From Latvia to Greece
The IMF's Road to Ruin
By MARK WEISBROT
Latvia has experienced the worst two-year economic downturn on recorde, losing more than 25 percent of GDP. It is projected to shrink further during the first half of this year, before beginning a slow recovery, in which the International Monetary Fund (IMF) projects that it will not reach even its 2006 level of output by 2015 – nine years later.
With 22 percent unemployment, a sharp increase in emigration and cuts to education funding that will cause long-term damage, the social costs of this trajectory are also high.
By keeping its currency pegged to the euro, the government gives up the opportunity to allow a depreciation that would stimulate growth by improving the trade balance. But even more importantly, maintaining the peg means that Latvia cannot use expansionary monetary policy, or expansionary fiscal policy, to get out of recession. (The United States has used both: in addition to its fiscal stimulus and cutting interest rates to near zero, it has created more than 1.5 trillion dollars since the recession began).
Some who believe that doing the opposite of what rich countries do – i.e. pro-cyclical policies -- can work point to neighboring Estonia as a success story. Estonia has kept its currency pegged to the Euro, and like Latvia is trying to accomplish an “internal devaluation.” In other words, with a deep enough recession and sufficient unemployment, wages and prices can be pushed down. In theory this would allow the economy to become competitive again, even while keeping the (nominal) exchange rate fixed. more