Toughing it out: How the Baltics defied predictions

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The article below is a guest contribution by Christoph Rosenberg, an Advisor in the IMF’s European Department.

Two years ago, the eyes of the financial world were not on Europe’s Western periphery but on its North-Eastern corner. The three Baltic states—Estonia, Latvia and Lithuania—were among the first victims of the global financial crisis.

After a spectacular boom, with several years of Chinese-style growth rates, these small and open economies faced an equally spectacular bust. Credit―and with it property prices, consumption, and investment―collapsed. Exports were hit by the global depression. And the financial sector came under severe stress. Indeed, Latvia was forced to nationalize its largest domestic bank and had to ask for a bailout from the European Union and the IMF.

The conventional wisdom at the time was that these three countries would have to give up their long-standing currency pegs against the euro and devalue. After all, this is what countries facing a trade and financial shock most often choose to do.

But the Baltic governments begged to differ. They opted to maintain their currency pegs and instead let their economies adjust through “internal devaluation”: a mix of budget and wage cuts, supported by financial and structural reforms.

Click here for the full article.

Source: iMFdirect, January 7, 2010.

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