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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: