The outcome of the ECB meeting yesterday was rather more positive than I had hoped. Why? Because the decision to do nothing was not unanimous. That’s it I’m afraid, but my expectations beforehand were very low. One reason was reading this short speech by Jörg Asmussen, a member of the Executive Board of the ECB. (HT P O Neill) It was delivered in Riga, and extols the path of internal devaluation and austerity taken by Latvia.
Let me quote, to give you the flavour. “From 2008, Latvia was faced with the deepest recession in the world. The cumulative output decline was 24%; unemployment peaked at 20%. Keeping the euro peg was considered by many as a “mission impossible””. “External devaluation was presented as the only way forward. But Latvia did not choose the easy “quick fix”. It embarked on a courageous fiscal consolidation path and structural reforms. Two years later, the speed of the economic rebound is as extraordinary as the depth of the recession. Against all the odds, Latvia recorded a real GDP growth rate of 5.5% in 2011.”
An extraordinary success story: after an 18% decline in GDP in 2009, and flat GDP in 2010, we now have 5.5% growth in 2011. But surely I’m being economical with my quotes here. Isn’t the 5.5% growth last year just the beginning, with the economy achieving a new dynamism. Mr. Asmussen does not provide any additional evidence on this. Perhaps wisely, as the IMF are predicting 2% growth this year, and 2.5% next year. So the 5.5% growth last year is all we have.
Mr. Asmussen could have talked about unemployment, which has also fallen rapidly, from a peak of 20% to 15% currently. Perhaps he did not, because unemployment shows more clearly what has actually happened. We have had a huge recession, followed by a much more modest recovery. And, as we might guess, there is apparently much more talk about structural unemployment in Latvia today. For a rather more objective account of the Latvian experience of internal devaluation, see this (US) CEPR study, or a number of Paul Krugman's posts.
Earlier this year I wrote that when growth returned, some would say this proved those pessimistic Keynesians had been all wrong. I must admit the ‘some’ I had in mind were politicians and journalists, not senior central bankers. By this logic, an even better strategy is to close the whole economy down for a year. The following year we could get fantastic growth as the economy starts up again.
But the really scary thing about this speech is the lesson Mr. Asmussen draws from Latvia’s ‘success’. “The Baltic experience shows clearly that speed is of the essence. In all three Baltic countries, the government reacted swiftly to the deterioration of public finances and frontloaded fiscal adjustment. With a budget consolidation of around 9% of GDP in 2009 alone, Latvia’s effort is unparalleled in Europe.” So, Ireland and Greece, you know where you went wrong. You have been far too tentative with your austerity.
The language is indicative. We have a “courageous fiscal consolidation path”, “it is better to take the medicine right away than to let the fever rise for months”, and “Latvia’s effort is unparalleled”. Perhaps we can describe this as ‘masochism macroeconomics’. Or is it faith in the macroeconomic afterlife: penury (a massive waste of resources) today bringing virtue (austerity and structural reform) that promises redemption (wealth creation) in the distant future.