Posted by: Dirk | September 28, 2012

The debate over the lessons for the euro zone from the Nordic’s financial crisis

A new CEPR paper by Martin Foldén asks whether there are any lessons to be learned from the Scandinavian and more specifically from the Swedish crisis. The findings are very interesting (my highlighting):

Policy measures include abandoning the fixed exchange rate, fiscal austerity, a new stricter fiscal framework, and several structural reforms in the 1990s. These policies were appropriate for handling the Swedish crisis, but the Swedish experiences have limited applicability for the current debt crisis, in particular because currency depreciation in combination with strong growth on export markets was a key ingredient in the Swedish recovery. Implementing fiscal austerity would have been more complicated absent this export-led growth.

So, this something very different from Lars Jonung’s AEA paper from December 2010, which ends like this:

One important lesson concerns the long-run effects of the crises. They contributed to major changes and restructuring, which transformed the Nordics into some of the fastest-growing economies in Europe. These long-run effects of financial liberalization and integration are not as dramatic as the short-run effects, but they may prove to be of greater importance over time. The future will tell if these long-run benefits will balance or even outweigh the enormous short-run costs of the crises.

There is no mention of the positive effects from having a lower real exchange rate as the result of a fall of the nominal fall in the exchange rate in the whole paper. However, this should be a crucial concern. Being in a crisis when all your neighbours are in crisis is something very different from being in a crisis with all your neighbors growing strongly. Exporting yourself out of the crisis was possible for Scandinavia, which is relatively small compared to the rest of Europe. However, if all your neighbors are in crisis, too, and those that are doing relatively well are still seeing mediocre growth, then the route via more exports seems to be blocked.

Cutting government spending will lower aggregate demand, as the IS/LM model already tells us. Replacing that shortfall in demand by foreign demand is an option that must be discussed and is by no means guaranteed. Martin Foldén deserves some praise for reminding us of that.

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