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    • Thread Starter

    A recent article on Latvia read:

    “…After years of the fastest growth in the EU, Riga now foresees the economy shrinking 18 per cent this year, the bloc’s worst recession….
    …Landmark property developments such as the twin Panorama Plaza towers on the road between Riga and the airport stand all but empty and shopping malls look forlorn. House prices fell by one-third last year, insolvencies are up and banks are repossessing more mortgaged properties and leased cars. “Business is in hibernation,” says Gunnar Ljungdahl, who chairs the Swedish chamber of commerce in Riga….
    …Latvia sees the currency peg [to the euro] as the linchpin of its economic policies. It helped drive down inflation and is the route to euro entry. Latvia’s governments have often been weak but have always defended the peg and supported the powerful central bank, where both the prime minister and finance minister used to serve. “For Latvia the peg is the last pillar of trust,” says Henrik Hololei, an Estonian cabinet head at the European Commission….”

    Q1. If policy makers at the Latvian Central Bank were unconstrained, what monetary policy change would they likely want to pursue and explain why?
    1. Increase taxes
    2. Increase government spending
    3. Increase the interest rate
    4. Decrease the interest rate
    5. Make no change in monetary policy

    Q2. Some observers, including IMF officials, have suggested that Latvia devalue its currency, the Lat. Latvian policy makers are very committed to joining the Euro zone and remain committed to maintaining the narrow trading band with the Euro (as is required for joining the Euro zone) and thus are opposed to devaluation.
    Given Latvian officials’ commitment to the peg to the euro, what policy objectives do policy makers in Latvia appear to value?
    1. Independent monetary policy
    2. Independent fiscal policy
    3. Open capital markets
    4. A stable currency

    Another article about Latvia read:
    “RIGA, April 14 (LETA) - Continuing work on amending the state budget this year, ministries could be assigned to cut their spending by another 40 percent, Finance Minister Einars Repse (New Era) said to media representatives today.
    Ministries have to submit suggestions how their spending could be cut by 20 percent, 30 percent or 40 percent to the Finance Ministry by the end of this week. Such a demand has been made due to the fact that the state budget revenue continues to reduce.
    As Repse admitted, the Finance Ministry itself has already drawn up a plan, how its expenditure could be cut by 40 percent.”

    Q3: If Latvia is successful in reducing government spending by 40%, what impact would you expect this to have on Latvian GDP growth and explain why? (Assume Latvia makes no change in taxes.)
    1. Increase GDP growth
    2. Decrease GDP growth
    3. No impact on GDP growth

    Please advice.

    imo I see the economic affairs as being very much like the Darvin's theory of evolution. it almost depends on the world context. This is further reinforced by the integrated system of world capitalism. the countries and their economies adapt and evolve accordingly with the global economic environment. At the time of their joining, the Baltic economies, which also includes latvia, were booming. It coincided with the excess liquidity in the global economies with many countries recording record growth rates. 5 years on the same countries, including the baltics, are in economic despair. Now let me just cite you some figures from the Economist

    Turkey: -13.8 (First quarter)
    Russia: -10

    And the list just goes on. I have specifically listed those two as they were experiencing stunnning growth rates. These countries are endowed with very different economic structure. But that did not matter in terms of the growth rates back then and at the moment.

    Let me touch on some of policies you have put forward as a possible escape from the crisis.

    Tax increase: would mean scaling back investment and consumer demand
    Tax Cut: The government needs finance to narrow the budget and trade deficit
    increase interest: would have pretty much the swame effects as the tax increase. Would cause further appreciation of the currency meaning more imports and less exports and deterioration of GDP
    Decrease Interest rate: The government needs to keep the rates attractive to the investors to finance the deficits. (not to mention they have pegged their currencies to euro as a preparation to join the euro)

    As for the independet monetary policy, the only reason they managed to survive the crisis by by sticking to what their european rulers ask them to do.

    depending on the size of the government spending as a proportion of total AD, the consequences could be far stretching. these are countries where the government tends to play a large role (bear in mind these are the former communist countries, the politicians can't just risk being out of touch from the economy and thus the people who vote for them) The companies are wary of investing due to gloomy outlook. Consumers, cut down on their luxury expenditures and where possible outflow their savings elsewhere to guarantee their retirement plans. The foreign investment has largely withdrawn from the emergin economies and focus rather on their home market.

    All in all the only way out for these countries is way out for all the other countries including the rich anglo-saxons. No matter what they do it will be pointless and absolutely waste of money.

    The only short term solution in my opinion is to increase the government speding on supporting the poor who are likely to spend more than the rich. They will spend not on ferrari or guccis but on essential items that are made by the labour intensive industries.
    • Thread Starter

    Thanks a bunch mezitli for the detailed response. Some of the points you made were eye-opening.
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Updated: July 17, 2009


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