The Last Shall Be the First: The East European Financial Crisis

by Anders Åslund

Overview

This book deals with the financial crisis in Eastern Europe that erupted in the fall of 2008 and abated in the spring of 2010. It concentrates on the ten new eastern members of the European Union. The causes of the crisis posed no mysteries. This was a typical credit-driven boom-and-bust cycle that led to excessive current account deficits. When global liquidity dried up, the overheated East European economies faced a sudden stop of financial inflows. What is remarkable is how well these countries have steered out of the crisis.

The worst hit countries—Latvia, Lithuania, and Estonia—refused to devalue their currencies and instead pursued internal devaluations, successfully cutting public wages and expenditures. They swiftly turned large current account deficits into substantial surpluses and minimized their inflation. The political economy of crisis resolution has been equally striking. The public accepted significant hardship with minimal protests. Eastern Europe's fragmented proportional parliaments made it possible to quickly change governments when the incumbents fall short. Unstable coalition governments proved eminently able to pursued resolute anticrisis policies. They carried out impressive fiscal retrenchment without any public reaction against capitalism or globalization. The East European economies have come out leaner and more efficient.

The International Monetary Fund stands out as the great victor on the international stage, having revived the old Washington consensus of a few rudimentary financial conditions, such as tenable exchange rate policy and reasonable fiscal and monetary policy, while it allowed well-governed countries larger public deficits during the crisis and offered much more financing. The European Commission entered into a successful partnership with the IMF, allowing the IMF to take the lead, while providing substantial financing. The great disappointment in the East European financial crisis has been the European Central Bank, which needs to reconsider its policies outside the eurozone to become more proactive.

Product Details

ISBN-13:	9780881325218
Publisher:	Peterson Institute for International Economics
Publication date:	10/01/2010
Pages:	136
Product dimensions:	6.00(w) x 9.00(h) x (d)
Age Range:	18 Years

About the Author

Anders Åslund was a senior fellow at the Peterson Institute for International Economics from 2006 to May 2015. He examined the economic policies of Russia, Ukraine, and Eastern Europe, as well as the broader implications of economic transition. Åslund served as an economic adviser to the governments of Russia in 1991-94 and Ukraine in 1994-97.

Table of Contents

Preface ix

Acknowledgments xiii

Map xvi

1 Introduction 1

What Went Wrong and How It Was Fixed 4

Maastricht Citeria and Euro Adoption 8

Parallels to the East Asian Financial Crisis of 1997-98 10

Structure of the Book 12

2 Causes and Eruption of the Financial Crisis 13

Causes of the Crisis 14

Eruption of the Crisis 25

3 Political Economy of Crisis Resolution 31

Hungary: Straightforward Crisis Resolution 33

Latvia: The most Complex Stabilization 35

Romania: All about Politics 38

Lithuania, Estonia, and Bulgaria: Robust Anticrisis Policy without the IMF 40

Poland, the Czech Republic, Slovakia, and Slovenia: No Serious Overheating or Crisis 42

Fast Financial Adjustment 43

4 The Exchange Rate Dilemma 53

The Baltic Exchange Rate Conundrum 56

Why Latvia Did Not Have to Devalue Like Argentina 60

Multiple Exchange Rate Options Remain 65

5 The Banking Crisis That Never Materialized 67

West European Banks Expand in the East 67

The Vienna Iniative 71

6 International Cooperation in Crisis 75

International Monetary Fund: Financial Savior 75

European Union: The Rookie 77

European Central Bank: Voldemort 78

The United States: Keeping a Low Profile 81

World Bank: The Third Fiddle 82

A New Pattern of International Financial Crisis Resolution 83

7 Why Eastern Europe Acted So Responsibility 85

Strong Center-Right Tendency in Elections 85

Causes of Popular Fiscal Restraint 87

8 Eastern Europe and the Fiscal Crisis in the Eurozone 91

The Greek Tragedy 93

The Greek Rescue Package of May 2, 2010 95

The South European Rescue Package, May 9-10, 2010 97

East European Lessons Dawn on the Eurozone 98

9 Toward European Convergence 103

Outcome of the Crisis in Eastern Europe 104

EU Convergence or Divergence 107

The Last Shall Be the First 111

Table

Table 1.1 Overview of the CEE-10 countries 4-5

Figures

Figure 2.1 Real GDP growth, 2000-10e 15

Figure 2.2 Real GDP decline, 2009 15

Figure 2.3 Current account deficit as share of GDP, 2006 and 2007 17

Figure 2.4 Gross foreign debt as share of GDP, end 2008 17

Figure 2.5 Real effective exchange rate growth, 1999-2008 19

Figure 2.6 International currency reserves as share of imports, end 2008 19

Figure 2.7 Share of foreign currency loans in total domestic credit, 2007 20

Figure 2.8 Monetary expansion, 2004-08 21

Figure 2.9 Inflation, 2007 and 2008 22

Figure 2.10 Budget balance, 2000-10e 23

Figure 2.11 Public debt as share of GDP, end 2008 23

Figure 3.1 Current account balance, 2008-09 44

Figure 3.2 Inflation, 2009 and 2010e 45

Figure 3.3 Average budget deficit, CEE-10 and PIGS, 2008-10e 46

Figure 3.4 Total general government expenditure, CEE-10 and EU-15, 2004-11f 46

Figure 3.5 Total GDP growth, 2000-10f 49

Figure 3.6 GDP per capita in the CEE-10 as share of average Eu-15 GDP per capita 50

Figure 4.1 Public debt as share of GDP, 2000-09e 57

Figure 5.1 Exposure of West European banks in CEE-10 71

Figure 9.1 Unemployment rate, monthly average, January 2008-June 2010 105

Box

Box 1.1 The ten Central and East European countries (CEE-10) 3

Editorial Reviews

This book deals with the financial crisis in Eastern Europe that erupted in the fall of 2008 and abated in the spring of 2010. It concentrates on the ten new eastern members of the European Union. The causes of the crisis posed no mysteries. This was a typical credit-driven boom-and-bust cycle that led to excessive current account deficits. When global liquidity dried up, the overheated East European economies faced a sudden stop of financial inflows.

Europe-Asia Studies