In the paper we will try to find an answer to the following two questions. Why the financial crisis had such a strong negative impact on the Baltic countries? What explains the differences in the individual countries’ ability to deal with the common negative shock? For that purpose we will identify the vulnerabilities prior to the outbreak of the financial crisis and analyse the effectiveness of the main channels of adjustment. We will also discuss how the present exchange rate and monetary policies and the eventual participation in the euro area would help to solve the main challenges currently facing the Baltic economies.
Data and methods
For the most part, we use macroeconomic data from Eurostat and various structural indicators (eg describing the rigidities in labour and product markets, qualitative indicators of the financial sector) to analyse the impact of the financial crisis. At this stage we plan to use structural VAR’s to determine the relative significance of various shocks to individual Baltic economies. In addition, we will use simple comparative statistics to determine the differences between the Baltic countries and also the differences between the Baltic countries with other country groups (eg. Central European EU countries, Southern European EU countries).
Results/Expected results
After several years of very strong economic growth, the Baltic countries have lately witnessed one of the steepest recessions in the world. In a historical context, the expected cumulative output loss in all of the Baltic countries is almost twice higher than in the hardest-hit countries during the Asian crises in 1997-98, and in the case of Latvia comes close to the size of the output decline in the US during the Great Depression.
Despite several similarities in the structural features of the Baltic economies (including fixed exchange rate arrangements) and the macroeconomic developments prior to the crisis, the individual countries’ ability to deal with the common negative shocks has been different. Estonia has been more successful than its Baltic neighbours in withstanding the negative impact of the financial crisis, and is currently a likely candidate to join the euro area from 2011. The resilience to the crisis has been the weakest in Latvia, which is dependent on the financial support from the IMF and EU countries and has an uncertain outlook for joining the euro area.
We expect that the main reason for the disproportionately large decline in the output in the Baltic countries as compared to the other countries were mainly due to the larger vulnerabilities prior to the crisis, the significant changes in the financing conditions and the larger openness of the Baltic economies. As regards the resilience of the economies, the crisis has highlighted the importance of liquidity and capital buffers in the banking sector, the role of foreign banks, fiscal discipline and the flexibility of the price- and wage-setting mechanisms. The differences in the Baltic countries are strongly related to the first three aspects.