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Citation Information

Type Journal Article - Brookings Papers on Economic Activity
Title Boom, bust, recovery: forensics of the Latvia crisis
Author(s)
Volume 2013
Issue 2
Publication (Day/Month/Year) 2013
Page numbers 325-388
URL http://www.brookings.edu/~/media/projects/bpea/fall 2013/2013b_blanchard_latvia_crisis.pdf
Abstract
Latvia’s boom, bust, and recovery provide a rare case study for macroeconomists: an economy that responded to a balance-of-payments crisis by maintaining its currency peg and adjusting through internal devaluation and front-loaded consolidation. This paper lays down the facts about Latvia’s boom and bust and analyzes the policy response and the mechanics of the adjustment through internal devaluation. While Latvia’s adjustment was very costly, with a large drop in output, a big increase in unemployment, and substantial emigration, it was eventually successful. The internal devaluation worked faster, though quite differently, than what had been expected. Productivity increases, rather than nominal wage cuts, drove much of the unit labor cost reduction. These then led to an increase in profit margins, rather than a decrease in prices, and to a surprisingly fast supply response. The strong front-loaded adjustment did not prevent the recovery. The lessons of the Latvian experience for other countries may however be limited, since many of the elements of the eventual success appear to have been due to factors largely specific to Latvia, factors that are not present in southern euro countries, in particular.

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