn?), they are willing only to lend short-term.