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The AmCham lecture 11

Some impressions from last Friday's lecture, organized by the American Chamber of Commerce, which featured Governor of the Bank of Latvia Rimsevics and Andris Strazds, my colleague at the school.

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In short, nothing exciting has happened. The Governor repeated his old points on why nominal devaluation would be bad for Latvia, in contrast to what he referred to as "wage devaluation". Discussion by Andris Strazds was nicely summarized by him saying there should be no discussion (of devaluation). The government adopted a plan and that's it, we should just all work on this plan. Needless to say, Andris was in complete accord with Governor Rimsevics on all the major points.

Well, maybe the Prime Minister Godmanis (or is it the President?) is a commander-in-chief, but I thought you're only supposed to blindly follow the orders if you're in the military, or if there is a state of war. I might be committing an act of treason here (by interpretation of some gentlemen), but I am not convinced by the 'official' arguments. I think government decisions should be discussed, and I believe that's what the taxpayers pay me for. So here comes some discussion of the major points.

1. Devaluation is a bad idea because most private sector loans are denominated in euros. Thus, devaluation will result in large-scale defaults as many people will not be able to pay back their loans.

Well, what difference does it make whether you're not able to pay your loan because the value of payment in lats has increased (devaluation), or because your wage is cut via 'wage devaluation'? And there will be a world of difference to those who lost their jobs. In the end, it's going to be the same effect, nominal devaluation or 'wage devaluation'. Moreover, because 'wage devaluation' usually results in a more protracted recession, it is likely that more people will be affected.

2. Devaluation will result in inflation because many intermediate goods and production inputs (e.g. energy) are imported.

Actually, more like a one-time increase in prices. But you shouldn't forget that in this case wages need not fall by the amount they will without the devaluation. Whether the purchasing power of your income will decrease as a result of higher prices (devaluation), or as a result of lower wages (wage devaluation) is a matter of taste, not of substance.

3. Devaluation will not increase exports because of (i) global recession, and (ii) Latvia's major trade partners (Estonia and Lithuania) would devalue as well.

I'll agree to that it may not increase exports, giving decreasing global demand. However, it will make exports decrease by less, especially in the environment where many other trade partners have devalued (Sweden, Poland, Ukraine, Belorussia, Russia, etc.) Exporters will be better off from devaluation and the effect will be immediate, even if it would be somewhat ameliorated by the likely devaluations of Estonia and Lithuania. Thus, the notion that devaluation will not help exporters is just wrong.

4. Devaluation will not help the local producers because prices for their products will increase

Well this is just bad economics. Of course the prices in lats would increase and overall demand will fall. However, wage devaluation means exactly the same thing. In case of devaluation, however, locally produced goods would still become cheaper relative to imports. Thus, there would be a substitution effect and an increase in demand for locally produced goods.

5. Devaluation will result in the halt in lending

Maybe. However, hasn't lending halted anyway? Some time ago Governor Rimsevics himself said that with regard to lending Latvia is in the "state of clinical death".

6. Devaluation will undermine confidence in Latvia's economy

I think that would depend on the extent of devaluation. I used to think that the purpose of devaluing an overvalued currency is precisely to restore the confidence. In any case, the 7.5 billion euros loan may have bought some confidence, for now. However, the government is trying very hard not to see that one prominent economist after another says that this is a mistake. I mean Paul Krugman, Nouriel Roubini, etc. The list keeps growing. I wonder what effect it has on investors' confidence.

In the end, the only serious argument against devaluation is that it might result in disorderly adjustment, that is, that banks, courts, etc. will be overwhelmed by the wave of defaults. The opponents of devaluation say that Latvia's institutions are not ready for the amount of private debt restructuring (i.e. lots of people not being able to pay their loans). Well, I guess it better get ready real soon.

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Komentāri (11) secība: augoša / dilstoša

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g 25.02.2009 20:56
very nice blog, Slava. And I agree with your final para. At the end, the only big difference is that devaluation would speed up the inevitable adjustment process. Now, what are the benefits of adjusting faster vs. slower?

I suspect, the faster the adjustment the larger the population of Latvia will be in 2020.

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Baron Tornakalns 20.02.2009 11:18
Given the fact that there are clearly merits to both sides of the 'D-word' argument (alternatively, we're damned if we do and damned if we don't), the official insistence that this topic should be off limits is doubly stupid.
It's not that long ago Rimmer was assuring us that the Baltics were a "new paradigm" that did not fit with traditional economic models (oh, the irony!) so I can't understand why he still gets stroppy when people question his "cleverest boy in class" statements.
Perhaps he could lead us by example and publish his till receipts to show us how he is doing his "duty" and spending what money he has?
g

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Alumni 96 > Econ 18.02.2009 17:05
...bet citu valstu politiķos izraisa neviltotu izbrīnu par Latvijas sabiedrības kolektīvo apņemšanos kārt zobus vadzī, lai tikai saglābtu viena cilvēka reputāciju un apmierinātu viņa ambīcijas. Turklāt, ņemot vērā arī to, ka šim cilvēkam pilnīgi noteikti un pretēji tam, ko domā liela Latvijas sabiedrības daļa, ir jāuzņemas daļa atbildības par iepriekšējo gadu hiperinflāciju, jo viņš pieļāva trīs kļūdas: 1) savlaicīgi nepārsaistīja latu no SDR uz eiro; 2) 2004.g. beigās pārsaistot to, izvēlējās kursu, saskaņā ar kuru mūsu valūta bija par zemu novērtēta pret eiro; 3) 2005. sākumā Latvijai pievienojoties ERM2 stūrgalvīgi un vienpusēji pieturējās pie 1% svārstību koridora, cerot, ka tas Briselei pierādīs lata superstabilitāti. Tā teikt, gribēdams būt svētāks par Romas pāvestu...

