Question

What are the main difficulties encountered by the newly established central banks in transition economies?

Short answer

Increased and continued inflation is one of the major issues encountered by the transforming economies.

Step-by-step solution

Concept Introduction

Transitional economies are considered to be countries that are undertaking macroeconomic reforms in an attempt to change how their economies are managed.

Explanation

The newly established central banks in post-communist countries were provided with a considerable degree of legal independence. The reason for that was the empirical success of independent banks in developed countries in maintaining price stability. Institutional devices, such as an independent central bank, can impose necessary financial discipline on policymakers and restrict them from short-sighted monetary expansion. Of course, legal independence does not necessarily result in actual independence i.e., effective protection from political pressure.

Final Answer

High and persistent inflation is one of the main problems faced by the transforming economies. Monetary expansion driven by political factors seems to be the main cause of current inflationary episodes.