{
  "title": "Lessons from Latvia",
  "publication": "IMF Blog, June 11, 2012",
  "sourceUrl": "https://www.imf.org/en/blogs/articles/2012/06/11/lessons-from-latvia",
  "canonical": "https://www.imf.org/en/blogs/articles/2012/06/11/lessons-from-latvia",
  "overlayPath": "/en/blogs/articles/2012/06/11/lessons-from-latvia/index.md",
  "summary": "Author: Olivier Blanchard; Date: June 11, 2012.",
  "sections": [
    {
      "heading": "Background and crisis context",
      "content": "- Author: Olivier Blanchard; Date: June 11, 2012.\n- From 2005 to 2007, average annual growth had exceeded 10%.\n- The current account deficit had increased to more than 20% of GDP.\n- By early 2008 the boom had ended; by the end of 2008:\n  - output was down by 10% from its peak,\n  - the fiscal deficit was shooting up,\n  - capital was leaving the country,\n  - reserves were rapidly decreasing."
    },
    {
      "heading": "Policy choice and program design",
      "content": "- The government chose to keep the currency peg rather than pursue a sharp nominal depreciation because of:\n  - a commitment to eventually enter the euro,\n  - fear of balance sheet effects of devaluation on domestic loans (90% denominated in euros).\n- The IMF-supported program kept the peg and included a strongly front-loaded fiscal consolidation.\n- Latvian commitment and support from European Union partners were decisive in maintaining the peg."
    },
    {
      "heading": "Outcomes and mechanics of adjustment",
      "content": "- Subsequent outcomes:\n  - Four years later, Latvia had one of the highest growth rates in Europe.\n  - The peg has held.\n  - The fiscal and current accounts are close to balance.\n- Mechanics described:\n  - Initial sharp decrease in output,\n  - Increases in competitiveness due initially to decreases in wages, increasingly due to productivity gains,\n  - Growth initially from external demand, increasingly from domestic demand.\n- Projection qualifier: \"Unless Europe has a meltdown, growth should continue.\""
    },
    {
      "heading": "Economic and social costs",
      "content": "- Output dynamics:\n  - Output further contracted by 16% in 2009,\n  - Output is still 15% below its 2007 peak.\n- Labor market:\n  - Unemployment increased to more than 20% and still stands at 16% today.\n  - Concern about long term unemployment effects.\n- Assessment: The economic and social cost of adjustment has been substantial, but the adjustment looks likely to succeed under the peg."
    },
    {
      "heading": "Seven practical factors that supported adjustment (plumbing of the mechanism)",
      "content": "- Preceding boom: the adjustment was seen partly as a return to normal because of the unusually strong boom.\n- Political and social acceptance:\n  - Support for fiscal consolidation and acceptance of pain;\n  - Parties arguing for stronger fiscal austerity often did better at the polls;\n  - Pedagogy and historical experience (painful transition from central planning) helped acceptance.\n- Wage flexibility:\n  - Dramatic reduction in public sector wages improved the fiscal position and put pressure on private sector wages,\n  - Caveat: private sector wages adjusted much less than public sector wages; nominal wages have started to increase while more adjustment may be needed.\n- Productivity catch-up potential:\n  - Latvia has income per capita of half the European Union average, implying substantial room for productivity increases.\n- Openness of the economy:\n  - Exports around 50% of GDP, so competitiveness improvements have large effects on imports, exports, and GDP.\n- Low initial public debt:\n  - Public debt was very low to start, less than 10% of GDP.\n  - Even today, public debt remains around 40% of GDP — this helped alleviate foreign investor concerns about sovereign default and facilitated a quicker return to international markets.\n- Financial sector structure:\n  - The financial system was largely composed of relatively friendly foreign banks (notably Swedish banks) that recapitalized and maintained credit lines, reducing the intensity of the sudden stop and credit squeeze."
    },
    {
      "heading": "Fiscal front-loading and political economy lessons",
      "content": "- Fiscal consolidation intensity: over the first two years of the program, the cyclically adjusted primary balance was increased by 11% of GDP.\n- Political economy observations:\n  - Large initial budget cuts were implemented relatively easily; smaller subsequent steps proved more difficult (2011 budget example).\n  - The political argument for front loading is described as fairly strong.\n  - The political argument for focusing on spending cuts initially is also emphasized:\n    - Targeted spending cuts are typically more costly politically than general tax increases,\n    - It may be better to reserve tax increases for later, if and when adjustment fatigue sets in."
