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In exploring the short-term macroeconomic effects of energy-supply shocks in Ukraine, this paper relies on the simplifying assumption that enterprises face economic regulation but not ownership uncertainty that would adversely affect their behavior. In a sense, it assumes that Ukraine's economy is already at the second stage of reform, when ownership and contract-enforcement questions are less of an issue. Under these assumptions and if real wages are protected, the analysis yields clear messages. Protecting the domestic economy by not passing through external price increases may cushion the decline in production and social welfare, but at a heavy cost to savings and investment; not only does it postpone adjustment and the emergence of a competitive economy, but it also deprives the economy of investible resources. Passing through external price increases while maintaining a fixed-price regime may improve the mobilization of resources but at a heavy cost to output and welfare, since it induces a heavy contraction in activity. Liberalizing prices in the nonenergy sectors in conjunction with passing through external price increases allows these sectors to generate the larger resource transfers required by a deteriorating terms of trade, in turn pulling up output; the economy can settle at a higher level of activity and welfare than in the presence of fixed prices. The conclusion is that the Ukraine must clarify ownership and contract enforcement issues as rapidly as possible, liberalize nonenergy prices at a minimum, and begin adjusting domestic energy prices to reflect the opportunity cost of these resources.

Publisher: World Bank

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