Latvia: Should You Care?

In the current field of grand economic strategy, against crisis and for recovery, Latvia looms small. This is a country with just two million residents, best known recently for a huge current account deficit – the excess of imports over exports peaked out around 25 percent of GDP.  Ordinarily, there is nothing here that should move the world economy.

Yet, there are some intriguing and somewhat disconcerting signs that point towards our common future – much like a close study of Iceland, back in October 2008, told us a great deal about what was to come.

First and foremost, we are looking at a creditor bailout-type situation.  Latvia is receiving large amounts of foreign financial assistance – from the IMF and the European Union – with the express purpose of making all payments due on its debts (mostly owed to West European banks; thank you, Sweden).  This is strikingly reminiscent of Latin America after 1982: above all else, protect the foreign banks.

Second, the bailout – at Latvia’s request – focuses on keeping the exchange rate peg.  The payments adjustment (exports up, imports down) must still come entirely from lower wages and prices.  This is an incredibly difficult task, which brings to mind Argentina’s struggles within its currency board in the 1990s.  If you make it very costly to change an exchange rate, you won’t devalue – until you absolutely have to, and then of course it is very costly.

Third, there is a fundamental contradiction in the approach favored by Latvia and the European Union.  They say they can’t consider devaluation, because so many households have borrowed so heavily through mortgages denominated in foreign currency.  But what happens to real debt payments as wages fall?  Is debt default being avoided or just deferred until the banks have got their money out – and the IMF has come in to the full extent possible?

My takeaway: we are still not ready for hard economic conversations anywhere in the world.  Wishful thinking prevails, in Europe as much as in the United States.  No one wants to start the difficult and messy task of restructuring – i.e., reducing – debt payments.  Everyone feels entitled to a bailout.  And the banks get one.

Or put it to your elected representative like this – we’re transferring Latvia’s debts from European banks onto the IMF, which is underwritten by our future tax dollars; then there will be default and devaluation for which no one is prepared.

Brussels, you’re doing a heck of a job.

Disclaimer: This page contains affiliate links. If you choose to make a purchase after clicking a link, we may receive a commission at no additional cost to you. Thank you for your support!

About Simon Johnson 101 Articles

Simon Johnson is the Ronald A. Kurtz (1954) Professor of Entrepreneurship at MIT's Sloan School of Management. He is also a senior fellow at the Peterson Institute for International Economics in Washington, D.C., a co-founder of, a widely cited website on the global economy, and is a member of the Congressional Budget Office's Panel of Economic Advisers.

Mr. Johnson appears regularly on NPR's Planet Money podcast in the Economist House Calls feature, is a weekly contributor to's Economix, and has a video blog feature on The New Republic's website. He is co-director of the NBER project on Africa and President of the Association for Comparative Economic Studies (term of office 2008-2009).

From March 2007 through the end of August 2008, Professor Johnson was the International Monetary Fund's Economic Counsellor (chief economist) and Director of its Research Department. At the IMF, Professor Johnson led the global economic outlook team, helped formulate innovative responses to worldwide financial turmoil, and was among the earliest to propose new forms of engagement for sovereign wealth funds. He was also the first IMF chief economist to have a blog.

His PhD is in economics from MIT, while his MA is from the University of Manchester and his BA is from the University of Oxford.

Visit: The Baseline Scenario

Be the first to comment

Leave a Reply

Your email address will not be published.


This site uses Akismet to reduce spam. Learn how your comment data is processed.