COMPARISON OF THE ADJUSTMENT OF THE BALTIC ECONOMIES WITH IRELAND, GREECE AND PORTUGAL

The comparison of the adjustment in the Baltics with Ireland, Greece and Portugal (also referred to as the euro area-3 in the following), after the cyclical peak in 2007-2008 is valuable as there are many similarities

Table 12.2 Changes in real GDP since 2007 in the Baltics and Ireland, Greece and Portugal

Change in GDP from cyclical peak to trough during 2007-09 crisis (%)

Change in GDP from cyclical peak in 2007/08 to current GDP level (Q2 2012) (%)

GDP level in Q2 2012 (2000 = 100)

Latvia

-24.6

-15.1

156.9

Estonia

-19.5

-6.3

157.5

Lithuania

-15.9

-6.4

166.9

Ireland

-10.7

-8.4

132.3

Portugal

-4.1

-6.4

102.0

Greece

-

-18.3

110.9

Cyprus

-3.0

-2.3

130.2

Spain

-4.9

-5.3

121.6

Italy

-7.1

-6.9

101.9

EU-27 average

-8.4

-3.6

130.2

Source: Eurostat, Eesti Pank calculations.

between these country groups. Firstly, an obvious advantage is that we are analysing the same time period, which enables us to control for some of the impact from the international economic environment. Secondly, both country groups showed significant vulnerabilities and imbalances prior to the crisis. Thirdly, from a country perspective all of the countries were unable (Ireland, Greece and Portugal) or unwilling (the Baltic countries) to adjust via changes in nominal exchange rates.

Indeed, from a qualitative point of view, there are many similarities in the economic adjustment of both country groups. All of the countries have witnessed severe recessions that have been characterized by exceptionally large cumulative declines in domestic demand and strong increases in unemployment (see Table 12.2 and Figure 12.1). After an initial significant deterioration in fiscal balances, these countries have embarked on a process of fiscal consolidation, which has resulted in a marked improvement in fiscal balances. As compared to the period prior to the crisis, current account balances and several price and cost competitiveness indicators have improved.

At the same time, there are also significant differences. The most obvious one is in the speed of adjustment. For almost all key macroeconomic variables, the adjustment in the Baltics was at least twice as fast. An important example is the correction in current account balances. The sharp reversal of capital inflows into the Baltics brought about a rapid improvement in current account balances. In Ireland, Greece and Portugal the adjustment has been much more protracted. As a flipside, the sharp improvement in the current account balances in the Baltics has enabled these economies to avoid a significant increase in indebtedness, while Ireland, Greece and Portugal have all witnessed a sharp increase in their public and private sector debts.

There are several explanations for the large difference in the speed of adjustment between the two country groups. In our view, the main reason is the ability of the countries to mitigate the impact of the sudden stop in private sector capital flows, which took place in all of the six economies during 2007-2009. As members of the euro area, Ireland, Greece and Portugal were able to draw on a very substantial central bank liquidity support, which to a large extent offset the very high private capital outflows. For the Baltics this option was not available.8

The variation in the speed of adjustment can also be explained by the differences in the conduct of fiscal policy, especially in the first phase of the cycle. As compared to the Baltics, the deepening of the financial crisis in autumn 2008 clearly had a weaker impact on Greece and Portugal. Therefore these economies were initially able to postpone fiscal consolidation. Later on, international financial assistance programmes enabled the three euro area countries to avoid a sharper fiscal consolidation. Among the Baltic countries, only Latvia applied for the EU and International Monetary Fund (IMF) financial assistance programme.

The two country groups offer two noticeably different experiences of adjustment. What can we learn about the advantages and disadvantages of ‘fast’ versus ‘slow’ adjustment from these episodes? We will turn to this question in the next section.

 
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