mārtiņš bitāns. lessons from the latvian austerity program
Post on 19-Oct-2014
447 Views
Preview:
DESCRIPTION
TRANSCRIPT
Lessons from the Latvian austerity program
Martins Bitans Bank of Latvia 18 April 2013
1
Expansionary fiscal contraction • Giavazzi, Pagano (1990): The Danish experience shows that cuts in
government spending can be associated with increases in consumption;
• Blachard (1990): Sometimes, decrease in spending or an increase in taxes indeed increases demand, consumption and output. The questions are that of when and how;
• Alesina and Ardagana (1997): Fiscal tightening produces (non-Keynesian) expansionary effects. One interpretation is that a serious fiscal tightening increases demand;
• Alesina and Perotti (1998): Fiscal corrections relying mostly on spending cuts that are concentrated on government wages and transfers tend to be expansionary ;
• Alesina and Ardagana (2009): We uncover several episodes in which spending cuts adopted to reduce deficits have been associated with economic expansions rather than recessions.
2
Expansionary fiscal contraction : critique
• IMF WEO (October 2010): Fiscal consolidation typically reduces output and raises unemployment in the short term. Over the long term, reducing government debt is likely to raise output.
• DeLong and Summers (2012):Need for considerable caution re-garding the pace of fiscal consolidation in depressed economies where interest rates are constrained by a zero lower bound
• Blanchard and Leigh (2013): Stronger planned fiscal consolidation associated with lower growth than expected.
• Krugman (2010): What sounds like hardheaded realism actually rests on a foundation of fantasy, on the belief that invisible vigilantes will punish us if we’re bad and the confidence fairy will reward us if we’re good.
3
Fiscal Policy Changes and Economic Growth in Latvia
-10
-7.5
-5
-2.5
0
2.5
5
-20.0
-15.0
-10.0
-5.0
0.0
5.0
10.0
2008 2009 2010 2011 2012 2013 (f)
Cyclically adjusted government balance (% of GDP), RHS
GDP growth (%), LHS
Source: EC, CSB Latvia 4
HAS FISCAL AUSTERITY WORKED IN LATVIA?
5
Main problem of the boom years – unsustainable current account position
-30.0
-20.0
-10.0
0.0
10.0
20.0
30.0
40.0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Savings, Investments and Current Account Balance in Latvia (% of GDP)
Current account Savings Investments
• Current account (by identity) is the difference between income and consumption, but also the difference between domestic savings and investment
• Current account deficits can be reduced by increasing savings (lower consumption) or lower investments
• Both approaches imply GDP will inevitably decline
6
In two years from 2008-2010, GDP declined by almost a quarter…
Real GDP, 4 quarter moving average (1Q 2007=100)
80.0
85.0
90.0
95.0
100.0
105.0
110.0
20
07
Q1
20
07
Q2
20
07
Q3
20
07
Q4
20
08
Q1
20
08
Q2
20
08
Q3
20
08
Q4
20
09
Q1
20
09
Q2
20
09
Q3
20
09
Q4
20
10
Q1
20
10
Q2
20
10
Q3
20
10
Q4
20
11
Q1
20
11
Q2
20
11
Q3
20
11
Q4
20
12
Q1
20
12
Q2
7
… but much of it was correcting for
previous (unsustainable) excesses
75.0
100.0
125.0
150.0
175.0
200.0
Actual GDP
Long-term trend
Real GDP, 4 quarter moving average (1Q 2000=100)
8
Assessing devaluation options
88
90
92
94
96
98
100
102
104
2008 2009 2010 2011 2012 2013
GDP with fixed peg: IMF assessment
