## 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

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### 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).*

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## References

- [Europe](http://www.imf.org/external/region/eur/index.htm)
- [Vienna Initiative](http://www.imf.org/external/pubs/ft/survey/so/2009/INT102809A.htm)
- [non-performing loans](http://blogs.imf.org/2012/03/29/debt-hangover-nonperforming-loans-in-europes-emerging-economies/)

_Source: https://www.imf.org/en/blogs/articles/2012/09/10/taking-away-the-punch-bowl-lessons-from-the-booms-and-busts-in-emerging-europe_