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On the Credibility of Big Bang Programs: A Note on Wage Claims and Soft Budget Constraints on Economies in Transition

F  Coricelli,  G  Milesi-Feretti,  March 1993
Paper No' CEPDP0124:
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This Paper is published under the following series: CEP Discussion Papers
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Abstract:

The paper examines cases in which from a production efficiency standpoint "big bang" programs are superior to gradualist programs. Nevertheless, in the presence of (I) uncertainty about the exogenous shocks, (ii) dependence of policy actions on the state of the economy, and (iii) uncertain future of firms in the context of a generalized short-run output contraction, "big bang" programs can lead to inferior outcomes. We argue that short-term effects of a "big-bang" on output and employment may endogenously weaken the credibility of the program. This can induce perverse behaviour on the part of the economic agents, leading to outcomes that are worse than those associated with a gradual program. For example, if the government is perceived to face a political constraints that make high rates of unemployment unacceptable, then workers'' wage claims may be "too high" because of the perception of a government bailout of insolvent firms should times be tough.