Until 2007, the Baltic countries went through a fast growth, at the expense of inflationary tensions, current account deficits and widening external debts which, even before the global crisis, have appeared as unsustainable. In Latvia, the joint rescue package from the IMF, the EU and Nordic countries has allowed to stabilise the situation. However, the three countries are now facing a sharp recession. The sustainability of the pegs between the Baltic currencies and the euro is regularly in doubt, in particular in the case of Latvia. Yet, devaluations would put at risk the solvability of households and corporates, which have deeply resorted to euro-denominated loans. Against this backdrop, deflation and fiscal tightening are required in order to manage the needed adjustment of the Baltic economies, which destroys prospects for any economic stimulus tool.... which destroys prospects for any economic stimulus tool. Hmmm. Not so sure.
However, deflation + devaluation would be a nightmare!
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