GDP with wider fluctuation bands: IMF assessment
GDP with wider fluctuation bands: BoL assessment
9
Structure of Domestic Loans (%)
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
100% 2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
LVL EUR USD other 10
Impact of devaluation on the banking system
12 12.4
0
23.8
7.2 6
43.6
-5.6
17
-10
-5
0
5
10
15
20
25
30
35
40
45
Share of loans overdue (more
than 90 days)
Capital adequacy ratio Number of banks with CAR
lower than 8%
As of 30.06.09 With 15% devaluation With 30% devaluation 11
Today Latvia is again the fastest growing EU country, but this time with sound fundamentals
-7
-6
-5
-4
-3
-2
-1
0
1
2
3
4
5
6
Latv
ia
Lith
uan
ia
Esto
nia
Po
lan
d
Slo
vaki
a
Bu
lgar
ia
Mal
ta
Au
stri
a
Swe
de
n
Ge
rman
y
Ire
lan
d
Ro
man
ia
Luxe
mb
ou
rg
Un
ite
d K
ingd
om
Fran
ce
Be
lgiu
m
Fin
lan
d
Euro
pe
an U
nio
n
De
nm
ark
Net
he
rlan
ds
Cze
ch R
ep
ub
lic
Spai
n
Hu
nga
ry
Slo
ven
ia
Ital
y
Cyp
rus
Po
rtu
gal
Gre
ece
GDP growth in 2012 (% y-o-y)
12
Source: Eurostat
Average annual growth in 2004-2014: Latvia 3.4% vs Iceland 2.3%
-20.0
-15.0
-10.0
-5.0
0.0
5.0
10.0
15.0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 (F)
2014 (F)
Latvia
Iceland
GDP growth, %
Source: Eurostat
13
Real GDP: Latvia vs Iceland (1Q 2004=100)
95
100
105
110
115
120
125
130
135
140
145
150
20
04
Q1
20
04
Q4
20
05
Q3
20
06
Q2
20
07
Q1
20
07
Q4
20
08
Q3
20
09
Q2
20
10
Q1
20
10
Q4
20
11
Q3
20
12
Q2
20
13
Q1
20
13
Q4
20
14
Q3
20
15
Q2
20
16
Q1
20
16
Q4
Latvia
Iceland
14
WHY HAS FISCAL AUSTERITY WORKED IN LATVIA?
15
Blanchard (1990) • Fiscal consolidation has two effects:
– increases tax burden and reduces consumption (strength depends on how far economy departs from Ricardian equivalence)
– by reducing deficit today the government eliminates the need for more adjustments in the future
• When would expect a fiscal consolidation to increase rather than decrease output? – when the first effect dominates the second
• This is more likely under two conditions: – small effects of intertemporal tax reallocation
• consumers more Ricardian if credit markets developed
– when the economy is closer to the brink (of insolvency)
• debt approaching critical levels
16
Bond yields vs government debt in 2009
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
30.0 35.0 40.0 45.0 50.0 55.0
Go
vern
me
nt
lon
g-te
rm b
on
d y
ield
s (%
)
Government debt (% of GDP)
LV
17
Debt projections for Latvia: where is the critical threshold?
0
20
40
60
80
100
120
140
Public sector debt
Scenario under the program adjustment
Scenario with no policy change
Source: IMF, First Review under IMF Stand-By Agreement; September 2009 18
Yields on long-term government bonds: Latvia vs Germany
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
20
06
M0
1D
02
2
00
6M
03
D0
8
20
06
M0
5D
12
2
00
6M
07
D1
8
20
06
M0
9D
21
2
00
6M
11
D2
7
20
07
M0
1D
31
2
00
7M
04
D0
6
20
07
M0
6D
12
2
00
7M
08
D1
6
20
07
M1
0D
22
2
00
7M
12
D2
6
20
08
M0
2D
29
2
00
8M
05
D0
6
20
08
M0
7D
10
2
00
8M
09
D1
5
20
08
M1
1D
19
2
00
9M
01
D2
3
20
09
M0
3D
31
2
00
9M
06
D0
4
20
09
M0
8D
10
2
00
9M
10
D1
4
20
09
M1
2D
18
2
01
0M
02
D2
4
20
10
M0
5D
13
2
01
0M
07
D2
8
20
10
M1
0D
04
2
01
0M
12
D0
9
20
11
M0
2D
16
2
01
1M
04
D2
6
20
11
M0
7D
05
2
01
1M
09
D0
8
20
11
M1
1D
17
2
01
2M
01
D2
5
