Taking Away the Punch Bowl: Lessons from the Booms and Busts in Emerging Europe
IMF Blog, September 10, 2012
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Bibliographic details
- Authors: Bas B Bakker, Christoph Klingen
- Published: September 10, 2012
Fiscal stance and context
- Publication: Bas B. Bakker, Christoph Klingen, September 10, 2012
- Regional focus: emerging economies of Europe, from the Baltic to the Black Sea.
- Underlying drivers of the precrisis boom:
- Easy global financial conditions.
- Confidence in rapid catch-up with western living standards.
- Initially underdeveloped financial sectors.
- Western banking groups funding eastern subsidiaries, enabling credit expansion.
Causes and features of the boom
- Key imbalances during the half decade before the crisis:
- Current account deficits as high as 15-25 percent of GDP in the Baltic countries and Bulgaria.
- Private sector credit surged, much of it denominated in foreign currency.
- Housing prices boomed.
- Non tradable sectors, such as construction, became bloated.
- Governments used buoyant taxes to fund rapid spending growth; headline fiscal balances looked good while underlying public finances deteriorated.
Crisis trigger, transmission, and impact
- Trigger event: Lehman Brothers defaulted in September 2008.
- Transmission mechanism:
- Western banking groups came under pressure and new funding for eastern subsidiaries stopped.
- This halted credit and domestic demand booms as global trade collapsed.
- Macroeconomic impact:
- The region’s economy contracted by 6 percent in 2009.
- Some countries experienced recessions comparable to the Great Depression in the United States.
- Housing prices collapsed and unemployment surged.
Policy responses and international support
- Rapid government actions helped contain the crisis:
- Stabilization of financial systems.
- Fiscal consolidation to get public finances back under control.
- International and private sector support:
- The international community committed €100 billion of financing under IMF-supported programs.
- Western banks contributed by refraining from recalling previously provided financing in a coordinated effort under the Vienna Initiative.
Recovery, outcomes, and indicators of improvement
- Recovery achievements:
- Currency and systemic banking crises largely avoided.
- Growth in the region bounced back—4½ percent in 2010-11.
- Unemployment has started to come down.
- Repair of public finances and financial systems is well underway.
- External flow imbalances have disappeared.
- Renewed focus on exports: Estonia’s sales abroad now account for 100 percent of GDP, up from 70 percent of GDP in 2007.
- Country example:
- Poland implemented preemptive policies and avoided a recession in 2009, later achieving healthy growth.
Lessons and policy recommendations
- Preventive action:
- Deal forcefully with domestic demand booms before they get out of hand.
- “Taking away the punch bowl” in good times helps mitigate imbalances and creates buffers for downturns.
- Fiscal policy:
- Keep a lid on expenditure growth in boom periods, even if the government’s fiscal balance is in surplus and higher spending seems easily affordable.
- Financial sector and credit:
- Keep credit growth in check.
- Require more effective cooperation with bank supervisors in Western Europe, where emerging Europe’s banks are headquartered.
- Adopt a tougher line on foreign-currency lending.
- Crisis adjustment:
- Determined post-crisis adjustment works—examples include reducing government debt and deficits, bank restructuring, labor cost reductions, and measures to restore competitiveness.
Remaining vulnerabilities and outlook
- Ongoing challenges:
- External debt is still high.
- Fiscal repair has further to go.
- Banks need to resolve a large stock of non-performing loans.
- The crisis in the euro area poses new challenges given tight linkages with emerging Europe.
- Forward-looking observation:
- Risk premiums for sovereigns in emerging Europe are now often lower than those in Western Europe, marking a significant turnaround since 2009.
Source: Taking Away the Punch Bowl: Lessons from the Booms and Busts in Emerging Europe (IMF blog post, September 10, 2012).