Long shadows from the financial crisis

 

The recession following the financial crisis here in Latvia ended five years ago and since then the unemployment rate has also come down substantially: From a high of 21.3% among the 15-74 year old in the first quarter of 2010 it has now dropped below 10% for the first time since the third quarter of 2008. I was about to call this a normalization of the unemployment rate but it is not – of the 54 quarters from Q1 2002 (starting point for the unemployment rate at the Central Statistical Bureau’s web site), unemployment has only been below 10% on 14 occasions: Q3 2005 – Q3 2008 and then now, Q2 2015.

In a way not bad (but not good either – a country where 9.8% unemployment can be considered low has a serious problem) but it is certainly not everything that has made a comeback since the financial crisis.

Unless you arrived recently from another galaxy you will be aware of the Mother of All Credit Booms that Latvia experienced in the early 00s. As can be seen from Figure 1, with data from the Financial and Capital Markets Commission, the amount of loans issued in Latvia roughly quintupled between 2004 and 2008, peaking in Q3 2008. Since then deleveraging plus write-downs have taken place and although the total amount of loans has been roughly flat since the beginning of 2014, there is still no rebound in lending here, almost seven(!) years after lending peaked.

Figure 1: Total amount of loans from Latvian banks to the non-bank sector, bill. EUR

Source: FKTK and own calculations

Economic theory tells us that deleveraging is indeed a slow process but a period of seven years is remarkably long – seven years with no extra boost from lending to the real economy and helping to explain part of the less than impressive growth rates we have at the moment.

This lack of boost to the economy is not necessarily the only thing that explains the difference in growth performance in Figure 2 but I still think it is remarkable how Poland (no credit boom and no credit bust) has fared considerably better than the Baltics during the Baltic boom-bust cycle.

Figure 2: GDP performance in the Baltics and Poland, 2005 = 100

Source: Eurostat and own calculations

As mentioned, deleveraging is not necessarily the only explanation for this different growth experience but I believe it is significant.

Credit booms create some short-term gains but cast a very long shadow. No repetition, please.

Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga and a member of the Fiscal Discipline Council of Latvia