Ardo Hansson: rapid economic adjustment helps prevent reform fatigue
At Eesti Pank on Wednesday Ardo Hansson, Governor of the central bank, compared the economic adjustment made in the Baltic States with that in Greece, Ireland and Portugal. He said that rapid economic adjustment helped prevent reform fatigue, the build-up of excessive debt and the economic damage caused by a prolonged period of uncertainty.
Hansson was speaking in the Eesti Pank museum, where he was presenting the analysis he had written with Martti Randveer, Head of the Economics and Research Department at Eesti Pank, comparing the way that Estonia, Latvia and Lithuania adjusted after the economic crisis with the way that Ireland, Greece and Portugal did.
He explained that the results of the research show that the three Baltic states stand out in international comparison after the global financial crisis for the speed of their economic adjustment and that they have regained the majority of the total output that was lost during the crisis. The three states have also managed to lower unemployment and reduce several pre-existing imbalances and vulnerabilities.
He added that the research revealed several similarities in economic developments between the Baltic states and Ireland, Greece and Portugal, but it had shown several major differences too. “The economic adjustment in the Baltic states was twice as fast as that in Ireland, Greece and Portugal. The main reason for this was the difference in the ability of the six countries to mitigate the impact of the sudden stop in private sector capital flows that happened in 2007-2009”, he said.
The research identified that the drawbacks to the rapid adjustment were the risk of costly excess volatility, political difficulties and the likelihood of mistakes in economic policy. On the other hand, rapid adjustment helps in avoiding reform fatigue, the build-up of excessive debt and a long period of uncertainty weighing on economic activity. In addition, a rapid adjustment helps to bring about a faster closure of unsustainable activities, making resources available for productive means elsewhere in the economy.
“The current evidence of the recovery of the economies suggests that the strategy of rapid adjustment has overall been a successful response to a very difficult situation in the Baltic economies. Our analysis shows clearly that any build-up of imbalances and vulnerabilities should be addressed early and decisively as adjustment afterwards through wages and prices is likely to be protracted and painful”, explained Hansson.
He added that the current financial and sovereign distress in the euro area also offers proof that a strong external anchor in the form of membership of a currency union cannot be a substitute for policy discipline in other areas, but that, on the contrary, it increases the need for stronger discipline in other economic policies.
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