20
12
M0
4D
03
2
01
2M
06
D1
3
20
12
M0
8D
17
2
01
2M
10
D2
3
20
13
M0
1D
03
Germany
Latvia
19
General Government budget balance (ESA’95), % of GDP
-1.6 -2.9
-5.6 -6.9 -6.4
-3.1
-0.8 -1.3 -0.9
-20
-18
-16
-14
-12
-10
-8
-6
-4
-2
0
2005 2006 2007 2008 2009 2010 2011 2012F 2013F 2014F
Consolidation effort Actual (targeted) balance
Structural budget balance (PF) Source: Eurostat, F – Bank of Latvia staff estimation
20 20
Breakdown of budget consolidation measures, % of GDP
Source: Ministry of Finance; Bank of Latvia staff calculations 21
ULC adjustment through lower wages, but also higher productivity
80
120
160
200
240
20
00
Q1
Q3
20
01
Q1
Q3
20
02
Q1
Q3
20
03
Q1
Q3
20
04
Q1
Q3
20
05
Q1
Q3
20
06
Q1
Q3
20
07
Q1
Q3
20
08
Q1
Q3
20
09
Q1
Q3
20
10
Q1
Q3
20
11
Q1
Q3
20
12
Q1
Nominal ULC Real ULC
Unit labour cost index (2000 Q1 = 100; seasonally adjusted)
-23%
-28%
22
Adjustment in economy supported by flexible labour market framework
16
0 20 40 60 80
100
De
nm
ark
Swe
de
n
Fin
lan
d
Cyp
rus
Mal
ta
Be
lgiu
m
Luxe
mb
o…
Slo
ven
ia
Au
stri
a
Ire
lan
d
Ital
y
Gre
ece
Ro
man
ia
Slo
vaki
a
Un
ite
d …
Cze
ch …
Ge
rman
y
Net
he
rlan…
Bu
lgar
ia
Hu
nga
ry
Latv
ia
Po
lan
d
Spai
n
Po
rtu
gal
Lith
uan
ia
Esto
nia
Fran
ce
20
0 20 40 60 80
100
Au
stri
a
Be
lgiu
m
Slo
ven
ia
Po
rtu
gal
Fran
ce
Fin
lan
d
Swe
de
n
Net
he
rl…
Gre
ece
Spai
n
De
nm
ark
Ital
y
Cyp
rus
Ge
rman
y
Luxe
mb…
Mal
ta
Cze
ch …
Ire
lan
d
Po
lan
d
Slo
vaki
a
Un
ite
d …
Ro
man
ia
Bu
lgar
ia
Esto
nia
Hu
nga
ry
Latv
ia
Lith
uan
ia
Collective bargaining coverage (%)
Trade union density, %
Source: www.worker-participation.eu
23
Economic and export growth underpinned by restored competitiveness as wage-productivity gap has been closed
70
90
110
130
150
20
00
Q1
Q3
20
01
Q1
Q3
20
02
Q1
Q3
20
03
Q1
Q3
20
04
Q1
Q3
20
05
Q1
Q3
20
06
Q1
Q3
20
07
Q1
Q3
20
08
Q1
Q3
20
09
Q1
Q3
20
10
Q1
Q3
20
11
Q1
Q3
20
12
Q1
Q3
Labour productivity Real wage
Wage and productivity index (2005 Q1 = 100, seasonally adjusted)
Source: Central Statistical Bureau of Latvia data, Bank of Latvia staff calculations (2012 Q4: flash productivity data) 24
Exports in Latvia growing faster than in countries where currency depreciated
Exports of goods and services (in euros), 2006=100
60.0
80.0
100.0
120.0
140.0
160.0
180.0
2006 2007 2008 2009 2010 2011
Latvia
Sweden
United Kingdom
Iceland
Poland
Estonia
25
CAN FISCAL AUSTERITY WORK ELSWHERE?
26
All PIIGS countries had vulnerable government debt positions
-30
-20
-10
0
10
20
30
40
50
60
0 20 40 60 80 100 120 140
Exp
ect
ed
ch
ange
s in
go
vern
mn
t d
eb
t (%
of
GD
P),
20
09
-20
16
Government debt in 2009 (% of GDP)
Source: IMF WEO April 2010
LV IE
IT
GR
PT
SP US
BE
FR
UK
Hazard
zone
Hazard
zone
27
Potential credibility gains before adjustment: largest in Greece, smallest in Italy
-4
-2
0
2
4
6
8
10
0 20 40 60 80 100 120 140
Spre
ads
on
go
vern
me
nt
bo
nd
yie
lds
vis-
a-vi
s G
erm
any
(% p
oin
ts),
20
10
Government debt (% of GDP), 2009
IT
PT
GR
IE
ES
LV
Source: IMF 28
4. Relationship between Government Debt and Bond Yields in Selected European Countries
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
0 20 40 60 80 100 120
10
Y G
ove
rnm
en
t b
on
d y
ield
s
Expected gross government debt in 2017 (% of GDP)
Advanced EU
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
0 20 40 60 80 100 120
.
.
