Transcript The Last Shall Be the First: The East European Financial Crisis

The Last Shall Be the First:
The East European
Financial Crisis, 2008-10
Anders Åslund
Senior Fellow
Peterson Institute for International
Economics, Washington, DC
Queries
Causes
of crisis?
To devalue or not?
Outcome?
Political economy?
Outlook?
Causes of the Crisis
Loose Monetary policy of the US Fed and
ECB
 Excessive capital inflows (carry trade)
 Excessive credit expansion
 Real estate bubble
 Rising inflation
 Current account deficit
 Currency mismatches
But decent public finances and little leverage

Credit Expansion, 2000-2009
60
Percent Change
50
40
30
20
10
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
-10
-20
Baltics
Hungary, Slovakia, and Poland
Romania and Bulgaria
2009
Inflation in 2008
18
(average consumer prices, percent change)
16
14
12
10
8
6
4
2
0
Latvia Lithuania Estonia Slovenia Hungary Slovakia Czech Poland Romania Bulgaria
Republic
Current Account Deficit, 2007, 2009,
(Percent of GDP)
*2010 figures based on IMF estimates
Source: World Economic Outlook , IMF, (accessed on March 24, 2011)
Foreign Debt, end 2009
180
(percent of GDP)
160
140
120
100
80
60
40
20
0
Latvia Lithuania Estonia Slovenia Hungary Slovakia
Czech Republic
Poland Romania Bulgaria
Currency Mismatches:
100
Share
of Foreign Currency Loans, 2007
90
(percent of total loans)
80
70
60
50
40
30
20
10
0
Latvia
Lithuania
Estonia
Hungary
Czech Slovakia
Republic
Poland
Romania Bulgaria
Big GDP Fall in Baltics in 2009
15
(percent annual growth)
10
5
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
-5
-10
-15
-20
Baltics
Central Europe
Southeastern Europe
Issues
 Overheating
followed by “sudden
stop”
 Large falls in GDP: Latvia 25%
 Caused big budget deficits
 Large current account deficits
Needed: Liquidity, budget cuts &
competitiveness
To Devalue or Not? No!
No country changed exchange
rate policy:
Slovenia & Slovakia: euro
Poland, Czech, Hungary &
Romania – floating
Baltics & Bulgaria - fixed
Holding the Peg
Bank
system survived & govt
did not have to recapitalize it
Bankruptcies avoided
Great integration renders
devaluation ineffective
Internal Devaluation: A crisis
is a terrible thing to waste
Major
fiscal adjustment 10% in
2009 in Baltic countries
Reduced public salaries & staff
Closed state agencies
Closed schools & hospitals
Lean & efficient public sector
Alternative:
Devaluation
Advantage:
Earlier recovery
through exports
Disadvantages:
Bank system collapse
 Oligarchs/big exporters would have
gained wealth and power
 Less reforms

Conclusion
Ultimate
problem: Loose monetary
policy of US Fed and ECB
No exchange rate regime could
salvage these open and attractive
economies
 No
country changed exchange rate
regime as no evident advantage
Poor Macroeconomics
Paul Krugman: “Latvia is the new
Argentina.” !
Devaluation was neither necessary
nor inevitable in the Baltics...
Outcome (1)
 Unit
labor costs fell sharply
 Flat income tax and low corporate
taxes survived
 Current account turned around to big
surplus in 2009
 No deflationary cycle
 Return to growth sooner than
expected
Outcome (2)
 Minimal
bank collapses
 All foreign-owned banks survived
changes over the corresponding period of the previous year, %
Inflation and Gross Wages:
up and down, 2004-2010
40
35
30
25
20
15
10
5
0
2004
2005
2006
2007
2008
-5
-10
-15
Consumer Prices
Source: Central Statistical Bureau of Latvia, www.csb.gov.lv.
Gross Wages
2009
2010
Crisis bred budget deficits 2009-11
2
(percent of GDP)
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010 2011E
-2
-4
-6
-8
-10
Estonia, Latvia, Lithuania, and Bulgaria
Poland, Czech Republic, Hungary, and Romania
Slovenia and Slovakia
Public debt remains limited
60
(percent of GDP)
50
40
30
20
10
0
2000
2001
2002
2003
Estonia, Latvia, Lithuania, and Bulgaria
2004
2005
2006
2007
2008
2009
Poland, Czech Republic, Hungary, and Romania
2010 2011E
Slovenia and Slovakia
Apart from in Hungary & Poland,
end 2010
90
80
(percent of GDP)
70
60
50
40
30
20
10
0
Latvia Lithuania Estonia Slovenia Hungary Slovakia Czech Poland Romania Bulgaria
Republic
Political Economy
People
have demanded realistic,
radical crisis resolution
Minimal social unrest
Cuts of 10% of GDP (Baltics)
politically easier than 2% of GDP
Strange myth that democracies
cannot cut public expenditures:
Political Economy 2
Radical,
early adjustment
preferable
Better to cut expenditures
than raise taxes
Equity is important
Political Economy 3
8
of 10 countries have changed
government during the crisis
 9 of 10 countries have centerright governments – center right
stronger than ever
 Multi-party coalitions most
effective in crisis
International Assistance
1. International liquidity crucial: missing
first because ECB was passive
2. Large early international assistance
vital
3. New cooperation IMF-EU worked
well
4. EU grants important: 4-7% of GDP
Outlook
 Main
concerns: reversed pension
reforms and rising inflation
 Trimmed public sectors: Expenditure
cuts rather than higher taxes
 Eastern Europe has gained efficiency
and self-confidence: European
convergence continues
The Last Shall Be the First
20
Inflation: Threat again
(percent change)
18
16
14
12
10
8
6
4
2
0
2000
2001
2002
2003
Estonia, Latvia, Lithuania, and Bulgaria
2004
2005
2006
2007
2008
Poland, Czech Republic, Hungary, and Romania
2009
2010
2011E
Slovenia and Slovakia
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
GDP in PPP as % of EU Average