Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday 7 June 2012

Why cannot other European countries show this courage?

                The outcome of the ECB meeting yesterday was rather more positive than I had hoped. Why? Because the decision to do nothing was not unanimous. That’s it I’m afraid, but my expectations beforehand were very low. One reason was reading this short speech by Jörg Asmussen, a member of the Executive Board of the ECB. (HT P O Neill) It was delivered in Riga, and extols the path of internal devaluation and austerity taken by Latvia.
                Let me quote, to give you the flavour. “From 2008, Latvia was faced with the deepest recession in the world. The cumulative output decline was 24%; unemployment peaked at 20%. Keeping the euro peg was considered by many as a “mission impossible””. “External devaluation was presented as the only way forward. But Latvia did not choose the easy “quick fix”. It embarked on a courageous fiscal consolidation path and structural reforms. Two years later, the speed of the economic rebound is as extraordinary as the depth of the recession. Against all the odds, Latvia recorded a real GDP growth rate of 5.5% in 2011.”
                An extraordinary success story: after an 18% decline in GDP in 2009, and flat GDP in 2010, we now have 5.5% growth in 2011. But surely I’m being economical with my quotes here. Isn’t the 5.5% growth last year just the beginning, with the economy achieving a new dynamism. Mr. Asmussen does not provide any additional evidence on this. Perhaps wisely, as the IMF are predicting 2% growth this year, and 2.5% next year. So the 5.5% growth last year is all we have.
                Mr. Asmussen could have talked about unemployment, which has also fallen rapidly, from a peak of 20% to 15% currently. Perhaps he did not, because unemployment shows more clearly what has actually happened. We have had a huge recession, followed by a much more modest recovery. And, as we might guess, there is apparently much more talk about structural unemployment in Latvia today. For a rather more objective account of the Latvian experience of internal devaluation, see this (US) CEPR study, or a number of Paul Krugman's posts.
Earlier this year I wrote that when growth returned, some would say this proved those pessimistic Keynesians had been all wrong. I must admit the ‘some’ I had in mind were politicians and journalists, not senior central bankers. By this logic, an even better strategy is to close the whole economy down for a year. The following year we could get fantastic growth as the economy starts up again.
But the really scary thing about this speech is the lesson Mr. Asmussen draws from Latvia’s ‘success’. “The Baltic experience shows clearly that speed is of the essence. In all three Baltic countries, the government reacted swiftly to the deterioration of public finances and frontloaded fiscal adjustment. With a budget consolidation of around 9% of GDP in 2009 alone, Latvia’s effort is unparalleled in Europe.” So, Ireland and Greece, you know where you went wrong. You have been far too tentative with your austerity.
The language is indicative. We have a “courageous fiscal consolidation path”, “it is better to take the medicine right away than to let the fever rise for months”, and “Latvia’s effort is unparalleled”.  Perhaps we can describe this as ‘masochism macroeconomics’. Or is it faith in the macroeconomic afterlife: penury (a massive waste of resources) today bringing virtue (austerity and structural reform) that promises redemption (wealth creation) in the distant future.
So this is why I was pleased to hear that the ECB’s decision had not been unanimous. At last, some policymakers in Europe do not believe this dangerous nonsense any more. 

Postscript. Mark Weisbrot at the Guardian alerts us to Christine Legarde singing from the same script, alas.


  1. This comment has been removed by the author.

  2. Both nominal and real Latvian GDP are miles from their pre-crisis peak.

    Where is the recovery? If you wanted a perfect example of a unit-root type drop in output, where losses are frozen in, this is most definitely one such example.

    Sweden and Israel are two examples of countries I've seen that have recovered from the crisis reasonably well. Some suspect this is due to implicit NGDP targeting.

  3. just mentioning 2008-2011 for GDP distorts the picture, you should look at the long term trend of GDP growth for Latvia. In years around 2008 they had a huge bubble, no wonder they plunged. But long term Latvia is still showing economic growth.

    1. The key is to look at measures of output relative to potential, which is why the unemployment number is important. 15% must be well above the natural rate, and that is despite a large number of people leaving the country to find work. The estimates I can find of the output gap also suggest GDP is still well below potential.

    2. before the bubble (like early 2000s) the unemployment was close to 15% as well in Latvia.
      Same for Spain: always had unemployment above 20%, until the bubble during the euro era started (and they let in millions of immigrants, making the current unemployment number even higher than what they used to have).
      All that happened after the bubble bursted in those bubble countries is that they went back to their ''normal'' rates.

    3. some numbers for Latvia
      select the period late nineties until now, take out the bubble in 2008, and the numbers are not bad at all.
      It seems to me that some economists are making the mistake that what they call the depressed economies should return to their bubble peaks in 2008/9 with lots of stimulus. This seems unrealistic to me.

    4. "But long term Latvia is still showing economic growth."

      Most countries, maybe apart from Italy, Japan en Portugal, are still showing longterm economic growth. I don't understand why this is supposed to make Latvia look better.

    5. The point is the troubled countries had a bubble, why do some want to reflate the bubble, if this is possible at all?

    6. But why not to aim to produce as much as they are able to produce?

      Existence of output gap is evidence that these countries are not producing to their fullest potential.

  4. Wow! I just found this blog (was directed here from Krugman's blog). I was studied economics as an undergrad and am still a macro junkie. This site looks really interesting and informative. Great analysis of Latvia.

  5. " By this logic, an even better strategy is to close the whole economy down for a year. The following year we could get fantastic growth as the economy starts up again." I think these are some of my favorite words ever written. Also visiting from Krugman's blog.

  6. The basic question; can countries like the US, Japan and EU, able to pay their debt? how can they, if they have a 3% allowable yearly deficit?


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