Download The Last Shall Be the First: The East European Financial

Lessons from the
East European
Financial Crisis
Anders Åslund
Senior Fellow,
Peterson Institute for International Economics,
Washington, DC
Theses
1. Sharp output falls:
Caused by liquidity freeze
2. Devaluation: No salvation
3. Radical Crisis Resolution
4. Good politics
5. Early & decent growth
1. Causes of Crisis
 Massive
overheating with large
current account deficits
 Followed by “sudden stops”
 Which caused large falls in GDP,
Latvia 25%, Est 20%, Lith 18%
 Led to large budget deficits
Austerity did not cause output falls,
but was a consequence
GDP Growth 2007 & 2009
(Percent)
Crisis bred budget deficits 2009-11
2
(percent of GDP)
1
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010 2011E
-1
-2
-3
-4
-5
-6
-7
-8
Baltics
Central Europe
Southeastern Europe
2. Why Devalue?
Paul Krugman: “Latvia is the new
Argentina.”
• Latvia’s competitiveness had
fallen too sharply
• Internal devaluation was
politically impossible
• Latvia needed stimulus
Why Devalue? (2)
Danger of deflationary cycle
Latvia did not deserve help
“Latvia doesn’t produce much
to export”
• Roubini: “devaluation seems
unavoidable”
•
•
•
But Devaluation Was Risky
• Devaluation could have been
uncontrollably large (Belarus)
• Led to wild inflation (Belarus)
• Less reform pressure (Ukraine)
• Bank system could have collapsed
(Ukraine)
• Mass bankruptcies
• Real foreign debt would have doubled
Conclusion on Devaluation
• No exchange rate regime could have
salvaged the open Latvian economy
• Fixed exchange rate saved Latvia
from collapse of bank system, mass
bankruptcies and doubling of foreign
debt
• It facilitated vital structural reforms
• Latvia ready for euro adoption 2014
3. Crisis Resolution
• Early
and comprehensive
fiscal adjustment
• IMF & EU program in
Hungary, Latvia &
Romania
Substantial Fiscal Adjustments
Balts:
Public adjustment of 9% of
GDP in 2009
Latvia sacked 30% of public
employees
Closed half state agencies
Reduced public salaries by 26% in
one year
Major Public Sector Reforms
Public
administration trimmed
Education reforms – more
efficiency
Health care reforms - same
Alas pension reforms reversed to
save the poor
Maastricht Criteria More
Respected in East
Average
public debt in 10 CEE
39% of GDP in 2010, but 85%
of GDP in eurozone
Only Hungary has exceeded
the Maastricht debt ceiling, but
12 of 14 Western EMU
members
Sharp Improvement in Current Account
2007-2009 (Percent of GDP)
Public debt remains limited, 2010
90
(percent of GDP)
80
70
60
50
40
30
20
10
0
Latvia Lithuania Estonia Slovenia Hungary Slovakia Czech Poland Romania Bulgaria
Republic
4. Good Politics
1. Severe crises bred action
2. Origin of crisis external
3. Small countries more vulnerable
4. Prior great economic success
5. Credible culprits: oligarchs
6. Free market ideology
7. New leaders
8. Political instability
9. Parliamentary support
10.Expert policymakers
4. Good Politics (2)
11. Comprehensive crisis program
12. Front-loaded measures
13. More expenditure cuts than tax increases
14. Social compact
15. Equity
16. International support & sufficient finance
17. Domestic ownership
18. Early and decisive implementation
19. Good salesmanship and transparency
20. Policy review
7 Conclusions
1. No country changed exchange
rate policy: Internal devaluation is
possible and effective
2. Goal of euro accession is
valuable: Maastricht criteria more
respected outside the eurozone
3. Substantial, early fiscal
adjustments preferable
7 Conclusions
4. Better to cut public expenditures
than to raise taxes: Drives public
sector reforms
5. Strange myth that democracies
cannot cut public expenditures
6. International rescue should be large
and front-loaded
7. Growth has returned fast but is
likely to stay lower than before
Renewed growth, good but lower
15
(percent annual growth)
10
5
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
-5
-10
-15
-20
Baltics
Central Europe
Southeastern Europe
2010
2011E
Total GDP Growth, 2000-2010
70
(percent change)
60
50
40
30
20
10
0
Slovakia Romania Lithuania Bulgaria Poland
Estonia
Latvia
Czech Republic
Slovenia Hungary
European Convergence Proceeds
GDP in PPP as % of EU Average