Economic Turmoil in Latvia
1. What kind of crisis was Latvia experiencing in 2008, a currency crisis, banking crisis, or debt crisis? What started Latvia’s turmoil was a banking crisis. In 2008, Parex, Latvia’s largest private bank, revealed that it was in financial distress and requested government assistance. The bank that had made some risky and extended loans during the country’s more prosperous years, found itself on the verge of collapse. While government tried to save the bank by injecting 200 million lats (about $390 million) into the bank, the institution did not recover and was shortly nationalized. However, this only increased fear that the Latvian currency would have to be devalued and investors began to pull their currency out changing it into euros and dollars. Currency speculators also joined the chaos, betting that the government would have to devalue the lat and selling it short. Eventually, the IMF, the European Union, neighboring Sweden and Finland, and the World Bank provided assistant to the country to help it pull out of what had turned into a currency crisis.
2. If the IMF had not stepped in with support, what do you think might have occurred? It is difficult to predict what would have been of Latvia with so many uncertain variables. However, I think that if the IMF had not stepped in to aid Latvia, the economy would have collapsed completely. One possible outcome would have been the devaluation of the lat against the euro. This would only have been a short-term solution, as it would have created many additional problems. One of the biggest issues being the fact that many Latvians had borrowed in euros. The depreciation of the lat would cause a dramatic increase the cost of servicing these loans in local currency. Which in turn, would cause immediate hardship for local borrowers.
3. Could the Latvian government have headed off the 2008 crisis? What policy actions could it have to do this? What might the economic and political...
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