Biggs, M. & Mayer, T. (2014) “Latvia and Greece: Less is More“, Economic Policy, CEPS High-Briefs, 12 February 2014
Despite considerable differences, there were also many similarities in economic performance between Latvia and Greece before their respective adjustment crises. After the immediate crisis, however, economic activity rebounded sharply in Latvia but continued to contract in Greece.
This paper argues that this difference was due primarily to developments in credit. In Latvia, credit growth fell sharply, and the economy was deleveraging aggressively by 2009. When the pace of deleveraging started to stabilise, the rebound in the credit impulse caused domestic demand growth to recover. Real GDP has increased about 20% since reaching its trough in the third quarter of 2009.
Owing to more generous external assistance for Greece, credit growth declined more slowly and only turned negative in 2011. Credit growth kept falling through 2011 and 2012, the credit impulse remained negative, and domestic demand and GDP continued to contract.
It has been a widely held view that countries facing a credit crunch under a fixed exchange rate regime are doomed to failure, as they cannot use currency weakness to regain competitiveness. The Latvian case, however, suggests that internal adjustment, while costly, is certainly achievable.
- Baldacci, Ε., Gupta, S. and Mulas-Granados, C., (2013), “Debt Reduction, Fiscal Adjustment, and Growth in Credit-Constrained Economies”, International Monetary Fund, Working Paper No.13/238, 22 November.
- Oppers, E., (2013), “Giving Credit Where Credit is Due: How to Design Policies that Work”, IMF direct, 02 October.
- Filinis, Κ. (2013) “Απομόχλευση του Τραπεζικού Συστήματος και Αγορά Εργασίας“, Crisis Observatory, Policy Paper, Νο.5, April 2013.