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Latvia's Internal Devaluation: A Success Story?

Latvia's Internal Devaluation: A Success Story?

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Advocates of an economic strategy of “internal devaluation” have recently pointed to Latvia as an example of successful macroeconomic policy. The Latvian economy is projected to grow by four percent in 2011. They argue that the Latvian government, along with the European authorities (including the International Monetary Fund – IMF), pursued the correct macroeconomic policies by maintaining Latvia’s fixed exchange rate and implementing pro-cyclical fiscal policies (that shrunk the economy further) and sometimes pro-cyclical monetary policies. They argue that these were the best policies –as opposed to counter-cyclical, expansionary fiscal and monetary policies, accompanied by devaluation– designed to promote a rapid economic recovery.

The data, however, contradict the notion that Latvia’s experience provides an example of successful internal devaluation. This paper looks at the Latvian case and provides further evidence that internal devaluation can be a very costly strategy and one that does not work. The risks in the eurozone are even greater because of the financial crisis that has resulted from these pro-cyclical policies.
Advocates of an economic strategy of “internal devaluation” have recently pointed to Latvia as an example of successful macroeconomic policy. The Latvian economy is projected to grow by four percent in 2011. They argue that the Latvian government, along with the European authorities (including the International Monetary Fund – IMF), pursued the correct macroeconomic policies by maintaining Latvia’s fixed exchange rate and implementing pro-cyclical fiscal policies (that shrunk the economy further) and sometimes pro-cyclical monetary policies. They argue that these were the best policies –as opposed to counter-cyclical, expansionary fiscal and monetary policies, accompanied by devaluation– designed to promote a rapid economic recovery.

The data, however, contradict the notion that Latvia’s experience provides an example of successful internal devaluation. This paper looks at the Latvian case and provides further evidence that internal devaluation can be a very costly strategy and one that does not work. The risks in the eurozone are even greater because of the financial crisis that has resulted from these pro-cyclical policies.

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Published by: Center for Economic and Policy Research on Dec 08, 2011
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Center for Economic and Policy Research
1611 Connecticut Avenue, NW, Suite 400Washington, D.C. 20009202-293-5380www.cepr.net
 
Latvia's Internal Devaluation:A Success Story?
 
Mark Weisbrot and Rebecca Ray
December 2011(Revised and updated)
 
 
CEPR Latvia's Internal Devaluation: A Success Story?
i
 About the Authors
Mark Weisbrot is an economist and Co-Director, and Rebecca Ray is a Research Associate, at theCenter for Economic and Policy Research, in Washington, DC.
 Acknowledgments
 The authors thank Janis Oslejs and Mihails Hazens for valuable comments.
 
 
CEPR Latvia's Internal Devaluation: A Success Story?
i
 About the Authors
Mark Weisbrot is an economist and Co-Director, and Rebecca Ray is a Research Associate, at theCenter for Economic and Policy Research, in Washington, DC.
 Acknowledgments
 The authors thank Janis Oslejs and Mihails Hazens for valuable comments.
Contents
Executive Summary ........................................................................................................................................... 1
 
Introduction ........................................................................................................................................................ 3
 
 The Costs of Devaluation- Internal versus External .................................................................................... 4
 
Social Costs of Latvia’s Internal Devaluation ................................................................................................ 8
 
How Latvia Came Out of its Recession: It Wasn’t Internal Devaluation .............................................. 10
 
Conclusion ........................................................................................................................................................ 15
 
References ......................................................................................................................................................... 16
 

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