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Econ 18.02.2009 16:49
Labi, ko tur daudz diskutēt, ja Polija zlotam kopš vasaras ir ļāvusi devalvēties par 40%, tāpat apkārt devalvējušas valūtu ir arī citas valstis, tajā skaitā - Krievija, Latvijas uzņēmēji vairs vienkārši nevar konkurēt ar kaimiņvalstīm situācijā, kad konkurence Pasaulē arvien pieaug. Lats ir pārvērtēts, bez tam - visai pamatīgi, algu deflācija ir visai riskants pasākums, jo var sanākt, ka tās algas (un algas jau nav vienīgās izmaksas) kritīs visu laiku, jo uzņēmumi, kas eksportē, konkurētspējas zaudēšanas dēļ bankrotēs viens pēc otra, beigās līdzsvars, kas tiks sasniegts, būs tāds, ka notiks tirgošanās ar kartupeļiem un burkāniem bartera veidā (smagi, ja nebūs vietas, kur kaut ko izaudzēt), tādēļ ir nepieciešams atjaunot kaut cik normālu paritāti, nevis gaidīt to brīdi, kad valstī būs palikuši tikai pensionāri un tie, kas vienkārši nevarēs aizbraukt, jo tad pensionāriem nebūs, par ko pensiju samaksāt.

Un nav ko noliegt - tas, ka Latvija vēl arvien turas pie tik pārvērtēta kursa, ārvalstīs tiek uztverta par neracionālu darbību, kas ārvalstu investorus tikai attur no ienākšanas vai domas par ienākšanu.

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G.D. > Reinis 18.02.2009 10:51
Answers, as far as I see, can be given only to numbers not to words like "maybe", "I am not convinced" or even better "a lot of economists in say so"

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Krish 18.02.2009 10:50
One thing on wage-devaluation - in my mind, unlike regular devaluation, wage-devaluation is mainly driven by the invisible hand and so it would decrease only to the point necessary, but the necessary % of regular devaluation is unclear and can only build more uncertainty.

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G.D. 18.02.2009 10:49
Well, Slava. That is all nice but somewoow I see only negative arguments. I think you understand that finding "may be not" flaws in someones argument does not prove that the other option is better. Latvian government have their plan what and when will happen. But where is your plan? What will be the immediate balance sheet effects? How will we manage the banking sector and budget immediately after devalueation? What will happend to the private and public debt? And of course, when, by how much, and in what markets our exports will increase and by how much and what kind of imports will decrease? What new investments there will be in Latvia? Otherwise the arguments look somehow thin...

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Reinis 18.02.2009 09:46
I fully agree discussion is mandatory in this situation. I would like to hear answers to your arguments from your opponents.

As of your first argument - it might be the case that wage devaluation is more fair and gradual than currency devaluation. One example, when wage cuts are implemented, the best workers can get a lesser cut. Or at least people can have a feeling of more control over situation.

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Juris Kaža 17.02.2009 23:42
So, Vjačeslav, when are they coming for you? Our noble Security Police.

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Alumni 96 17.02.2009 18:30
I totally agree, although I was reluctant to support this point of view earlier. By now, I also think that real devaluation will hurt (unnecessarily) more people in Latvia than a nominal one. And it will be protracted. Besides, your point regarding exports is important, since exports represent the only glimmer of hope for Latvia in the medium term. That is to say, external demand is likely to recover earlier than the internal one. Although that is not entirely certain either, given our traditional export markets. But perhaps this is an excellent opportunity to seize and to penetrate more mature EU markets, vis-a-vis which Latvia would have an immediate cost relief (after devaluation) and which would certainly recover ahead of our traditional export markets.

Last but not least, perhaps the smartest way would be to do a little bit of both nominal and real devaluation. A so-called devaluation need not necessarily take an ugly form that endangers our prospects of euro adoption, i.e. it can be achieved simply by FINALLY correcting the mistake of the Bank of Latvia and letting the lat back to the EU requirement of 15% fluctuation corridor within the ERM2. This would first imply a depreciation by 15%, but later offer the additional flexibility for appreciation by up to 35% (!). Thus, we would avoid another inflation onslaught should Latvia's growth pick up in the near future. Taking into account the fact that the lat has experienced some 36% real appreciation against the euro (based on export prices deflator) since 2003, the rest of the lost competitiveness would have to be regained through real devaluation. But it somehow does not seem to me either politically and or socially feasible to go for the entire 36% via real depreciation...

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