    },
    {
      "heading": "Applicability to other European countries",
      "content": "- Many supportive conditions present in Latvia are not satisfied in Europe’s southern periphery.\n- Comparative constraints in the South:\n  - Adjustments required are smaller than Latvia’s but economies are less flexible and less open,\n  - Less obvious potential gains in productivity in tradables,\n  - Much higher public debt to start.\n- Conclusion: The lessons are not easily exportable; adjustment in the South will be difficult and painful.\n- Policy implication for the South: a social pact and faster joint adjustment of wages and prices than implied by market mechanisms remains a very strong recommendation.\n\nSource: Olivier Blanchard, \"Lessons from Latvia\", June 11, 2012.\n\n---\n\n\n References\n\n- IMF\n- Latvia\n- growth should continue.\n- conference\n\nSource: https://www.imf.org/en/blogs/articles/2012/06/11/lessons-from-latvia"
    }
  ],
  "bullets": [
    "[Markdown version](/en/blogs/articles/2012/06/11/lessons-from-latvia/index.md)",
    "[Structured JSON version](/en/blogs/articles/2012/06/11/lessons-from-latvia/index.json)",
    "[Bundle manifest](/en/blogs/articles/2012/06/11/lessons-from-latvia/bundle-manifest.json)",
    "Authors: Olivier Blanchard",
    "Published: June 11, 2012",
    "Author: Olivier Blanchard; Date: June 11, 2012.",
    "From 2005 to 2007, average annual growth had exceeded 10%.",
    "The current account deficit had increased to more than 20% of GDP.",
    "By early 2008 the boom had ended; by the end of 2008:",
    "The government chose to keep the currency peg rather than pursue a sharp nominal depreciation because of:",
    "The IMF-supported program kept the peg and included a strongly front-loaded fiscal consolidation.",
    "Latvian commitment and support from European Union partners were decisive in maintaining the peg.",
    "Subsequent outcomes:",
    "Mechanics described:",
    "Projection qualifier: \"Unless Europe has a meltdown, growth should continue.\"",
    "Output dynamics:",
    "Labor market:",
    "Assessment: The economic and social cost of adjustment has been substantial, but the adjustment looks likely to succeed under the peg.",
    "Preceding boom: the adjustment was seen partly as a return to normal because of the unusually strong boom.",
    "Political and social acceptance:",
    "Wage flexibility:",
    "Productivity catch-up potential:",
    "Openness of the economy:",
    "Low initial public debt:",
    "Financial sector structure:",
    "Fiscal consolidation intensity: over the first two years of the program, the cyclically adjusted primary balance was increased by 11% of GDP.",
    "Political economy observations:",
    "Many supportive conditions present in Latvia are not satisfied in Europe’s southern periphery.",
    "Comparative constraints in the South:",
    "Conclusion: The lessons are not easily exportable; adjustment in the South will be difficult and painful.",
    "Policy implication for the South: a social pact and faster joint adjustment of wages and prices than implied by market mechanisms remains a very strong recommendation.",
    "[IMF](http://www.imf.org/external/pubs/ft/survey/so/2012/int020712a.htm)",
    "[Latvia](http://www.imf.org/external/pubs/ft/survey/so/2012/CAR061112A.htm)",
    "[growth should continue.](http://blogs.imf.org/2012/06/01/latvia-beat-the-odds-but-the-battle-is-far-from-over/)",
    "[conference](http://www.imf.org/external/np/seminars/eng/2012/latvia/index.htm)"
  ],
  "alternates": {
    "markdown": "/en/blogs/articles/2012/06/11/lessons-from-latvia/index.md",
    "json": "/en/blogs/articles/2012/06/11/lessons-from-latvia/index.json",
    "bundleManifest": "/en/blogs/articles/2012/06/11/lessons-from-latvia/bundle-manifest.json"
  },
  "generatedAtUtc": "2026-08-28T02:59:37.550Z"
}