CEEC
Source: Eurostat, ECB, IMF
29
When does Keynesianism work? • Total demand in the economy significantly below total
supply
– in Latvia, both demand and supply contracted
• Extra government spending can be financed
– Latvia had not accumulated budget surpluses during the boom years
– markets were not able or willing to finance government spending almost at any cost
• Stable money demand
– in Latvia, national and foreign currencies are close substitutes
• Relatively closed economy
– in Latvia, imports account for a significant share of total income
30
How counter-cyclical was fiscal policy during the boom years
-8
-7
-6
-5
-4
-3
-2
-1
0
Spain Ireland Latvia Italy Portugal Greece
Structural budget deficit (average 2004-2008, % of GDP)
Source: EC 31
Countercyclical fiscal policy must be countercyclical throughout the cycle, not just
during the downturn
FI
DK SE
BG
LU
ES
NE
IE
EE
BE
CY
AU
DE
SK SI
CZ
LV
LT FR
PL
IT
UK
RO
MT
PT
GR
HU
-1
0
1
2
3
4
5
6
7
-8 -6 -4 -2 0 2 4 Ch
ange
s in
str
uct
ura
l bal
ance
20
13
-20
11
(%
of
GD
P)
Average structural balance 2004-2008 (% of GDP) Source: EC
32
Labour market flexibility
0
10
20
30
40
50
60
70
80
90
100
Latvia Ireland Greece Spain Italy Portugal
Collective bargaining coverage (% labour force)
33
Source: www.worker-participation.eu
Openess to foreign trade
0
20
40
60
80
100
120
140
160
180
200
Latvia Ireland Greece Spain Italy Portugal
Exports and imports of goods and services (% of GDP)
34 Source: Eurostat
Estimating chances of expansionary fiscal consolidation
Debt before adjustment
Spread before adjustment
Flexibility of labour markets
Openness to trade
Frontloading of fiscal adjustment
TOTAL
Latvia 36.7 9.14 20 126 6.4 HIGH
Ireland 92.2 3.0 35 192 6.2 HIGH
Portugal 93.5 2.66 94 77.9 4.8 MEDIUM
Italy 119 1.3 80 59.4 1.6 LOW
Greece 148 6.35 85 59 4.1 MEDIUM
Spain 61.5 1.51 82 63.8 -0.5 LOW
35
A LOOK INTO THE FUTURE
36
Forecasts of GDP growth in 2013 for Latvia (%)
2.4
2.6
2.8
3
3.2
3.4
3.6
3.8
4
no
v.1
1
de
c.1
1
jan
.12
feb
.12
mar
.12
apr.
12
mai
.12
jūn
.12
jūl.1
2
aug.
12
sep
.12
okt
.12
no
v.1
2
de
c.1
2
jan
.13
feb
.13
mar
.13
EC
IMF
Consensus
37
Economic growth in Latvia generated by exports and private consumption
-40 -35 -30 -25 -20 -15 -10
-5 0 5
10 15 20 25
2005 2006 2007 2008 2009 2010 2011 2012
Imports
Exports
Investments
Government consumption
Private consumption
GDP
Contribution to GDP growth (% points)
Source: Statistics Latvia 38
Decline in credit stock reflects still ongoing deleveraging
Credit to private sector (y-o-y, %)
Source: Bank of Latvia
39
-20
0
20
40
60
80
100
I 2
00
4
IV
VII
X
I 2
00
5
IV
VII
X
I 2
00
6
IV
VII
X
I 2
00
7
IV
VII
X
I 2
00
8
IV
VII
X
I 2
00
9
IV
VII
X
I 2
01
0
IV
VII
X
I 2
011
IV
VII
X
I 2
01
2
IV
VII
X
I 2
01
3
Annual growth of household credit stock
Annual growth of nonfinancial corporation credit stock
Annual growth of resident credit stock (without government)
Deleveraging in the banking system continues, limits loan growth
Loan-to-Deposit Ratio in Latvia (%)
100
150
200
250
300
350
I 20
05
V
II I 2
00
6
VII
I 20
07
V
II I 2
00
8
VII
I 20
09
V
II I 2
01
0
VII
I 20
11
V
II I 2
01
2
VII
Total Foreign banks
Domestic banks
Loan growth in Latvia (%)
Source: Bank of Latvia
-20
-10
-
10
20
30
40
50
I 2008
VII I 2009
VII I 2010
VII I 2011
VII I 2012
VII
Contribution to lending growth by foreign banks (% points) Contribution to lending growth by domestic banks (% points) Total lending growth (%)
40
Confidence indicators strong, but for how long?
