Austerity’s outlier

September 20, 2013

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Latvia, a country with a population roughly the size of Brooklyn (or Nebraska!), took over the debate at this week’s Brookings Panel on Economic Activity conference. Latvia’s economy went through a spectacular boom in the early 2000s, a terrific bust during the Great Recession, and is experiencing a quick, if moderate, recovery.

Yesterday’s discussion surrounded a paper by three IMF economists, Olivier Blanchard, Mark Griffiths, and Bertrand Gruss, titled “Boom, Bust, Recovery: Forensics of the Latvia Crisis”. The paper tackled the country’s decision to keep its currency pegged to the euro instead of letting it depreciate as its economy cratered in 2008.

Jan Cienski sums up the disagreement among economists:

They debate whether it made sense for the country to stick with its peg to the euro and undergoing a severe internal devaluation instead of unpegging and allowing the lat to depreciate, and whether that risky choice qualifies Latvia to serve as an example to other troubled EU countries.

Latvia has become something of a poster child for the salutary effects of austerity; the question is whether its policies can really be described as a success story. Blanchard, Griffiths, and Gruss claim they don’t have a definitive answer, but the paper leans toward yes. “What can be said is that the sharp fall in output was not primarily due to the adjustment policies. That fiscal consolidation was associated with higher credibility, and did not prevent the recovery. And that internal devaluation worked surprisingly quickly”, they write.

The paper is largely in agreement with Latvia’s policymakers, who argue that the economy in 2007 was in a huge bubble, so where they are now — although lower than 2007 — can be considered almost fully recovered. Paul Krugman takes issue with their arguments, however. He claims, first, that the output gap the IMF find in 2007 Latvia is exaggerated. Second, he says, if the output gap was as large as the paper claims, there actually isn’t a debate at all: “with a double-digit inflationary output gap, even the most ultra-Keynesian Keynesian would call for fiscal austerity”.

The Economist pares down Krugman’s argument to one line: “Latvia’s relevance may be limited because politically and economically it is an outlier”. — Shane Ferro

On to today’s links:

Alpha
“Making money is the easy part”: A terrific first-person account of life as a banker – Guardian

Crisis Retro
A guide to money market funds, the world’s still-unreformed pre-crisis threat – Floyd Norris

UGH
The House voted to cut $39 billion from the food stamp program, which keeps millions out of poverty – Brad Plummer

Ouch
Summers fell because key Dems don’t trust the Obama administration on Wall Street regulation – Ezra Klein

Your Retirement Plans
The global quest to save retirement – Bloomberg

New Normal
Why the world is stuck in a series of jobless recoveries – Brad Plumer
Full BPEA study on why jobless recoveries are much more likely – Brookings Institute

Financial Arcana
It it time to start worrying about banks’ accounting? – Jonathan Weil

Right On
A scathing editorial on food stamp cuts, plus a Louis Vuitton ad for a $4000 handbag – Choire Sicha

Neo-Buddhist Comedians
“You never feel completely sad or completely happy. You just feel kind of satisfied with your products. And then you die.” – Louis C.K.

JP Morgan
While you were whaling: JP Morgan fined $389 million for deceptive credit card practices – WaPo

Elasticity
A 1% increase in beer prices usually causes a .3% decrease in demand. Except during Oktoberfest – Quartz

Billionaire Whimsy
The pros and cons of running a soccer team from a tax haven – Guardian

Oxpeckers
AllThingsD is parting ways with the WSJ – Dan Primack

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Comments

It’s obvious that Latvia has little or nothing to do with the USA’s economy, or any other major economy in the world. This has similarity to the differences between Fortune 500 companies and startup entrepreneurs.

Latvia is a tiny bit-player on the world stage. That means that it can find markets to export to and get a positive trade balance quite easily. The case of Latvia applies to countries like Greece, but not to Germany, the USA, Japan, or any other major nation.

Yes, Latvia has accepted austerity, and Latvia has reformed some things. That was easy for Latvia to do because Latvia had lived under austerity for generations before it had a brief period of growth after the breakup of the USSR. Those things are necessary for Greece. Greece has to face up to its endemic deep-seated corruption and its bread-and-circuses politics.

But those lessons don’t apply to the USA, which has the opposite problem. In the USA, the corruption and free lunches are all in the elites. The USA is not a populist nation.

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