What Can We Learn From Latvia?


The Baltic state is sometimes touted as proof that austerity works. Derek Thompson, who provides the above chart, tackles the claim:

First, Latvia had a massive bubble financed by massive foreign borrowing, with its current account deficit hitting a mind-blowing 22 percent of GDP in 2006-07 before the debt music stopped following Lehman's bankruptcy. And second, Latvia didn't do anything to cushion its subsequent crash. It didn't devalue its currency, and it didn't increase government spending. Instead, it kept its currency pegged to the euro, and actually gashed its budget. Now, it didn't have much of a choice when it came to austerity — that was the condition for its €7.5 billion IMF-led bailout — but it could have chosen depreciation over deflation. It did not.

He goes on:

The combination of tight money and tight budgets took Latvia's economy from "calamity" to "historical calamity"; its GDP fell by over 17 percent in 2009 alone. That's Great Depression territory.

Yglesias chips in two cents.