Tuesday, May 12, 2009

Latvia's Great Depression

And you thought that the Latvian GDP number (-10.5%) for Q4 2008 was bad. Well, that's nothing compared to the 18% decline in Q1 2009. There's a great risk that the Q2 number will be at least as bad.

The main reason for this depression is the sudden shift from a real money supply growth of about 30% during the boom years, to a contraction in real money supply of more than 20% in the year to March 2009. That reflects both a 17.8% nominal money supply contraction and a price inflation rate of 8.2%. Latvia's depression is thus a extreme but clear real life illustration of the Austrian business cycle theory

The price inflation rate fell back significantly in April, but it is still far too high at 6.2%. Latvia has adjusted more slowly than neighboring Estonia, which is why its depression will probably be both longer and deeper than Estonia's.

4 Comments:

Blogger Reginald said...

I just wanted to say I have enjoyed your blog over the years, I still do, and you have won me over on certain issues.

10:06 PM  
Blogger Peter said...

Stefan, can you explain why Latvia's economic conditions -- 17.8% nominal money supply contraction and 8.2% price inflation -- illustrate the Austrian business cycle theory? Thanks.

1:43 AM  
Blogger stefankarlsson said...

Peter, the Austrian business cycle theory is about how monetary expansion creates an artificial boom until money supply growth ends and/or price inflation increases in the consumer goods sector. Which is to say, it tells of how an artificial boom is created by high real money supply growth that then turns into real money supply contraction.

In Latvia, we had extremely high money supply growth for years, the lagged effects of which are still creating price inflation. At the same time, monetary inflation has not only ended, but turned into significant monetary deflation (money supply contraction). Latvia has thus had the extreme swings in real money supply growth that according to the ABCT will create a boom-bust cycle.

7:31 AM  
Blogger investmentgardener said...

Stefan,

A question I asked on the Q&A as well:

Is the Latvian government right in keeping its peg to the € at the cost of severe deflation, or should they have chosen for devaluation? In other words, what would Von Mises or Rothbard or Hayek have done if they were elected right now by the Latvians?

Cheers,
Marc

10:35 AM  

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