Economic Sentiment Index (ESI)
80
85
90
95
100
105
110
115
I 2010
V IX I 2011
V IX I 2012
V IX I 2013
Latvia
Lithuania
Estonia
Source: EC 41
Euro: why now?
42
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
IV 2
011
V
VI
VII
VII
I
IX
X
XI
XII
I 2012
II
III
IV
V
VI
VII
VII
I
IX
X
XI
XII
I 2013
II
III
IV
12m average inflation in Latvia Estimated Maastrich criterion*
1.6
2.9
Maastricht reference value for price stability will be reached with a significant margin in Latvia
Estimates of 12 month average inflation and the Maastricht criterion, %
Sources: Eurostat, EC, Bank of Latvia estimates * - Greece excluded from calculation 43
Actual and estimated inflation: Latvia vs EU best inflation performers (%)
Jan.13 Feb.13 Mar.13 Apr.13*
Annual inflation Latvia(%) 0.6 0.3 0.3 0.4
12 month average inflation in Latvia (%) 2.05 1.81 1.57 1.36
12 month HCPI inflation (%):
Sweden 0.93 0.89 0.84 0.80
Ireland 1.95 1.92 1.78 1.68
Germany 2.11 2.05 2.01 1.98
Denmark 2.22 2.08 1.91 1.78
France 2.13 2.02 1.89 1.78
Maastricht criterion (Greece assumed as outlier) (%)
3.1 (SE, IR,
LV)
3.0 (SE, LV,
IR)
2.9 (SE, LV,
IR)
2.8 (SE, LV, IR)
* BoL forecasts 44
Interest rate criterion scenario analysis
Jan.13 Feb.13 Mar.13* Apr.13*
12 month average interest rates in Latvia (%) 4.35 4.17 4.00 3.84
12 month average interest rates (%):
Sweden 1.60 1.61 1.61 1.63
Ireland 5.88 5.61 5.35 5.09
Germany 1.47 1.44 1.42 1.41
Denmark 1.39 1.38 1.37 1.37
France 2.45 2.39 2.33 2.27
Maastricht criterion (LV, SE, IR), % 5.94 5.80 5.65 5.52
Maastricht criterion (LV, SE), % 4.98 4.89 4.81 4.74
Maastricht criterion (LV, SE, FR), % 4.80 4.72 4.65 4.58
Maastricht criterion (LV, SE, DK), % 4.45 4.39 4.33 4.28
* BoL forecast 45
Contribution of main components to the annual average inflation, pp
2.3
1.3
2.6 2.4
-1
0
1
1
2
2
3
3
2012 2013 2014 2015
Fuel
Unprocessed food
Regulated prices
Core inflation
Annual average inflation
Source: Central Statistical Bureau of Latvia, forecast - Bank of Latvia staff estimation
46
Euro zone’s policy response to crisis
POLICY AREA BEFORE THE CRISIS NOW
Monetary policy Liquidity support Lender of last resort
Coordinated financial assiatance
None European Stability Mechanism
Fiscal policy Stability and growth pact (SGP)
Enhanced SGP (Fiscal Compact, European Semester)
Banking National supervision Coordinated supervision (banking union in the future?)
47
Policy coordination is good but market discipline is essential
2008
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
0.0 25.0 50.0 75.0 100.0 125.0
Go
vern
men
t b
on
d y
ield
s (%
)
Government debt (% of GDP)
2012
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
0.0 25.0 50.0 75.0 100.0 125.0
Go
vern
me
nt
bo
nd
yie
lds
(%)
Government debt (% of GDP)
48
Summary: costs and benefits of joining versus waiting
Latvia joins the euro in 2014 Latvia waits
Banking sector problems solved, growth in the euro zone picks up
•Latvia benefits from lower interest rates, additional investment
•Higher interest rates hamper growth. •Risks of marginalization
Euro zone continues “muddling through” the crisis
•Lower interest rates •Participation in EMS, but money not lost •Latvia paticipates in designing euro zone policies
•Uncertainty leads to higher interest rates •Ultimately costs of joining (EMS) the same or higher •Will adopt policy framework which was designed without Latvia
Euro zone disintegrates •Latvia suffers severe macro consequences •Extra costs of currency re-introduction •Some payments into EMS may be lost
•Latvia suffers severe macro consequences
49
top related