Question

Short Answers 2: Write a paragraph about each topic/question.

A. Monetary Policy in Transition What are the problems that newly created central

banks in transition economies experienced after 1990? In answering the question, draw

comparisons between central banks’ policy effectiveness in transition and established

market economies.

B. Islamic Banking Describe the institution of banking within the Islamic economic

system. What are the principal-agent problems prevalent in the system? How do

Islamic banks practice lending?

C. Dual Track Reform Briefly describe the main characteristics of the Chinese dual

track approach to economic reform/transition. What makes it an appealing approach

to economic reform/transition?

D. Hyperinflation After the collapse of central planning, transition economies experienced

cases of hyperinflation. Explain why this occurred.

Answer 1

Answer 1 -
All three of the transition economies have made
p ro g ress in creating a banking system that corre s -
ponds to the needs of a developed market economy.
Their central banks have considerable independence
f rom government influence in fo l l owing their man-
dates to control inflation and maintain the inter-
national value of their curre n cy. At the same time,
the commercial banking sector remains re l a t i ve l y
f ra g i l e, plagued by poor loans made in the past as
well as by questionable lending policies that, fo r
some banks, continue to the present. These pro b l e m s
a re most visible in the Czech Re p u b l i c, but even in
Poland and Hungary loan portfolios of individual com-
m e rcial banks remain pro b l e m a t i c. This weakness of
the commercial bank secto r, and its re l a t i vely small
role in financing the investment activity of the corpo-
rate secto r, limits the policies that central banks can
fo l l ow and may attenuate or distort the tra n s m i s s i o n
of monetary policy impulses to the economy.
The problems created by the fragility of the
commercial bank sector are exacerbated by the
underdevelopment of the other components of
the capital market. Each of the countries has a
stock exchange, but markets for shares are thin,
and stock markets have performed poorly since
the middle of the decade.

All three countries experienced a significant
decline in production at the outset as a
result of the collapse of CMEA trade. This placed
a serious burden on fiscal policy because tax
revenues declined and the need for a social safety
net for the swelling numbers of unemployed
increased. Monetary policy was complicated by
the fact that investment in plant and equipment
decreased as excess capacity emerged in many
industries. Many firms failed to respond to the new
environment by reducing or altering their output.
Instead they accumulated large stocks of inve n to r i e s
and corresponding debts that threatened not only
their liquidity but also that of their suppliers and of
the newly created commercial banks.

Answer 2 -

Sharia is the Islamic law based on the teachings of the Koran and the traditions of the Prophet (Hadith and Sunna), prescribing both religious and secular duties and sometimes retributive penalties for lawbreaking. Among the several principles there is the fundamental concept of Tawhid which emphasizes that there is only One God who is the creator and sovereign of all. Islam requires total submission to Him in all aspects of life. This includes commerce and banking.

Thus, Islamic Banking and Finance is born.

Islamic Banking and Finance is governed by the Sharia, this integrates several ethical checks on the functioning of financial institutions. One of the most striking features of Islamic Banking and Finance is the prohibition of interest.

The idea behind this is that money in itself should not create more money, instead wealth must be built by investing in socially profitable ventures and real assets.

Answer 3 -
The basic principle of the dual-track approach is as follows. Under the plan track, economic agents are assigned rights to and obligations for fixed quantities of goods at fixed plan prices as specified in the preexisting plan. In addition, a market track is introduced under which economic agents participate in the market at free-market prices, provided that they fulfill their obligations under the preexisting plan. As the economy grew, the proportion of resources that was allocated according to the planned prices became increasingly small. As a result, the economy is able to “grow out of the plan” on the basis of the market track expansion by state or/and non-state enterprises (Naughton 1995).

Chinese economic reforms have been brought enormous impact on China’s economic landscape. Between 1978 and 2003, China’s GDP increased by more than nine times and the average growth rate was 9.5 percent; while China’s GDP per capita increased by about seven times and the average growth rate was 8.2 percent. In addition, this paper explores three major consequences of Chinese economic reforms: the diminishing role of the state sector, global integration of the Chinese economy, and the contribution of FDI in China’s economic development.