Soft Budget Constraints and Banking in Transition Economies

We analyze the problem of soft budget constraints of enterprises financed by banks in transition economies and review the similarities and the differences in various models addressing that issue. We reconstruct these models as several variants of a basic sequential model of soft budget constraints. In each case, we analyze both the sources of the soft budget constraint and the mechanisms for hardening budget constraints, including the policy implications of the analysis. Despite various mechanisms and channels for soft budget constraints, all models share the same sequential structure where soft budget constraints arise due to the endogenous lack of credibility for liquidation of a project instead of continuation and refinancing. All share the same feature that mechanisms for hardening are mechanisms for endogenously restoring such a credibility for liquidation.